Frontier markets are moving ahead of EMs

Mark Mobius, executive chairman of the Templeton Emerging Markets Group at Franklin Templeton, says frontier markets are a “subset” of emerging markets and that they are typically economies “at the lower end” of the spectrum.

Mr Mobius adds: “They are the generally smaller, less developed and less liquid emerging market countries that are considered to be in the nascent stages of development. In essence, they represent what some emerging market countries, such as Brazil, Russia, India and China, were 20 to 25 years ago.”

Of the 192 members of the UN, BlackRock views 145 of those as frontiers, with 22 considered emerging markets. It has estimated that roughly $20bn (£11.9bn) of active institutional money is being invested in frontier markets, which compares to approximately $1trn invested in emerging markets.

Ross Teverson, investment director of global emerging markets at Standard Life Investments, suggests that for index providers such as MSCI one of the factors to consider in deciding whether a country is classified as ‘frontier’ is the maturity of its capital markets and its economy.

Mr Teverson says this results in a collection of economies within the frontier market indices at very different stages of economic development.

“In the Gulf region some of the economies that are currently classified as frontier markets are very mature in terms of the level of GDP per capita and also some of the institutional structures in those markets. But because there may be ways in which the capital markets still have scope for further development those markets are still classified as frontier,” he adds.

Qatar and the United Arab Emirates (UAE) are due to be reclassified as emerging markets from frontier markets in May 2014. Mr Mobius says the UAE has benefited from improving local economic data and the prospect of increasing international trade flows through the port of Dubai. Likewise countries can be downgraded, as Morocco was in June last year by MSCI to frontier market status.

Mr Teverson explains: “I think that we’re likely to see ongoing improvement in terms of the way in which capital markets operate in various different frontier economies and as you see improvements in the way in which capital markets operate then it’s only natural we will see further promotions from the frontier markets indices to emerging market indices.”

The projected GDP growth rates indicate that frontier markets show no sign of slowing, which it is hoped will translate to returns for investors.

Dominic Bokor-Ingram, co-portfolio adviser of the Magna New Frontiers fund at Charlemagne Capital, says studies suggest GDP growth rates for the next 30 years for frontier markets are going to be 6-7 per cent versus 4-5 per cent for emerging markets. He also cites population growth figures for the same period which are expected to be approximately 1.5 per cent in frontier countries, compared to roughly 1 per cent in emerging market countries.

For him, the economic growth and competitive advantages are reasons for investing in frontiers over emerging markets, many of which he warns have fallen victim to a “middle income trap”.

Mr Bokor-Ingram explains: “Once wages get to a certain level, like they have done in China, in order [for emerging markets] to keep growing they have to move up the productivity curve and start producing more value added product.

“A lot of the emerging markets are being caught in what we call the middle income trap, where they are not the lowest cost producer anymore and they have not made the move to value added products and services.”

While he suggests Korea and Taiwan have managed to move up the “productivity curve”, Pakistan, Bangladesh and Vietnam now have cheaper labour costs than China, which is seeing economic growth slow. However, Gordon Fraser, member of the BlackRock Emerging Markets team, suggests frontier markets are now less attractive than they were 18 months to two years ago.

Mr Fraser says: “They were actually cheaper than emerging markets a couple of years ago. They are now trading more in line with emerging markets although they still have a superior dividend yield.”

He insists, however, that the long-term investment case for frontiers still applies as they continue to have less debt than emerging markets and remain much less penetrated markets in terms of opportunities.

Ellie Duncan is deputy features editor at Investment Adviser