Cover Story: The Next Frontier

The Edge Markets

As returns flatten in the mainstream markets, investors are looking for other investment destinations. Opportunities abound in frontier markets, say industry experts, but they also warn of risks from investing in these fast-growing economies.

Frontier markets around the world are gaining traction among investors as their valuations are now at attractive levels, say industry experts. They believe more should diversify into these pre-emerging economies to take advantage of their healthy growth in the coming years.

Rayan Rafay, investment manager and co-founder of the Canada-based, one of the largest frontier investment websites in the world, attributes the cheap valuations to the frontier markets having underperformed in the last few years.

“This is primarily because the US dollar has appreciated so much since the 2008 global financial crisis, making it difficult for foreign governments and companies to borrow externally. And they usually lack internal credit markets to provide expansionary lending,” he says.

“Additionally, negative rates in Europe and quantitative easing in the US resulted in a spike in the value of assets, which in turn led to superior returns in developed markets. However, this has largely come to an end and frontier markets are in the right part of the global economic cycle to grow.”

At present, frontier market stocks are more attractively valued than developed market equities. For example, the MSCI Frontier Markets Index has a price-earnings ratio (PER) of 13 times and a price-to-book value (P/BV) ratio of 1.55 times compared with the S&P 500’s PER of 24.34 times and P/BV of 2.82 times, says Germaine Share, senior analyst and research manager at Morningstar Investment Management Asia Ltd.

Meanwhile, Sarona Asset Management co-managing partner Vivina Berla believes now is a very good time to invest in frontier markets. Sarona is an independent investment firm that focuses on frontier and emerging markets.

“It is a sad but well-known fact that most investors tend to buy high and sell low. When most investors are apprehensive, valuations tend to fall, therefore increasing the opportunities for disciplined and experienced managers.

“Private equity in frontier and emerging markets is a young but rapidly maturing industry and it displays characteristics similar to the US private equity industry of the 1980s — plenty of potential opportunities for investors who have an ‘information advantage’ to capture the growth of the ‘real’ economy,” says Berla.

Aberdeen Asset Management frontier markets fund manager Gabriel Sacks says that in 1988, the newly launched MSCI Emerging Markets Index represented less than 1% of total stock market capitalisation. Today, it represents 13% of the total.

“Similarly, the MSCI Frontier Markets Index represents less than 1% of total stock market capitalisation today while these economies (in their broadest definition) comprise more than 100 countries, and account for some 30% of the world’s population and around 10% of global GDP.

“There are no guarantees that frontier markets will emulate what emerging markets have achieved. But as economic power shifts further away from the developed world, it is a good bet that wealth and economic activity will be more evenly distributed around the globe. On top of that, valuations currently look attractive, relative to the history of the asset class, compared with the more mainstream equity markets,” he says.

According to Billy Hii, chief investment officer at Bill & Morrison Ltd, an offshore investment broker, although there is no overlap between the MSCI Emerging Markets and MSCI Frontier Markets indices, as nations develop, markets can be promoted from the frontier to the emerging markets indices and vice versa.

“For example, Argentina was demoted from MSCI Emerging Markets to MSCI Frontier Markets in 2009 and the UAE was promoted to MSCI Emerging Markets in 2014. Thus, in many ways, it is possible to view frontier markets as the global emerging markets of tomorrow. Like emerging markets back in the 1980s, they will offer attractive investment opportunities if you can take the volatility,” he says.

Frontier markets, according to Morningstar, are emerging economies that are typically smaller and less developed, and have lower liquidity than emerging markets in Asia, Europe, the Middle East, Africa and Latin America. Frontier markets are also more difficult to access than emerging markets. Examples are Kuwait, Argentina, Pakistan and Myanmar.

Hii says frontier markets should be considered an alternative investment option for global investors seeking diversification. “These markets are generally less correlated to the major developed or emerging markets due to their limited economic exposure to the rest of the world. They do offer higher investment returns because of their significant growth potential. But their risks are generally higher than those of developed or emerging markets.”

