Investors looking to emerging markets to be the driving force of growth in the world are behind the curve, according to Franklin Templeton’s Carlos von Hardenberg, who says he is seeing a growing appetite for frontier markets.
Of the world’s 10 fastest-growing countries of the last decade – according to GDP growth – only one of them is an emerging market.
The rest are frontier markets, which von Hardenberg says have been wrongly overlooked by the majority of retail investors.
However, the deputy manager of the $1.2bn Templeton Frontier Markets fund says investors are finally having a change of heart when it comes to frontier markets, and reaping the rewards as a result.
"People are finally realising that frontier markets are not a basket case," he said. "They’ve realised they’re not illiquid and that they need to be taken seriously."
"There’s a big premium in investing in emerging markets compared with frontier markets. Emerging markets are trading on 13-times earnings, while frontier markets are on 7.5-times."
He points out that companies are benefitting from increased demand in these fast-changing countries and highlights Nigeria as a particularly interesting story.
"Guinness is now selling more beer in Nigeria than in Ireland," he said.
However, he adds that Europeans are lagging in terms of investment in fledgling regions such as Africa, where Chinese investors have rushed in to take advantage of growth and development.
While in the past, domestic companies in fast-growing economies have failed to benefit from expansion, the manager says this is no longer the case.
He adds that while many teams do not have the depth of resources needed to fully investigate the under-researched countries that make up the frontier index, the Templeton fund benefits from being the largest fund of its kind in the world and also has the largest team.
Von Hardenberg and lead manager Mark Mobius
typically target undervalued large cap stocks that are unappreciated by the market.
He admits there are a certain number of risks in the area – corporate governance being one of the main ones – but he says that so far "we’ve been able to avoid the big disasters".
Over the fund’s history, only one company has suffered a default.
"For an active manager, the risk has been exaggerated, for sure," he said. "This is an area where an ETF doesn’t help you – you have to be highly selective."
The four crown-rated portfolio has easily outperformed the MSCI Frontier Markets index since its launch in October 2008.
From that time, it has returned 95.89 per cent to investors, while the index has lost 4.81 per cent.
Performance of fund vs index since launch
Source: FE Analytics
The fund has marginally underperformed the index over three years, however, returning 17.67 per cent while the MSCI Frontier Markets index has picked up 19.68 per cent. It has outperformed over the shorter term, leading the index over one year.
Its outperformance comes with a surprisingly low level of volatility given the perception that frontier economies are inherently unstable.
Over four years, the fund has an annualised volatility score of 15.29 per cent, compared with 14.9 per cent from the FTSE All Share.
The MSCI Frontier Markets index has a volatility of 14.98 per cent over the period.
The fund’s relative stability should not downplay the risks that exist in frontier markets.
Investors should keep in mind there is low liquidity in the sector – meaning it is more difficult for the managers to sell any underperforming holdings – as well as poor corporate governance and political and economic instability.
However, von Hardenberg says these risks can be effectively counteracted by dedicated and in-depth research on a company-specific level.
The portfolio is tipped towards financial stocks, with 40 per cent in the sector. Basic materials make up the second-highest weighting in the fund, at 26.87 per cent.
The fund requires a minimum investment of £5,000 and has a total expense ratio (TER) of 2.58 per cent.
Ben Seager-Scott (pictured)
, senior research analyst at Bestinvest, says the fund is a great option for the extreme long-term investor.
"It’s an attractive fund and Templeton is well known for emerging and frontier markets," he said.
"They have a lot of feet on the ground and were one of the earliest teams to get into frontier markets."
"Frontier markets are developing economies with very attractive demographics and a growing workforce. There is a lot of scope to develop over the next several decades."
"It’s a very good long-term investment if you’re going to buy and hold over 10 years."
Seager-Scott says that while there is a huge amount of growth potential in frontier markets, it is unclear when that catalyst for growth may push through and says investors need to be wary of the risks.
"Frontier markets are very niche and very high risk," he continued. "If you think emerging markets are risky, then this is a step above that."
However, he agrees investors can no longer ignore frontier markets.
"They aren’t as illiquid as some people think, especially if you’re investing in larger companies," he said. "It’s not like there isn’t going to be anywhere to dump them [if you want to sell]."
He likens frontier countries to emerging markets 20 or more years ago in terms of growth potential; however, he says there are still some unknowns.
"Just because emerging markets were successful for some investors, it doesn’t mean frontier markets will be," he finished.