Tap into the prospects of frontier markets

The strong position of South-east Asian economies has attracted the attention of fund managers in Britain.

Most investors looking to tap into booming emerging markets look to China and India, and it is easy to see why: Anthony Bolton's Fidelity China Special Situations fund recently unveiled a near 13 per cent return in the five months since it launched. It now plans to raise £162.1m in a new share offer.

However, some analysts warn that these markets could be set for a correction. "There are pockets of over-valuation in emerging markets, particularly those stocks which are exposed to the burgeoning domestic consumption story in China and India," says Craig Heron, director of multi-manager funds at Henderson.

Other emerging markets which are yet to cross mainstream investors' radars could hold greater prospects. Relatively smaller emerging south-east Asian countries, such as Malaysia, Thailand, Indonesia and the Philippines, not only benefit from but are an integral part of the economic boom in the Asia-Pacific region.

Meanwhile, the Middle East and Africa (MENA) and Latin America are also increasingly attracting fund managers' attention. Adrian Lowcock, a senior adviser at Bestinvest, says: "Often referred to as frontier markets or 'emerging emerging' regions, these economies are becoming interesting stories in their own right.

"They may not be as big as the BRIC [Brazil, Russia, India and China] nations but they have the economic growth and rising wealth associated with developing economies. They stand to benefit greatly from the continued demand for resources in which they are rich."

In the last six months of 2010, the MSCI Frontier Markets index outperformed emerging markets, gaining 16.5 per cent compared with 12.3 per cent.

From 2002 to 2010 the Frontier Markets index returned 9.2 per cent a year, outperforming global equities by more than 3 per cent, according to figures from Merrill Lynch.

There is growing demand for the new frontiers: Jupiter launched its Global Emerging Markets fund in November and BlackRock raised £94.8m last month when it launched its Frontiers Investment Trust.

Aberdeen Asset Management is poised to launch the UK-domiciled Aberdeen Latin American Equity Fund, a sister to the $505m Luxembourg-domiciled Aberdeen Global Latin American Equity fund. The new fund will open for general investment on 9 February. Lowcock expects more frontier funds to be launched in 2011.

We ask the experts for their pick of the frontier markets, what to buy, and weigh up the risks:

South-east Asia

The 10 members of the Association of Southeast Asian Nations (ASEAN) has a combined population of more than a half a billion people – twice as many as the US. However, they generate only one-tenth of the economic output of the States, reflecting a huge untapped potential for growth, says Raiffeisen Capital Management.

Many of the ASEAN markets have significant natural resources and produce highly-sought agricultural products such as wood, rubber, sugar cane, palm oil and rice.

Not only are they well-positioned geographically to supply the billion people-strong markets of China and India but in many cases they have competitive advantages over their larger neighbours, according to Mark Monson, senior fund manager of emerging markets at Raiffeisen in Vienna.

"As the level of integration between Asia's economies increases, these markets are more and more independent of the fluctuations in economic cycles in the more developed economic regions," he says. "An investment in ASEAN markets is an ideal form of diversification for a global equities portfolio."

Monson believes Thailand and the Philippines are the most promising markets in the region.

The Philippine stock market has risen 39.8 per cent in the past year for Sterling investors, while the Bangkok stock exchange has increased by 61.2 per cent, figures from Aberdeen Asset Management show.

In the Philippines, political risk is less acute than it once was. President Corazon Aquino is expected to push through more reforms designed to reduce corruption and improve public finances.

Coupled with a boom in domestic consumption, they should continue to support share prices. In Thailand, corporate earnings are rising quickly and are poised to grow at 10 t o20 per cent for the next few years. "Thailand may be about to experience a burst of strong economic growth similar to the beginning of the 1990s," says Monson. "A really negative scenario for Thailand is only conceivable within the framework of an economic collapse in Asia, and there are no signs of that happening."

Raiffeisen tips consumer-related stocks, selected banks and property companies. For a less risky play, Ben Yearsley, an investment manager at Hargreaves Lansdown, recommends buying into a traditional emerging markets fund which has some exposure to smaller Asian markets. "The amount invested in frontier markets will often be small but generally the manager will invest only if the company is exceptional," he says.

