Frontier Markets Offer a Wild Ride

The hunt is on for the next generation of emerging markets.


Looking forward 25 years, Chinese telephone companies and Brazilian oil refiners won't seem like such undiscovered, exotic investments. As more investors pile into the so-called BRIC countries—Brazil, Russia, India, and China—the hunt is on for the next generation of emerging markets. Some intrepid money managers are scouting for untapped investing opportunities in such far-out locales as Namibia, Bangladesh, and Kazakhstan. "As mainstream emerging markets move to become high-income economies, it makes sense to look at countries that are still in an embryonic stage of development," says Christian Deseglise, hsbc's global head of emerging markets.

These economies may be too small and underdeveloped to yet be considered emerging, but their growth potential is tremendous. Goldman Sachs has identified 11 countries with BRIC-like possibilities, which include mainstream emerging markets like South Korea and Mexico as well as the more germinal economies of Pakistan and Nigeria. By the year 2050, Goldman says, the combined economies of the "Next 11" could reach two-thirds the size of the G-7 nations.

Look to Africa. So what's driving these markets? The global boom in commodities has sent a flood of investors into mineral-rich regions like sub-Saharan Africa and the oil-exporting nations of the Middle East. The investing climate is improving in some African countries, and investors are finding bargains in banks (which are often among the first beneficiaries of economic growth), wireless carriers, and construction companies. "For the first time ever in Africa's history, there has been major spending on infrastructure," says Joseph Rohm, an analyst for the T. Rowe Price Africa & Middle East fund. The fund's top holdings cover Orascom Construction Industries of Egypt, the largest contractor in the Middle East, and United Bank for Africa, the product of a recent merger of two of Nigeria's largest banks.

Frontier markets have more to offer investors than natural resources. Middle Eastern countries, such as the United Arab Emirates and Qatar, are diversifying away from oil and into real estate, tourism, and other industries. Meanwhile, rising consumer demand is drawing investors to a host of countries, including Iran, Kazakhstan, and Vietnam. Standard & Poor's Frontier Markets index returned an annualized 37 percent over the past five years, topping the 32 percent average yearly gain of the MSCI Emerging Markets index. As a group, frontier markets are less volatile than you'd expect, says Deseglise. "The individual countries can be very volatile, but consider the likelihood that Nigeria would move in sync with Vietnam," he says. Frontier markets' low correlation to developed markets also means more diversification potential for individual portfolios.

Only investors with strong stomachs need apply. Risks in these markets include political uprisings, corruption, currency devaluation, and hyperinflation. There's often limited research on companies, lax regulation, and sparse trading. For now, investing opportunities are limited, as mainstream emerging-market funds dabble only in frontier markets. The sole frontier-focused fund currently available to U.S. investors is T. Rowe's, which holds 31 mostly financial and industrial stocks in nine countries. The fund, which charges 1.75 percent in annual fees, is up 20 percent since its inception. A single exchange-traded fund exists in this category: the SPDR S&P Emerging Middle East & Africa fund, which has more than 80 percent of its assets in Israel and South Africa.