Exploring New Frontiers

07/15/2008 12:00 am EST

Focus: GLOBAL

David Stevenson

Columnist; Adventurous Investor, The Investors Chronicle; Financial Times

David Stevenson, author of the Adventurous Investing blog, says "frontier markets" have been a hot spot of international investing.

Many emerging markets have "emerged," leaving behind dozens of newer markets in countries as varied as UAE and Mongolia. This "second division" of smaller, faster growing, more risky countries forms a new frontier in investing, collectively called the frontier markets.

Frontier markets comprise roughly one billion people, and about $2.4 trillion of global capital. They're typically difficult to access for outside investors, fairly risky on the political (and economic) front, and they have the potential for huge returns and even bigger declines.

Institutional funds have only recently caught on to this new world, scrambling into a small number of highly specialized funds. And now intensifying financial globalization combined with new fund launches that make accessing the sector much easier, are about to force private investors to sit up and take notice.

You can now buy into experienced investment trusts (from Progressive fund management) and index tracker funds (from Deutsche DBX) that follow the bigger frontier companies. And a small but growing number of listed UK and US companies offer direct equity exposure to some of the big frontier economies. (So do various ETFs and some traditional mutual funds like T. Rowe Price Africa & Middle East Fund (TRAMX)-Editor.)

Since 2000, frontier markets' GDP has grown at an annualized rate of 5.6%, and according to S&P, "this GDP growth has been higher than that of emerging and developed markets for every year since 2001". To be fair, this is primarily because these countries started from a much lower base. The GDP per capita of much of the developed world is roughly $37,500 compared to just $1,845 for frontier markets (and $2,390 for emerging markets).

Still, the potential is obvious, leading the economists at Goldman Sachs to speculate on the Next 11. These are the countries most likely to follow in the path of today's mighty BRIC economies, and include Egypt, Pakistan, Vietnam, [and] Turkey.

The big question is that while economies like Pakistan or Cambodia may be growing like gangbusters, will any of that rapid growth actually a) trickle down to local stock markets, and b) ever make it out of the country into the investment portfolios of investors who have financed this growth? (The stock markets of Pakistan, Turkey, and Vietnam have plunged in 2008-Editor.)

Economic theory suggests that frontier markets, with their heavy commodity bias and their startup industrial exposure (refining, basic materials processing, etc.) should provide low correlation to the Standard & Poor's 500. And according to analyst Heather Bell of Index Universe, correlation was just 0.175 between the S&P Broad Market Index and the Select Frontier Index.

That makes frontier markets one of the most compelling alternative investments you can buy-provided you can stand the potential for high volatility.

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