Friday, March 19, 2010

The Case for Frontier Markets

Notes from Mark Mobius
Lara Crigger caught up with Mobius about the case for investing in frontier markets, including what makes a good frontier market, what connection they have to commodities, and why frontier markets offer lower volatility than many developed markets—including the U.S.
So why should investors consider adding frontier markets to their portfolio? 
What's the appeal of these tiny, illiquid economies?
Mobius: The first and foremost appeal is the valuation. In these markets, we're able to find cheaper stocks that are significantly better valued than those in normal emerging markets. That's not true of every single company, of course, but it's certainly true of many. Of course, the reason why these frontier markets tend to be cheaper is because they have not yet been fully discovered by investors. They tend to be under-researched, and not so readily available to normal investors.

What do frontier markets offer investors that emerging markets don't?
Mobius: Well, frontier markets are really just a subset of emerging markets. In the future, we expect these frontier markets—at least some of them—to become quite important, and to even become full-fledged emerging markets or greater. When we started the very first emerging markets fund in 1987, at that time, it was impossible to find markets that were liquid and researched. So in some ways, we're returning back to where we were at that time.

Many frontier markets are very resource-rich. Do frontier markets make a good commodities play?
Mobius: The commodities arena is really very wide, and it includes normal emerging markets as well as frontier markets. In fact, I would say that one of the attractions of frontier markets is not only that they're in the commodities arena, but that they're also an opportunity to get into the consumer arena more easily.

When you look at disposable consumer goods, the large multinationals are usually the first in. They buy up the large companies that are established brands, and very often these companies don't find their way into the equity markets. In the frontier area, there are more of these available.

When investors look at a frontier market, what criteria should they use to evaluate whether it's a good investment or not?
Mobius: We use the same criteria that we would use for any market in the world. First and foremost is the balance sheet. We look at whether the company is faithful, in terms of its balance sheet. Then we look at earnings and earnings potential. And most importantly, we look at management. In emerging markets and frontier markets alike, the management capability is extremely important. You've got to get managers who are capable of managing in challenging environments.

Of course, there is one challenge that we get in these markets, and that is the custodial situation. We need a custodian bank who can safeguard our assets, look after dividend collection and so forth. That becomes a challenge in frontier markets. And at Templeton, we're actually pioneers in that area.

Frontier markets come with a lot of risks. What are some of the risks entailed with investing in frontier markets?
Mobius: That's an interesting point about risk; in fact, our studies show that the frontier markets do not necessarily have greater risk. That's because in many of these markets, the volatility is not as great as in other markets, including developed markets, since the markets are not so liquid. Thus there tends to be less volatility, and therefore less risk in that sense.

That certainly goes against the conventional wisdom of frontier markets being these "high risk, high reward" marketplaces.
Mobius: Exactly. I know there's that impression, and that impression carries over to emerging markets as well. But if you look at a diversified frontier markets portfolio, you'll find it has less risk than a portfolio, say, in the U.S. or in Canada. Diversification is key, of course. But the other important thing is dispersion in behavior between the frontier markets; in other words, these markets tend not to move in the same direction at the same time. With that dispersion, you have greater safety, because you have less volatility.

What do you see as some of the most promising countries or regions in the frontier market space?
Mobius: If you look at our portfolios, you'll see that the leading countries in the portfolios are Vietnam, Kazakhstan, Ukraine and Nigeria. Those are the top ones, and of course we're in many other markets around the world, and that lineup is subject to change. But those are the big four in our frontier market funds right now.

Vietnam certainly is attractive right now, with a growing economy and a population half of which is under 25. Why the other three?
Mobius: Kazakhstan is in natural resources. Ukraine is agriculture. And of course, Nigeria is big in banking and consumer products.

No comments:

Post a Comment