October 2016, James Brown, Portfolio Manager
With some emerging market economies currently experiencing slower rates of growth, alternative investment opportunities can be found in frontier market nations. These are largely buoyed by accelerated growth on the back of rising consumer spending and significant labour cost advantages.
Frontier markets are essentially where emerging markets were 25 years ago
Characterised by lower levels of economic, political and market development or sophistication; frontier markets generally refer to developing countries not considered ‘emerging’ due to smaller market capitalisation, lower liquidity or restricted market access.
They are a hugely disparate group. Classification varies among different investors but generally includes countries in early stages of developing their financial markets – for example, Vietnam, Bangladesh and Sri Lanka in Asia, Kuwait and Lebanon in the Middle East, most African nations (excluding Egypt and South Africa) and smaller Eastern European countries like Romania, Slovenia and Kazakhstan.
Frontier markets can also include relatively developed nations such as Argentina – whose financial markets suffered serious structural decay and was relegated to ‘frontier’ status in 2009 by MSCI (a leading provider of global equity indices) on account of significant restrictions on capital flows in and out of their equity market.
Frontier markets now enjoy significant labour cost advantages over emerging markets like China
Currently most oil-exporting countries in the Middle East and Nigeria are experiencing more difficult economic conditions and significant spending cuts from low oil prices. However, in positive developments, Bangladesh and Vietnam are the main beneficiaries of the manufacturing shift away from China – the latter part of the new Trans-Pacific Trade Partnership agreement to lower trade barriers between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, Peru, New Zealand, Singapore, US and Vietnam.
Meanwhile, recent political reform in Argentina includes the removal of foreign exchange restrictions (meaning it may be promoted to ‘emerging’ status again by MSCI in 2017), Myanmar is experiencing a boom in foreign direct investment – expected to increase in light of September’s vow by US President Barack Obama to scrap trade limits, while last month the Palestine Exchange began trading as a frontier market for the first time in its two-decade history.
While EU (and some US) sanctions have now been lifted in Iran, many US sanctions remain making it very difficult for any business with US ties to do business with the Middle Eastern nation. Although it is currently a slow moving market and remains largely uninvestible right now, we expect that its re-opening in coming years will provide investors the opportunity to access a large, dynamic market with a highly educated population.
One of the flow-on effects of frontier market growth is the rise in consumer spending
The opportunity for accelerated growth, lower labour costs, global demand for natural resources (as available in the Middle East and Nigeria), and commitment to infrastructure expenditure are key reasons that investors find frontier markets attractive. Once a certain level of development is achieved, countries may be elevated to ‘emerging’ status as occurred with the United Arab Emirates and Qatar in 2014, and as they grow, frontier markets may even reach ‘developed’ status.
In alignment with these factors, the disposable income of their consumers will also grow, creating significant opportunities for consumer-facing companies. On the flipside, fragility in economic stability, social and civil unrest, and non-democratic governments mean caution is required.
As seen with emerging markets, drivers of frontier economic growth can be attributed to growing populations (the rising proportion of working-age people helps sustain economic growth), natural resources (namely agriculture and oil reserves) and productivity improvements (partly driven by urbanisation and growing middle classes)1. In our view, Africa is a great example of the opportunities in frontier market growth.
African consumers are young and they’re willing to spend2
53 per cent of Africa’s income earners are between 16 and 34 and are predicted to contribute to more than $400 billion in total consumption growth in the next decade3 and despite their lower income levels, a Deloitte survey reveals young African consumers attach more importance to the quality of products than the price.4
Current spending by African consumers and businesses is around $4 trillion with household consumption – fueled by population growth and rising incomes – expected to grow on average 3.8 per cent per annum, reaching $2.1 trillion in 2025.5 In fact, the continent will account for one-fifth of the world’s population by 2025 with more Africans entering the consumer class, including tens of millions emerging from poverty.6 The accelerating urbanisation of Africa shows that it’s not suffering from a lack of demand, rather a lack of supply.7
Frontier markets remain significantly under-researched by large global investors and analysts
This means they remain inefficient yet provide significant opportunities for those willing to invest the time and effort to do the research themselves. While frontier markets remain very under-developed with higher risk, their equity markets are typically mostly owned by domestic investors rather than large global investors, meaning they are generally uncorrelated with other large stock markets. While accessing frontier markets can be a challenge for retail investors, a good investment adviser can help facilitate access via fund managers who specialise in these markets. If you have the ability to enjoy a longer-term focus in your portfolio, frontier markets could provide access to attractive growth potential and offer portfolio diversification benefits.
1. EY, ‘Frontier markets: know the opportunities and risks: Tomorrow’s emerging economies?’ viewed 4 October 2016
2. Y Agyenim-Boateng, R Benson-Armer, B Russo,’Winning in Africa’s consumer market’, McKinsey & Company, July 2015, viewed 4 October 2016
3.Y Agyenim-Boateng, R Benson-Armer, B Russo, loc.cit.
4.Deloitte, ‘The Deloitte Consumer Review, Africa: A 21st century view’, viewed 4 October 2016, p. 2
5. A Leke, P Jacobson, S Lund, ‘These 6 Sectors of Africa’s Economy Are Poised for Growth’, Harvard Business Review, 20 September 2015, viewed 4 October 2016
6. Deloitte, loc. cit.
7. Deloitte, ibid. p 22