He adds that frontier market investments are quickly becoming an asset class that is separate and distinct from emerging markets. “If you’ve never heard of frontier markets, you’re not alone. They only became the new hot investment a few years ago. In short, if you have the right risk appetite, frontier markets can serve as your diversification and growth strategy.”

Nevertheless, the valuations of frontier markets are relatively low due to investor apprehension about them — something that emerging markets experienced back in the 1980s. But at the time, says Rafay, emerging markets benefited from the rise of the world’s largest countries — China and India.

“It is hard to match the wealth creation seen then but there are still unique opportunities out there. Developed and some emerging markets are very crowded, especially with the move towards exchange-traded funds (ETFs). So, investing in frontier markets now will enable you to enter growing economies before anyone else, and with a diversification benefit to match.”

Equity funds that invest in frontier markets performed well last year, gaining 8.84% on average in USD terms, says Share, adding that they outperformed some funds that invest in the larger and more developed markets, such as Asian or European equity funds. The former were dragged down by uncertainties about the weak currencies of China and India while the latter were hurt by the Brexit vote. Asian equities, measured by the MSCI All Country Asia ex-Japan index, gained 5.44% last year while the benchmark for the European equity market was flat last year.

“However, the average Asian equity fund outperformed the average frontier market equity fund over a 10-year horizon,” observes Share.

Hii notes that last year, some of the best performing frontier markets included Pakistan, Saudi Arabia and Bangladesh. The MSCI Pakistan index gained more than 32% on strong economic growth, he says. “Saudi Arabia, despite being hurt by ongoing weakness in oil prices and surging fiscal deficit, saw its stock market deliver a solid return of more than 13%, according to MSCI’s gauge on the hope of economic reforms. Another high-growth South Asian market — Bangladesh — had a cumulative performance of about 37% over the past three years, though returns slowed to 10% last year.

“Stock selection is crucial in determining the success of investing in frontier markets as the risks involved are high. In Nigeria, for example, its broader stock index measured by MSCI has suffered three consecutive double-digit losses since 2014 due to lower oil prices and instable political conditions. Investors are strongly encouraged to do their due diligence or get advice from the professionals for the right frontier market products.”

In the last decade, notes Berla, the top quartile private equity managers who have invested in frontier markets have been able to outperform listed markets and their emerging market peers significantly.

According to the Emerging Market Private Equity Association, she adds, investments in private equity in frontier and emerging markets provides 7% more returns each year than those in more mature markets.

Over the long term, however, returns from frontier markets still fall behind those of emerging and developed markets. The MSCI Frontier Markets index recorded an annualised return of only -33.94% over 10 years (as at March 31) compared with the MSCI Emerging Markets’ 3.16% and the MSCI World’s 22.42%.


According to Harvard Business Review (HBR), frontier market economies offer “hyper-growth”. In an article entitled Mapping Frontier Economies, HBR cites IMF data that shows that of the 25 countries forecast to grow the fastest over the next five years, 19 are frontier economies. Among them are Myanmar, Mozambique, Vietnam and Rwanda.

In the current economic environment, frontier markets offer among the best returns because these countries are rich in minerals and metals. Despite the soft commodity prices, HBR says global investment in developing these resources is not only expected to increase income and growth but also boost returns on foreign investment. This is also partly due to these economies being less affected by global economic trends.

“Frontier market economies are growing fast as they are in the early stage of development, which means a very low economic base, favourable demographics, growth in infrastructure spending and, in some cases, abundant natural resources.

“As always, we advise investors to consider their investment objectives and risk appetite when selecting riskier investments such as frontier market equity funds. Nonetheless, we have found that actively managed frontier markets equity funds have generally done better than the frontier market indices or ETFs (see table),” says Share.

Rafay agrees, saying that the attraction of investing in frontier markets is the returns. “[It is also about] finding the next market that grows multiples from a small base and also from the diversification in getting uncorrelated returns with the rest of the world.”