He likes Aberdeen Emerging Markets, which is up 25.3 per cent in the past year and 126.9 per cent over five years, according to Trustnet, the data provider. Its largest three weightings are Brazil (17.2 per cent), Hong Kong and China (15.5 per cent) and India (13 per cent) but it also has 5.7 per cent in Thailand, three per cent in Malaysia, 2.3 per cent in Indonesia and two per cent in the Philippines.

Middle East and Africa

The economies of the MENA region are expected to grow by more than five per cent this year, though individual economies, such as Qatar and Egypt, are poised to expand far faster. Qatar is primed for double-digit growth and is set to expand by 50 per cent by the end of 2012, according to the International Monetary Fund.

Henderson's multi-manager team uses the Franklin Templeton MENA Fund, which is managed by Algebra Capital in the region. About 40 per cent of the portfolio is invested in Saudi Arabia, while Qatar, Egypt and Kuwait each account for 15 per cent.

Sam Vecht, portfolio manager of the BlackRock Frontiers Investment Trust, particularly likes Qatar, which will host the 2022 World Cup.

"Qatar has great potential for growth in sectors such as financials and industrials and there are several large cap stocks yielding more than seven per cent," he says. "Following the successful World Cup bid, Qatar's infrastructure will undergo significant transformation in the next few years, providing a new wave of opportunity."

The outlook for economic growth in parts of Africa is also bright, with Nigeria, Kenya and Zimbabwe anticipating increases of four to eight per cent.

Henderson has invested in the Imara African Opportunities fund, managed by Zimbabwe-based pan-African financial services company Imara. Nigeria, Zimbabwe and Kenya each account for about 20 per cent of the fund, with a further 10 per cent in Zambia. Top holdings include breweries in Nigeria and Kenya, British American Tobacco's operations in Kenya and Zimbabwean food producers.

Lowcock tips the First State Global Emerging Markets Leaders Fund, which has more than 26 per cent in the Middle East and Africa. Its second largest holding is AngloGold Ashanti, a global gold producer, based in Johannesburg, South Africa, according to Trustnet. The fund has made 24.7 per cent in the past year, 53.6 per cent over three years and 114.9 per cent over five.

Latin America

Many Latin American countries have come through the credit crisis relatively unscathed, thanks to strengthened financial systems and prudent banking practices.

Countries such as Brazil, Chile and Mexico are characterised by young, urban populations with rising incomes and a growing middle class. By 2020, the Future 7 (Argentina, Mexico, Indonesia, Vietnam, Turkey, Egypt and South Africa) population will account for a tenth of global consumers and disposable income per capita will rise by 52 per cent.

Devan Kaloo, head of global emerging markets at Aberdeen Asset Management, says expanding, young populations bode well for retailers, banks and consumer-related companies.

Kathryn Langridge, manager of the new Jupiter Global Emerging Markets Fund, has also been investing.

She has bought into clothing manufacturer and retailer Hering in Brazil and also likes plays on infrastructure, logistics and transportation.

The risks of frontier markets

Frontier markets are not for the faint-hearted. Investing in individual countries or regions increases risk and – if you get it wrong – could prove an expensive mistake.

Patrick Connolly, head of communications at AWD Chase de Vere, the financial adviser, says: "While the long-term story remains good, in the short-term Latin America is faced with headwinds of rising interest rates, high inflation, strengthening currencies, potentially unsustainable public spending and equity prices which are already above average." Brazil, for example, has just increased interest rates to 11.25 per cent to help combat inflation, which is expected to remain above five per cent throughout 2011.

Frontier market investors are also thwarted by a lack of liquidity and endemic problems such as political instability and social unrest.

For example, in Mexico the drugs war is "beyond crisis proportions", says Darius McDermott, managing director of discount broker Chelsea Financial Services.

He adds: "Frontier markets are a real 11 out of 10 investment. For investors, the major issue is a lack of liquidity. This can be brutal to shareholders as any rush to the door will send prices tumbling."

Ben Yearsley at Hargreaves Lansdown recommends putting a small percentage of your portfolio into frontier markets.

"The potential is obviously bigger the sooner you get into these small markets but the risk is greater, you could risk losing your shirt."