The emergence of frontier markets

Dubai: While emerging markets were considered a niche or "exotic" investment when I started investing in the late 1980s, many investors are now familiar with them and I'm seeing more and more investors turning to emerging markets as a way to diversify their portfolios.

Yet, emerging markets themselves are not a homogeneous zone. Within the emerging markets universe, we believe frontier markets as a whole have begun to take an impressive lead in terms of growth.

Frontier markets, as their name suggests, could be described as "new or younger emerging" markets. Located throughout Asia, Africa, Europe and South America, they are often in a much earlier stage of economic development than larger emerging markets and many have only recently opened to foreign investing. This helps explain their high growth potential.

I asked my colleagues Johan Meyer, senior vice-president of Equity Analysis in sub-Saharan Africa, and Claus Born, senior vice-president of Emerging Markets in Latin America, to share some of their thoughts on the frontier market regions of Africa and Latin America respectively.

Africa

Several African countries with developing markets appear to be potential candidates to join a second generation of emerging markets. The same crucial developments that presaged the arrival of investors in emerging markets in the 1980s are taking place in parts of sub-Saharan Africa today. Private sector growth has been increasing and financial markets have been opening up.

Africa is a very interesting continent that unfortunately very few people know much about. You have a billion people on the continent and you have big countries like Nigeria, for example, with a population of over 150 million. This is a country that has been growing over the past 10 years at about seven or eight per cent per year on average, and it's one of the top-10 fastest growing economies in the world.

This is a country that generates very little electricity on its own, so most of the electricity is provided by diesel generators. You can imagine the burden that this places on consumers, on companies and on industries in this market, and what potential, what opportunity this holds if this infrastructure constraint is lifted, and how this can improve the functioning of this economy. It's amazing the economy has managed to grow so fast despite this.

Kenya is very attractive to us because it's on the east coast of the continent, an attractive position as a centre for India's and China's investments and interests in Africa. We see many companies setting up their operations in Nairobi, the capital city. The United Nations has a massive base there that it uses for its operations on the rest of the continent.

Unfortunately there are countries that still suffer, like Zimbabwe. Even though we have seen massive improvements in that economy, there still needs to be some political change before we can really start to get excited.

Latin America

Across the Atlantic, many Latin American frontier nations are also attracting attention as their economies progress. These markets may not be as big as Brazil but they have been demonstrating the growth and rising wealth typically associated with more advanced emerging markets.

Peru has had a stable economic environment for nearly two decades now and it has huge mining resources, especially in copper and gold. We have seen a lot of investments here in the past few years.

Another interesting case is Panama, where the enlargement of the Panama Canal is underway. The country has a unique strategic location within the Americas. It's a nice hub to connect between South and North America. So you've seen some companies benefit from the location, not only with the canal, but also in airline connectivity. So we see very exciting developments also in Panama.

We believe frontier markets can be attractive opportunities for three reasons:

1) Growth Potential: If you look at a list of the 10 fastest growing economies during the last decade nine are frontier markets.

2) Valuations: Attractive valuations were found in many frontier markets during the past year.

3) Correlation: Historically, frontier markets have low correlations with emerging and developed ones, and among themselves. This increases their diversification potential.

The writer is executive chairman of Templeton Emerging Markets Group