Investing in frontier markets can come with
a higher degree of volatility than more established markets, but they offer
exciting potential. Some of yesterday’s small, agrarian economies have
transformed themselves into global powers today—China being the most impressive
example. China represents the second-largest economy in the world today,
depending on how you crunch the numbers, and it has been incredible to see the changes
taking place there in my lifetime. It gets me thinking about economies that were viewed as
largely untouchable or risky for investors and travellers even just a few years
ago, but that today are being discussed as interesting potential destinations
for both.
Here are some examples from recent history
of countries that were shunned or out of favour in the international community
at large, but have undergone big transformations. This includes some emerging
and frontier markets that are currently of great interest to us, and countries
we are not yet investing in, but that are opening up to investors.
China
In 1950, trade between the United States and
China was roughly US$200 million annually when China became subject to an
embargo that lasted 21 years, ending in 1971.1 Today, trade between China and
the United States adds up to more than US$500 billion, making China the United
States’ second-largest trading partner.2 China has undergone a huge growth
spurt over the past three decades and has transformed its economy. For emerging
markets investors, China is a destination that certainly can’t be ignored and
remains an engine of growth for the world. Even if market watchers have to get
used to a “new normal” of slightly slower gross domestic product (GDP) growth
than in past years, we think the 7.4% growth rate China reported in 2014,3 and
the target of around 7% in 2015 Chinese premier Li Keqiang gave at the National
People’s Congress in early March still looks impressive, given the size of
China’s economy, and is not something that concerns us.
Japan
An adversary to the West in World War II,
Japan is an example of a market that moved rapidly from frontier to emerging to
developed market status and is now considered one of the strongest allies of
both the United States and Europe. Japan’s rise to economic strength has been
well-documented as one of the biggest post-WWII achievements and its
high-quality, high-tech goods have permeated nearly every corner of the globe.
Since its boom times of the 1980s, Japan’s economy might be stagnating, but it
still holds plenty of sway in the world’s economy. Its government has been
working to increase consumption and jump-start growth through an ambitious,
three-pronged fiscal and monetary approach. In our view, the quantitative easing
regime the Bank of Japan began in 2013 that continues today should help support
global liquidity and trickle down to emerging markets in the region.
South Africa
Apartheid, a system of legalized
discrimination dating back to the 1950s, cast a shadow on South Africa in the
eyes of the international community for many years. In addition to United
Nations sanctions, the US Congress passed the Comprehensive Anti-Apartheid Act
in 1986, resulting in the withdrawal of many large multinational companies from
South Africa. The end of apartheid in South Africa in 1994 opened the door
again to wider investment in the country, but since then, its economy has been
struggling to reach its full potential for a variety of reasons.
South African stocks have started 2015 on a
solid note, aided by the recent drop in oil prices. In particular, retail
businesses (particularly clothing and food) seem to be benefiting from the
potential boost to domestic consumption from lower fuel prices. While South
Africa has been struggling with an electricity crisis that could stunt GDP
growth this year, we continue to believe that attractive long-term investment
opportunities exist across a range of South African markets and sectors.
With the government’s focus on
redistribution of wealth and extensive social grants, companies that provide
goods and services to consumers at the low end of the income scale have
benefited tremendously and, in our view, should continue to do so. Also, many
South African-based companies that generate a substantial portion of their
income from operations and investments in other markets have benefited from a
weakening of the South African rand relative to the US dollar and other major
currencies. The real estate sector has been stable with price growth in recent
years, fueled by demand that substantially outstrips supply, especially at the
entry level. In this regard, the financial sector plays a key role, with banks
taking a fairly conservative approach to both asset-backed and non-asset backed
lending activities. Moreover, a number of South African companies are investing
on the rest of the African continent across a variety of industries, including
infrastructure, retail, financial services and telecommunication.
Here are some examples of frontier markets
that were out of favor, but are transforming and opening up to wider foreign
investment. These are just a few of the markets in which we are investing, or
watching for potential future opportunities.
Vietnam
Since the end of what’s known as “the
Vietnam War” in the United States and “the American War” in Vietnam, the
country has seen some huge changes. Vietnam’s rise hasn’t been as powerful or
fast as Japan’s post-WWII experience but a construction boom has been underway.
In 2010, Vietnam got its first skyscraper, the striking Bitexco Financial
Tower, which stands as a beacon in Ho Chi Minh City. An even taller building is
currently under construction in the city, expected to rise to about 350 meters
and contain a luxury hotel, apartments, shopping and what is said to be
Southeast Asia’s highest restaurant and bar. Franklin Templeton has an office
in Ho Chi Minh City, and it’s been exciting to visit the city and see the
changes taking place there and around the country.
The middle class has been growing in Vietnam
and people have also been trading in bicycles for motorcycles, scooters and
automobiles. To help alleviate the traffic on busy city streets, Vietnam’s
first-ever subway system has been under construction with the help of foreign
investment from Japan, France and China.
The chart below shows how Vietnam’s people
have been eager to have access to new technology, with growth in mobile phone
subscription rates topping even India and the United States during 2002–2012.
While it is clear there has been progress, Vietnam’s
transformation has been slower than we’d like. The war was so traumatic and the
people remain a bit sensitive about foreign dominance, which has hindered the
acceptance of foreign investment. The Vietnamese seem to be gradually
overcoming these reservations because of the positive developments they see to
the north in China, and we have recently seen more movement in allowing greater
foreign investment. Vietnam’s stock market is not very liquid, and it is
considered a frontier market; but Vietnam has had a fast-growing economy, and
we have found good companies there, including some that are state-owned.
