After a decade of gains in emerging markets—Morningstar’s category of diversified emerging markets funds had annualized returns over 11% for the 10 years through August—financial planners may be eyeing the Next Big Thing: frontier markets, which have yet to develop into the “emerging” class.
Such countries can have relatively high economic growth, appealing demographics (many young people), an expanding middle class to support local companies, and perhaps natural resources that might profit from increasing worldwide demand.
“We invest in frontier markets by picking companies,” says Bill Mann, chief investment officer at Motley Fool Asset Management in Alexandria, Va., “but we also look at the country in which a company is based. We prefer markets, such as Nigeria, where the securities officials are serious professionals. In some other frontier markets, the securities industry is run by people appointed to patronage positions, including members of the ruling families.”
If a nation’s securities markets are handled professionally, Mann asserts, it’s more likely that asset managers can find responsibly-managed companies for a fair evaluation.
Even in leading frontier markets, however, “The level of regulatory oversight is not what you’ll find in the U.S. or Europe,” says Mann. Consequently, advisors may lack the inclination to select and obtain shares of companies based in, say, Argentina or Kuwait. Using a fund could make more sense; there are designated frontier markets funds as well as emerging markets funds with significant holdings on the far frontier.
“You should be careful in choosing a fund,” says Mann. “In some frontier market ETFs, you might be buying a portfolio of banks. Others might emphasize a particular industry. Investors probably will be better served by a more diversified fund.” Frontier markets can be high-risk, so spreading money among multiple industries might be advisable.
Mann suggests investing in frontier markets through an emerging markets fund that includes some companies from these yet-to-emerge nations.
“Funds that are limited to frontier markets, which tend to be very small, may be too volatile,” he says. “Look for funds where the returns have not followed an emerging markets benchmark. That can show that the managers are looking for companies with superior growth potential.”
Some emerging markets funds have lengthy track records, so advisors will have more evidence of their performance in up or down markets. Moreover, emerging markets managers may be knowledgeable about nearby frontier markets.
“A manager who has been following an emerging market such as Brazil, for instance, probably will be familiar with a frontier market such as Argentina,” says Mann. “The manager will want to know about possible competition from a neighboring country.”
Backing a manager who has been successful in emerging markets can be a practical plan for braving the new frontier.
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.