Berla points out that frontier and emerging markets have been growing faster than developed economies in the last decade and are expected to continue to surge forward for the foreseeable future as the global economic balance shifts towards the South and the East.

“According to The World In 2050 report by HSBC Bank, 19 of the 30 largest economies in 2050 will be the emerging markets of today and will represent almost half of the world’s GDP,” she says.

“The investment opportunity is driven by four main factors — a rising middle class (increasing spending power and demand for locally produced goods and services); change in demographics (young and growing population with significant aspirations, energy and drive); increasing urbanisation (cities’ contribution to the national economy is growing at a faster pace than the country average); and returning expatriates (well-educated professionals driven by an entrepreneurial desire to make a difference in their respective countries while generating profits).”

However, she cautions that economic growth does not translate automatically into financial returns. “The key to attractive returns resides in the ability of investors to find managers who are able to source great deals, manage and improve companies before exiting them successfully.”

Sacks says frontier markets are vibrant economies with thriving private enterprise and a high level of entrepreneurship. “Many of these countries have transformed themselves in the past two decades with great progress achieved in literacy, access to credit, communications (via mobile phones) and public sector accountability. These advances have elevated the sustainable growth rate of many of these markets and helped reduce systemic risks.”

According to Dun & Bradstreet’s Global Economic Outlook 2017, the GDP of frontier economies, such as those in the Middle East and North Africa (5.1%) and Sub-Saharan Africa (4.9%), far exceeds the world GDP (2.9%), and asset managers and brokers across the board agree that frontier markets provide better returns than developed markets. Dun & Bradstreet is a US-based data analytics company, which counts all 15 of the US Cabinet-level departments, the European Commission, the UN as well as nearly 90% of Fortune 500 companies as its clients.

Developing countries should have a higher growth rate, asserts Rafay, since they are growing from a much smaller base. “Hence, there is much more low-hanging fruit compared with developed markets. But if you look at studies, the GDP growth rate is less important than the actual growth in GDP in aggregate terms — that is partly why the US stock market continues to outperform the rest of the world despite a relatively slower GDP growth rate.

“The equity risk premium of frontier markets is much higher and the required return should also be much higher due to the lack of liquidity and higher cost of entering a frontier market. The returns come from getting in at the ground level of companies operating in economies that are at a very early stage of the business/economic cycle. Many frontier markets have lower capital gains and dividend tax policies compared with developed countries as a method of attracting foreign investment. Nevertheless, liquidity and political risks are much more pronounced in frontier markets.”

But Share points out that frontier markets are arguably more susceptible to political instability, social unrest, corruption, disease and terrorism, and have underdeveloped financial systems and capital markets, and a fickle regulatory environment. “During periods of extreme market stress, frontier markets’ relatively illiquid stock markets can suffer sharp declines in the face of heavy selling. During the 2008/09 global financial crisis, the MSCI Frontier Markets Index had the largest maximum drawdown relative to the MSCI Emerging Markets Index and the MSCI EAFE Index (an index that comprises developed Asian and European equity markets).

“From an investment perspective, frontier markets are not easily accessible. These markets tend to have a small number of liquid securities and restrictions on foreign ownership.”


Berla believes that local economic policies, such as in the Middle East, North Africa and Sub-Saharan Africa, are undergoing significant micro and macro-economic reforms and demographic changes, which have contributed to faster GDP growth in the region. But she observes that the implementation of proposed protectionist policies by the US could impact trade.

“Recent protectionist policies and the stance of the new US president will potentially reduce the benefits derived from trade in the short term. However, we expect south-to-south trade to increase and offset the current setbacks,” she says.

When investing in private equity in frontier and emerging markets, Berla says, there are four main areas of risks that differ from investing in private equity in developed markets. These are political risks, foreign exchange (forex) volatility, operational risk and cultural and governance factors.

“We believe that these risks are different, although not necessarily higher. There is a large gap between perceived risk and the ‘real’ risk faced by investors with local experience. Experience, knowledge, local presence, hands-on involvement and thoughtful portfolio construction can bridge the perception gap and capture opportunities while mitigating risks to deliver attractive risk-adjusted returns,” she says.