Myanmar
I had the pleasure of visiting Myanmar
earlier this year, and it’s a perfect example of what we view as “the next
frontier” of untapped markets in which we aren’t yet investing but are closely
watching. It’s truly a wonderful place that has seen a big change in policy and
global perceptions. My most recent visit included a trip to Mandalay, an
incredible city with its royal palace still intact. The city remains in a time
warp but 640 kilometers to the south, the country’s largest city and former
capital, Yangon has skyscrapers and development. Growth has also been robust,
with GDP growth of more than 8% in 2013 and 2014 and expected at a similar pace
in 2015.4 However, Myanmar’s capital
markets have a long way to go before we can consider investing there in a
meaningful way. Elections coming up in November could have a big impact on
acceptance by the United States and other countries that have had embargoes and
other constraints to doing business there. If Myanmar can successfully hold an
election that’s considered to be fair, we might see more constraints loosened.
During our visit, my team and I met with
officials who are planning a stock exchange, but it will take some time to
develop the necessary financial system infrastructure. Implementation of
foreign investment will take time; in order to invest, we need custodial banks
and so on.
To do business effectively in a country, we
believe it’s important to understand the culture and the people, including
traveling there and talking with ordinary citizens as well as government
officials and business leaders. Myanmar is steeped in history and is deeply
religious; gold-covered pagodas can be spotted in nearly every city, and in the
countryside, you can sense the deeply embedded spirituality in the culture.
Cuba
Cuba is another country that we are not yet
able to invest in, but are watching closely. There has been a lot of excitement
recently about what appears to be a new chapter in Cuba-US relations, including
the possible restoration of diplomatic ties between the countries and the end
to decades of US sanctions. The US State Department has conveyed that the
United States aims to lift restrictions on travel, commerce and financial
activities with Cuba. However, with a Republican-controlled Congress and a
strong anti-Castro Cuban diaspora still holding some influence in the United
States, it seems unlikely that rapid progress will be made unless there are
more signs of democratic reforms in Cuba. Nevertheless, it seems obvious there
will be some opportunities for airlines to increase flights to the island
following relaxed travel rules—and we’ve already heard that message from a few
US carriers eager to service or expand existing charter services to Cuba. US
banks could also benefit since US tourists visiting the island will be allowed
to use credit and debit cards issued by their banks, and US bank accounts of
Cuban citizens living on the island will be unlocked. Remittances from the
United States to Cuba are being raised from a maximum of US$2,000 to US$8,000
annually, but unless the 1962 embargo instituted by US President John F.
Kennedy is lifted, foreign investment from the United States into Cuba will
remain severely restricted.
In my view, the impact on US firms of the
new relationship with Cuba will likely be limited, at least in the short to
medium term, but the gains for non-US firms could be substantial. I think
Cuba’s ability to access the US market could make investing in export-oriented
Cuban enterprises more attractive. If the embargo were to be lifted, then Cuban
companies that escaped to the United States after the revolution could return
and relocate there. The Castro government’s tight grip on the economy remains
an additional barrier to wider investment, but there are some signs it could
loosen, and food could be the first item of trade to be liberalized in Cuba. A
US Agriculture Commission for Cuba including about 30 US companies and food-related
groups headed by an executive of a US food giant has been lobbying the US
Congress to lift the trade embargo with Cuba and ease trade sanctions. Despite
the obstacles, we think the long-term opportunities for potential investment in
Cuba look enormous.
Frontier Markets General Outlook
These are just a few frontier markets we are
watching—there are many more we are also excited about. Looking long term, we
believe the structural reasons behind frontier investing in general remain
generally solid, including good potential growth rates in many frontier
economies, strong domestic and capital markets growth, technology transfer,
demographic advantages and generally low sovereign and private indebtedness. Of
the 10 countries estimated by the International Monetary Fund to have achieved
the fastest economic growth between 2003 and 2013, eight were frontier markets,
with China and India being the other two (see chart below). The underlying
growth profile can be particularly attractive in frontier markets, as they tend
to be more exposed to their domestic economies—many of which are developing
rapidly—as opposed to the global economy, which is growing at a slower pace.
Furthermore, technology leapfrogging and partnerships between emerging markets
that are able to supply capital and technology (such as China), and frontier
markets with low labor cost structures, could be particularly potent sources of
growth.
In the current environment, a number of
countries are undergoing positive developments while headwinds remain for
others. Headlines of conflict and tension in some emerging and frontier markets
continue to affect overall investor sentiment. At the same time, the improving
macro environment and lower political risk have benefited individual economies
(Sri Lanka and Bangladesh being two examples). In recent days, major world
powers have been discussing a United Nations Security Council resolution to
lift sanctions against Iran. Meanwhile, planned economic reforms and a new
International Monetary Fund loan program could further promote Pakistan as an
investment destination.
While we don’t know what the future will
bring, this demonstrates to us how important active management—including
on-the-ground research and a bottom-up stock selection process—is when it comes
to investing in emerging and frontier markets.
Mark Mobius’s comments, opinions and
analyses are personal views and are intended to be for informational purposes
and general interest only and should not be construed as individual investment
advice or a recommendation or solicitation to buy, sell or hold any security or
to adopt any investment strategy. It does not constitute legal or tax advice.
The information provided in this material is rendered as at publication date
and may change without notice and it is not intended as a complete analysis of
every material fact regarding any country, region market or investment.
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(“FTI”) has not independently verified, validated or audited such data. FTI
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