Wealthy Investors Are The Most Enthusiastic Backers Of Frontier Market Funds - Research

Eliane Chavagnon

4 October 2013

High net worth private investors, with the capital and appetite for new ventures, are the most enthusiastic backers of frontier market funds, according to new research from Cerulli Associates.

Frontier markets - broadly defined as the “next generation” of emerging markets - represent about a quarter of the world's population, just under 11 per cent of global GDP and 2 per cent of global market capitalization, the research firm said.

In the October Cerulli Edge - Global Report, the firm highlights that, according to the IMF, 22 of the 25 fastest-growing economies will be frontier countries in the next five years.

“For sophisticated investors, there is a strong attraction in being a pioneer, since early gains are often the largest,” it said. “Leveraging their own global business and family networks, private deals and funds are often put together in bespoke structures. This is evident in the growing number of private equity funds, both listed and unlisted, targeting frontier markets, particularly in Africa.”

Global institutional investors, although not as excited, are now dedicating between 1 and 3 per cent of their emerging markets allocation to frontier holdings – a “steep” rise from five or even three years ago, said Barbara Wall, a director at Cerulli.

Data

According to data from Cerulli, assets under management held in frontier market funds in the US rose from $1.6 billion in 2011 to $3.2 billion as of May 2013, while net new flows edged up from $0.6 billion to $0.8 billion during this time.

Such growth was even more apparent in Europe, as AuM held in such funds swelled from $9.3 billion in 2011 to $15.7 billion in May this year. The pace of net new flows also quickened, having risen from $0.5 billion in 2011 to $2.9 billion as of May.

“Money tends to flow to markets with better infrastructure and liquidity, and then to those with low correlations to other asset classes,” said Yoon Ng, Cerulli associate director.

Ng added: “In Asia, that means Sri Lanka and Pakistan, while Argentina is the champion in Latin America. In Africa, investors are hailing opportunities in Ghana, Tanzania, and Kenya. And in Europe, there is nascent investment activity in tiny states like Macedonia, Bosnia, Belarus, and Armenia.”

Although frontier GDP rates have been slower than in emerging markets, volatility has actually been less of an issue. The main reason for this is because these economies have fewer links to international markets and are thus less impacted by developments affecting their emerging market peers.

Indeed, a growing number of wealth management firms in the US are turning their heads to frontier market investment prospects.

In November last year, for example, Northern Trust launched a Diversified Frontier Markets Index to provide endowments and foundations with exposure to frontier markets.

“The natural evolution for traditional emerging market portfolios will be into the frontier markets, driving demand for the larger, more liquid index positions,” Greg Behar, senior investment strategist for global index management at Northern Trust, said at the time.

Meanwhile, UK-based Insparo Asset Management appointed Glenda Levin as head of marketing, charging her with spearheading a marketing drive targeting international investors, but with a particular focus on the US.

Challenges

Critics, according to Cerulli, believe that frontier markets “remain a risky subset of an already risky asset class.”

As Northern Trust pointed out, risks are also magnified as frontier markets generally have smaller economies or less developed capital markets than traditional emerging markets. Other risks perceived by investors include political instability, inadequate regulation, sub-standard financial reporting and currency fluctuations.

But the biggest challenges – “essentially one of confidence” - centers around the need for frontier markets to create a virtuous liquidity circle to capitalize on potential inflows, Cerulli said.

The attraction of low debt levels, low stock valuations, diversification and financial infrastructure will wane if investors sense a lack of liquidity, it warned.