Mark Mobius on frontier markets
A recent Q&A with Mark Mobius, Templeton Asset Management’s emerging markets guru, follows below, courtesy of the company’s monthly newsletter.
What are frontier markets?
Frontier markets are commonly used to describe a subset of emerging markets which have lower market capitalization and liquidity than the more developed emerging markets. More importantly they are markets that have not yet been “discovered” by the majority of investors. They are markets where there is limited research available to investors.
Frontier markets may generally be smaller and less developed than emerging markets, but they continue to experience strong economic growth and maintain a low debt-to-GDP ratio. They are where many emerging markets were 20 years ago. In the future, we expect these markets – at least some of them – to become quite important and to eventually become full-fledged emerging markets.
What is your rationale for investing in them and what’s the essence of your investment strategy?
Economic growth in many frontier market countries remains high and is even faster than some emerging markets and exceeds the growth in developed markets by a wide margin. The growth is not only economic growth but also growth in capital markets. Some of these markets are moving from small and illiquid status to large and liquid.
Many frontier countries are also leading producers of oil, gas and precious metals, and they are well positioned to benefit from the high global demand for these resources. Additionally, as the economies of frontier market countries expand, they continue to increase investments in infrastructure, offering valuable opportunities in the construction, transportation, banking and finance and telecommunications industries. Rising consumption provides these economies with strong purchasing power and the ability to spend their way into growth. Moreover, frontier market countries have been, and continue to be, positively impacted by the substantial investments made by large emerging market countries such as China, India, Russia and Brazil.
The economic drivers across frontier markets are diverse. For example, Botswana, one of the world’s largest diamond exporters, is introducing call and data processing centers. On the other hand, Kazakhstan, a country rich in oil and other natural resources, is seeing significant investments in infrastructure development. These varied economic themes across frontier markets ensure a diversified portfolio.
And why should investors care about frontier markets? Aren’t emerging markets already “risky” enough?
Frontier markets are actually not more risky than emerging markets or developed markets. Although there are a lot of uncertainties because of the general lack of knowledge among investors who don’t have the resources to study those markets, the actual risks are not significantly different from other markets. Although individual markets can be volatile, combined in a diversified portfolio they could be less volatile than a portfolio of developed market stocks.
How does the disaster in Japan (and potential slower growth from Japan), as well as the turmoil in Middle East, factor in one’s analysis of frontier markets?
The Japan and Middle East situations are not having any more impact on frontier markets than any other markets around the world. Of course, in the case of some of the Middle East markets there has been some volatility. However, the wide range of frontier markets going from places like Nigeria, to Vietnam and Ukraine means that events in, say, Egypt, will not have much impact on the other markets.
In fact, we continue to invest in Middle East companies that we believe will survive the current turmoil and prosper over the next five years. Generally speaking the “information revolution” where people of all walks of live and in every economic status can communicate quickly and efficiently with cell phone and through the internet means that it will be more and more difficult for corrupt and dictatorial regimes to survive. This is quite beneficial for the development of capital markets and particularly stock markets so we are quite optimistic regarding the Middle East. Emerging markets growth rates and per capita income are moving up at a rapid pace. As foreign reserves in these countries reach sky-high levels, and their safety profile continues to improve, perceptions about emerging markets also continue to improve. People are beginning to realize they’re not as risky as they seem. Moreover, there’s quite a lot of value in emerging markets, because earnings growth is keeping up at a rapid pace, so we still are finding opportunities.
Do events such as the instability in the MENA region make “investing” during these volatile times more attractive? Or simply more dangerous?
If you have good research on the frontier market companies, volatility can be very good since with panic selling prices can come down temporarily to very low levels enabling the patient and knowledgeable investors buy stocks cheaply.
What are the challenges of investing in frontier markets and how do you try to circumvent them?
While frontier markets offer a potentially attractive investment opportunity, an array of challenges also exists. Examples include poor information flow, illiquid stocks and sudden government policy changes. Frontier markets are subject to additional, heightened risks due to a lack of established legal, political, business and social frameworks to support securities markets. Relying on seasoned international fund managers who have demonstrated knowledge in navigating through these relatively new and volatile markets is essential.
Our emerging markets team has over 40 investment professionals working from offices in 17 locations. In employing Templeton’s ground-up investment approach, our local analysts are able to address such issues because they not only understand the local languages and culture, but they get to know the companies and the market environment by meeting with company management teams, understanding the impact of local regulations, and talking with local customers and competitors. Frontier market investing often requires additional time and due diligence to assess the quality of the management team including more frequent on site visits to evaluate the business effectively.
Which countries and sectors in frontier markets look interesting?
We do not favor any particular market but select stocks which are the most attractive across all markets. A look at the breakdown of our frontier market funds country investments will show where we are finding the most bargains at this stage. Currently, our largest exposures are to Nigeria, Saudi Arabia, Egypt, Vietnam, Kazakhstan, Qatar, Ukraine and Argentina. Liquidity is the key concern for most investors, so markets that are the most liquid could attract greater investment flows.
In terms of sectors, our focus has been on what we refer to as the two ‘Cs’: consumers and commodities. Middle class expansion and the deceleration of population growth has triggered rising per capita income and increasing demand for consumer products. This in turn has led to positive earnings growth outlook for consumer-related companies. We look for opportunities not only in areas related to consumer products, such as automobiles and retailing, but also consider services such as finance, banking and telecommunications. Commodities can offer another way to access the high growth trajectory of nations like China and India and take advantage of greater demand. We are look for companies that are strong producers of commodities such as oil, iron ore, aluminum, copper, nickel and platinum. While infrastructure development in emerging markets has led to continued demand for hard commodities, demand for soft commodities such as sugar, cocoa and select grains has also increased. Resource-rich countries in Latin America, too, are benefiting from increasing global demand.
How can investors get exposure frontier markets?
The best way for retail investors to get exposure to frontier markets is to purchase a frontier markets fund. We have two major frontier markets funds. The total assets in our frontier markets funds has grown to about US$1.5 billion, probably making us the largest frontier markets investor. Trying to invest directly for an individual market is simply not practical since access too many of the markets is complex and expensive for the individual.
Source: Mark Mobius, Franklin Templeton Investments – Emerging Markets Overview, May 5, 2011.
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