What are the frontier markets to watch?

This hopefully allows individuals to adequately diversify their exposure in this area.

But in a universe of reasonable size, it is worth looking at those offering the best performance.

Fund managers have, in part, pointed to familiar names, including countries that are set to join MSCI’s emerging markets benchmark next year.

However, this need not necessarily put investors off, because frontier market definitions are flexible. While MSCI’s groupings act as a useful guide, and influence passive funds, active managers often tend to obey their own criteria.

The high growth potential in Vietnam is driven by a combination of factors, including favorable demographics and urbanisation dynamics creating a large domestic consumer market.Chetan Sehgal

Similarly, a mix of emerging and frontier markets can be useful within funds, as well as broader portfolios.

“We generally blend both an emerging market and a frontier market fund for clients with the required risk appetite. The low correlation and wide opportunity set of both asset classes means that they can complement each other,” says Ben Roberts, an investment director at wealth manager Brooks Macdonald.

Managers have identified Saudi Arabia as one notable market.

This is set to achieve emerging market status next year, a factor which tends to bolster share prices: because $600bn of passive money follows the MSCI and FTSE emerging market indices according to market estimates, some $16bn of extra money could move into Saudi Arabia from passives alone.

More importantly, investors believe this market will continue to perform well because of an ongoing economic reform programme, which has partly focused on making local business less reliant on government subsidies.

“While the upgrade news is hugely positive for the Saudi market […] the key driving factors behind the success of our fund’s Saudi investments remains a strict adherence to the ongoing reform process,” notes Dominic Bokor-Ingram, a manager for Fiera Capital.

Growth potential

Vietnam has also caught the eye of many professional investors because of the appeal associated with both frontier and emerging markets: a young, large and increasingly wealthy population.

“In the frontier market universe, Vietnam is one of the most populous countries, with approximately 100m [people], and it is also one of the fastest growing economies, with GDP growth in 2018 estimated at 6.6 per cent,” explains Chetan Sehgal, manager of the Templeton Emerging Markets Investment Trust.

“The high growth potential in Vietnam is driven by a combination of factors, including favorable demographics and urbanisation dynamics creating a large domestic consumer market, low penetration of goods and services, and the opportunity for technological leap-frogging, allowing growth in economic infrastructure and efficiency gains.”

Vietnam is a common favourite among managers.

An examination of some of the funds with a notable focus on frontier markets shows that nearly half have Vietnam as their biggest holding from the group.

But another popular preference listed in Table 1 (above) has struggled as of late.

Argentina has performed well in recent years. It was downgraded to frontier market status in 2009 after its then populist president imposed capital controls, but a reversal of this situation has seen it get the go-ahead to rejoin the MSCI Emerging Markets index next year.

Investors have enjoyed a rich run of form in the last five years, with the MSCI Argentina index gaining 168.1 per cent.

Figure 1

Source: FE Analytics

However, a decline has occurred more recently, as detailed in Figure 1, so caution may be justified.

“This [stockmarket rally] was very much derailed in recent months with the value of the Argentinian peso dropping significantly and inflation spiralling, leading to Argentina going to the IMF for help,” Mr Roberts explains.

On the up

Some managers have decided to focus elsewhere.

Mr Bokor-Ingram, who co-manages the Magna New Frontiers fund, has exited or reduced positions in markets such as Argentina and Pakistan to focus on the Middle East, where he believes geopolitical risks are “overstated”.

This has involved putting money into Saudi Arabia but also the United Arab Emirates, which recently announced new expatriate visa and foreign ownership rules.

“Both of these changes continue to open up the economy and drive investment. In addition, a new $13bn investment programme has just been announced,” he says.

As ever, choosing the right exposure is important, even if investors are backing an economy on the up.

Oliver Bell, portfolio manager for T Rowe Price, notes that he has attempted to identify companies “on the right side of change” within Saudi Arabia, opting to mainly invest in banking, consumer and healthcare names. 

Banks, for example, are beginning to feel the effects of broader improvements in the economy, and an increased level of loans being taken out.

david.baxter@ft.com