Hii agrees, saying that as most of the frontier markets are in the early stage of economic development, their growth rate tends to be higher. “Rapid growth is normally due to a boost in productivity as the economy starts to function more efficiently with the establishment of more investment opportunities and changes in economic and social structures.

“Frontier markets operate in a less mature regulatory environment compared with developed and emerging markets, making it difficult for investors to assess the level of transparency and governance of the businesses or investments they are exposed to.

“Political situations in many of the frontier markets are extremely unstable or could be unpredictable at times. Changes in ruling regimes or political uprisings are common in some of the notoriously unstable frontier economies and investors need to keep a close watch to avoid significant financial damage resulting from this risk.

“This is because political instability, weak economic policies and poor management may contribute to volatile foreign exchange rate movements. This is especially challenging when a frontier economy experiences out-of-control price increases that rapidly erode the value of the local currency.”

This could be exacerbated by investors not being able to find a buyer or seller at the right price when they want to do a transaction due to thin trading activity. This poses a big problem even for institutional investors, adds Hii. “On some occasions, the market size is so small that big institutional investors can move the market when they buy or sell, making it extremely difficult to make money.”

Sacks says liquidity can vary greatly and frontier markets lack scale and depth compared with their more mature counterparts. “New democracies (and the accountability and transparency they bring) can be fragile; governance and judiciary structures are often untested; corruption is common. Meanwhile, most frontier markets suffer from low domestic savings rates and are therefore dependent on foreign capital for investment. Others are overly dependent on agriculture and commodities.

“For fundamental, research-driven investors, there are opportunities to capitalise on market inefficiencies that occur because of a short-term liquidity squeeze, weak intelligence or corporate analysis, and fewer market participants.”

Generally, sound economic development policies, good rules of law and a stable political environment are among the crucial factors that determine the success of a frontier market. These states base their economic growth on a combination of low labour costs and abundant natural resources.

“In the past, frontier markets were characterised by instability, restricted market accessibility and low liquidity. Nowadays, their governments are opting to create sovereign wealth funds and technology hubs to avoid excessive dependence on commodities and guarantee sustainable growth over time,” Hii comments.


The asset managers, investment advisers and brokers Personal Wealth spoke to differ on the sectors that offer the most promising growth in frontier markets.

Rafay prefers private equity in developing countries as he likes companies that prosper on a growing middle-class population. “So, consumer goods, telecommunications and even leading financial companies [are our preference]. It is uncommon but when we find technology companies in frontier markets, they are usually worth a second look.”

Similarly, Berla invests in markets with a burgeoning middle class. “We seek opportunities in sectors that are set to benefit from the rapidly rising middle classes across Asia, Africa and Latin America. These sectors include healthcare, education, consumer goods and financial services, among others.”

She too believes that private equity is the best instrument to tap these sectors. “Mid-market companies, in their expansion stage, represent one of the best risk-adjusted return potential opportunities within these fast-growing markets. This is because of the large number of potential targets (ample deal flow), lower competition for deals and lower entry multiples.”

There are more opportunities to add value to mid-market companies than the larger ones, says Berla. “Financial structure, quality of management or governance and growth rates can often be improved quickly and effectively by experienced private equity professionals. These operational ‘quick wins’ usually lead to higher exit multiples. The returns profile of smaller companies is generally less correlated to macro trends than that of larger companies and often generate returns in excess of equivalent listed markets.

“Mid-market companies offer various exit options for sponsors, including selling upmarket to larger sponsors, selling to strategic buyers and potential initial public offerings. Furthermore, as economies mature and move from low income to high income, the small and medium enterprise (SME) sector grows exponentially as it’s the backbone of an economy,” she says.

But Sacks argues that the opportunities are company and not sector-specific. “We do have a natural bias towards consumer-oriented businesses. We like well-run companies, such as Vietnam Dairy Products, which is a big player in the country’s dairy industry and can benefit from growth in domestic consumption.

