Frontier markets remain in focus for the Templeton Emerging Markets Group in 2014, and my team and I have spent the early part of the year exploring potential investment opportunities in a number of them. I generally spend about a third of my time in these markets, with Dubai, Eastern Europe and South Africa serving as hubs for access. While the emerging markets we visit today were once considered niches or “exotic” investments when I first started investing in them in the late 1980s, many investors are now familiar with them. Many frontier markets are yet to be fully discovered by the investment community, and we believe they represent the next tier of investment opportunities within the overall emerging-markets universe. Frontier markets are located around the globe, in Asia, the Middle East, Eastern Europe, Central and South America, and Africa. We think there is good potential for frontier economies to forge ahead in their development this year and beyond.
Emerging vs. Frontier: The Distinction
There are a number of factors that go into qualifying a particular market as “developed,” “emerging,” or “frontier,” and different organizations or index providers may have slightly different criteria. Emerging-market countries include those considered to be developing or emerging by the World Bank, the International Finance Corporation, the United Nations, or the countries’ authorities, or defined as countries with a stock market capitalization of less than 3% of the Morgan Stanley Capital International (MSCI) World Index.
Frontier markets can be considered a subset of emerging markets, and they are typically economies at the lower end of the development spectrum. They are the generally smaller, less developed and less liquid emerging-market countries that are considered to be in the nascent stages of development. In essence, they represent what some emerging-market countries such as Brazil, Russia, India and China were 20 to 25 years ago. By offering investors the ability to invest in a “younger generation of emerging markets,” frontier markets may provide an attractive investment opportunity, in our view. The MSCI Frontier Markets Index provides a handy benchmark for investors and MSCI has its own criteria to determine classifications, but they are not something we strictly adhere to when making investment decisions for our portfolios.
Frontier Markets Charting Their Own Course
Frontier markets have caught the attention of many investors, as frontier markets tend to be more exposed to their domestic economies—many of which are developing rapidly—as opposed to the global economy, which is growing at a much slower pace. Moreover, positive local developments such as the implementation of reforms have further benefited many individual markets.
Overall, we believe there have been a number of factors supporting frontier markets’ long-term potential. These include high levels of economic growth, positive local developments such as reforms and relatively low levels of consumer and sovereign indebtedness, as well as what we consider attractive valuations, in our view. In addition, we believe undeveloped natural resources, low-cost labor, favorable demographic trends and potential technological catch-up could continue to support these markets.
Focusing on some individual frontier markets, the United Arab Emirates has been benefiting from improving local economic data and the prospect of rising international trade flows through the port of Dubai. The recent award of the 2020 World Expo to Dubai is likely to provide extra impetus to an already solid real estate market, in our view. Improving economic news from the eurozone and some positive local developments supported a number of frontier markets in Europe, notably the Republic of Serbia and Bulgaria. In Asia, Pakistan has benefited from an improving growth outlook, a new International Monetary Fund loan program and hopes that planned economic reforms will be pushed through in 2014.
At the end of January, valuations in frontier markets generally remained attractive to us. As you can see from the table below, the MSCI Frontier Markets Index was trading at a trailing price/earnings ratio (P/E) of 13.6 times, much lower than the 17.4 times P/E for the MSCI World Index. In terms of price-to-book value (P/BV), frontier markets look attractive to us at 1.8 times, versus 2.1 times for the MSCI World Index, and the dividend yield was much higher in frontier markets at 3.6%, compared to 2.5% for the MSCI World Index. Further, some individual markets are even more attractively valued, in our opinion. Thus, we have been able to find some cheaper stocks that we think are better valued. Of course, this is not the case for every single company operating in frontier markets, but it is certainly true for many of them, in our view. Hence, we feel it is important to undertake extensive research and study each individual company rather than generalize.
Frontier Fundamentals Appear Favorable
Investors have become increasingly open to new investment ideas and ways to diversify their portfolios. This trend is especially the case now, in our view, as relatively slower growth rates in major economies globally and low bank deposit interest rates have led many investors to look elsewhere for investment opportunities.
In our opinion, frontier markets remain among the most exciting investment opportunities for global equity investors. While the characteristics of frontier markets differ from region to region and country to country, as a group they share a number of traits. Similarities have included high levels of economic growth and relatively low levels of consumer and sovereign indebtedness that open up the potential for growth to accelerate, as well as valuations that we believe often have stood below the levels of equivalent businesses in developed and maturing emerging markets. We believe internal sources of potential growth, including undeveloped natural resources, low-cost labor, favorable demographic trends and potential technological catch-up, could also continue to support the development of frontier markets going forward.
(Mark Mobius, is executive chairman of Templeton Emerging Markets Group.)
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