There’s a lot to like about frontier markets, but investors looking for exposure to countries like Pakistan and Vietnam need a long-term focus and patience.
Demographics in frontier markets work in their favor, as many have large, young populations that are starting to develop a consumption culture, which means great opportunities for companies that sell to consumers. Additionally there are many well-run companies in these countries that can be bought at low valuations.
Still, three portfolio managers specializing in frontier markets said at the Morningstar Investment Conference in Chicago on Thursday that investors need to know that as these countries grow, they may experience some bumps. Some are moving to democracies, which can take time to develop. Liquidity is also an issue for investors as many of these markets are very small.
Taizo Ishida, portfolio manager for Matthews Asia, said frontier markets should be looked at by a country-by-country basis.
Political risk can work in an investor’s favor – but it depends on what kind of political risk, said Pradipta Chakrabortty, lead portfolio manager for Harding Loevner.
“Political risk is a concern. We try and understand if it’s short-term or a longer-term structural issue,” he said. “By and large, political risk and upheaval creates opportunity to take a bigger position in a company with good valuations. It doesn’t affect the underlying fundamentals of the companies.”
Political risk in a country like Pakistan, Nigeria or Kenya is likely short-term as those countries are on more stable footing. However, he said in other frontier markets like Argentina and Zimbabwe, the political risk is high and he wouldn’t touch them.
Laura Geritz, lead portfolio manager for Wasatch Funds, said diversification is important when investing in frontier markets because the asset class is so small. Actively managed funds are likely to be more diversified than index funds as currently the benchmark indexes are heavily weighted to three countries – Kuwait, Nigeria and Argentina.
“These are small countries and economies. They’re a lot more fragile. Things can change fast and you have to manage risk…. You need a very diversified portfolio on a country basis,” she said.
The portfolio managers said many companies in frontier markets are very well run in spite of a country’s politics.
“In Pakistan, many of these companies have learned to live, survive and prosper in these environments. Pakistan has some of the best managed companies I’ve seen. They’re good at containing risk,” Chakrabortty said.