“We also like companies like Kenya’s Safaricom, an innovative mobile operator that has revolutionised financial inclusion through its mobile money platform, M-PESA, which is now used by over half the country’s people.

“Another key holding is Habib Bank, one of Pakistan’s leading financial institutions, which boasts a strong deposit-gathering franchise and a professional management team that will drive credit penetration as the economy grows. So, the opportunity set from a sector perspective is fairly diverse,” he says.

Hii believes the scope of frontier markets is very wide as it depends on the economies and the economic structure of each of them because it varies greatly. He points out that the universe can be broadly divided by the principal growth drivers in each economy. For example, the Middle East uses oil revenue to diversify away from its reliance on oil. African growth, on the other hand, is being driven by China’s increasing influence on the continent and the construction of infrastructure and power networks that are helping to unlock Africa’s natural resource potential.

“Frontier Asia is benefiting from newly industrialised export manufacturing centres, China’s One Belt One Road initiative, low labour costs and growth in Frontier Europe, which is dominated by commodity-driven economies.

“In Saudi Arabia, the sectors that are more investable are finance, mining and materials. In Vietnam, the consumer goods sector is the biggest for listed stocks due to its population size.

“We don’t have a special preference for listed or private equity when it comes to investing in frontier markets as both have their pros and cons. For example, listed equities will be more transparent and liquid while private investment, though more profitable, probably will require more governance and oversight by the investors or the assigned private equity managers to mitigate the risks,” Hii says.

For Rafay, as limits on foreign ownership rarely come into play for retail and even most institutional investors who are not looking for a majority stake, buying stocks is the best option for investors who do not have large capital at their disposal.

“For investing small amounts, buying stocks is usually the only real option; this is more liquid than private equity. However, for investors with more capital, and especially for those looking to join the fray without strong (or any) stock markets, private equity makes sense. Just be prepared for your capital to be locked up for a longer period of time.”

Private markets are a better reflection of a country’s real economy than listed markets, says Berla, adding that  listed equities in emerging markets are skewed towards financials and energy while more than half of PER exposure targets the high-growth sectors.

Thus, she says, “the best risk-adjusted opportunities for investors lie in high-growth sectors that are set to benefit from the rapidly growing middle class in these markets. As people’s purchasing power increases, they typically spend more money on healthcare, consumer goods and education”.

Interestingly, Sacks says it is not a question of one or the other as the choice is really down to risk appetite and the opportunities in hand. “Investment in private equity usually requires long lock-up periods unlike investment in funds that hold publicly listed companies with daily trading. The reason for the lock-up is that private equity tends to be involved in the early stage of business development. This is when entrepreneurs need access to stable, long-term capital and are in a position to exchange this for share ownership.

“Sometimes, a public listing becomes the preferred exit route for private equity. Private markets by nature are more difficult to penetrate, often rely on word of mouth and require a level of price discovery that calls for thorough due diligence. It can also be harder to achieve true diversification via private equity funds, which tend to have a regional or single country focus.”

Frontier market investors keen on issues such as sustainability, good business practices and the level of international rule acceptance apart from investment returns will have to go the extra mile to find out if the underlying investments fit the investment guidelines, policy or any other priorities they might have, says Hii.

“As these markets are relatively immature, it is extremely difficult to have all the aforementioned conditions to be well in place. Conducting field research, on-the-ground due diligence or even establishing a good local connection will help one understand the business better and keep things under control.”

Hii adds that for retail investors who want to invest in these markets and who do not have the time or the resources to do their own due diligence, the best option is to invest via a mutual fund or ETF that focuses on frontier markets.

To Sacks, frontier market equities are a compelling investment opportunity from a risk-reward perspective. However, he insists that investing in a diversified frontier market portfolio is of crucial importance as it will help bring down the aggregate level of risk. “As with any investment, the timing in terms of the price you pay and the length of time you are prepared to hold the investment will affect returns. Frontier markets are implicitly volatile.

“Having said that, the definition of ‘frontier markets’ is inexact. These are generally accepted as markets that are not included in commonly used indices, such as the MSCI Emerging Markets, being too small or illiquid.

“But we have invested successfully in companies in non-benchmark emerging markets like Sri Lanka and Pakistan for as long as 20 years. Their markets are quite straightforward: the capital market infrastructure is long established, companies are open to outside shareholders and management teams are accessible.

“Moreover, the low intra-country correlation with frontier markets reduces the overall volatility of the asset class, given that the drivers of these individual economies can vary dramatically.”

Some of the investment instruments available to Malaysian investors are:

1 Schroders Frontier Markets Equity Fund, fund size of US$1.2 billion (as at December 2016) and 61.4% returns over five years.

2 Templeton Frontier Markets Fund, fund size of US$799 million (as at December 2016) and accumulative returns of 71.73% since its inception in October 2008.

3 HSBC Global Asset Management (USA) Inc recently reopened its HSBC Frontier Markets Fund to new investors. The fund achieved best in category performance over a five-year period out of 404 emerging markets funds.

Impact of China’s One Belt One Road policy on frontier markets

China’s One Belt One Road initiative is expected to have a positive impact on economic growth and returns on investment in Asian frontier markets.

Rayan Rafay, co-founder of, says the region that will benefit the most from the Chinese policy is Central Asia.

“We wrote about the impact of China’s new initiative in late 2014 when it was still being worked out. There are 18 countries listed as major points on the two Silk Road routes, and Kazakhstan, Kyrgyzstan, Uzbekistan and Tajikistan will be of interest due to their importance to the Silk Road Land Route.

“It will be game-changing as not only will infrastructure projects set the foundation for growth in the future but trade flow should also increase between the developed and frontier countries in the region.”

Billy Hii, chief investment officer at Bill & Morrison Ltd, says the initiative is expected to inject some degree of economic vibrancy into the frontier market economies covered by the proposed routes. He also agrees that Central Asia will benefit from it.

“Some of them, especially Central Asia and Indochina, will not only gain directly from the building of transport infrastructure, such as railways, roads or utility pipelines but also stand to benefit from better economic ties forged under this cooperation over the longer term.

“While we may not see instant economic boost from this collaboration, it could certainly make many of these frontier markets more investable going forward.”

Gabriel Sacks, a frontier market fund manager at Aberdeen Asset Management UK, says the effect of the Silk Road initiative, positive or negative, will rear its head in due course.

“It is an ambitious framework for trade and investment that involves countries across the Middle East, Central and Southeast Asia and through the so-called Maritime Silk Road. China is the driving force and many of the countries involved are members of the China-sponsored Asian Infrastructure Investment Bank.

“While it has targeted certain countries, beginning with road, rail and port upgrades, for example, the open question is how far China may then want to strike preferential deals and how fair it will be with recipient countries. Some countries might welcome its help; others will be warier, particularly if they have resources that China would be keen to buy.

“So in itself, One Belt One Road has potential, like any trade bloc. But how it gets implemented is largely still to be worked out. Nevertheless, we see Pakistan as one of the key beneficiaries of this policy as the prospect of significant infrastructure investment by the Chinese is seeing renewed effort by the government (and the private sector) to improve the security and energy situation in the country, which in turn will drive investment,” he says.

While Rafay agrees that there are attractive returns, he debunks the notion that frontier markets are notoriously volatile. “Frontier markets are less volatile than most people think. Given the liquidity, they favour value investors who are willing to adopt a buy-and-hold strategy rather than day traders. Another appeal is that as part of a portfolio, it can give you better risk-adjusted returns overall due to the benefits of diversification from reduced correlation.”

Hii takes a more conservative stance. He argues that individual investors have to carry out their own assessment to determine if the benefits of investing in frontier markets outstrip the risks. “We believe there is growing demand from investors who are comfortable with frontier market risks due to an increasingly sophisticated capital market. In short, the proposed investment has to meet the objective and risk tolerance of the investors.”