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Emerging-market portfolio managers specialize in finding the next big thing. But after the transformation of many economies in Asia and Latin America in the past two decades and the strong returns and mainstream popularity of their markets, what’s left to be found? How about stock markets in Africa, the Middle East and Asian countries like Vietnam, Bangladesh and Sri Lanka? Investment advisers who focus on the developing world contend that many of these so-called frontier markets, especially in Africa, offer similar opportunities to the fledgling markets of earlier generations. “Africa is going to be the next big growth story that’s largely undiscovered,” said Larry Seruma, manager of the Nile Pan Africa Fund, a U.S. mutual fund that holds shares in companies that are based in the region or that do substantial business there. “It can supplant Brazil, China and Russia if its potential is realized,” he said. That’s a big if, and contemplating Africa’s many problems only makes it seem bigger. There is desperate poverty, disease and hunger, compounded by other scourges that limit opportunities for Africans to improve their lives: political instability, deficient education systems and in some cases longstanding military conflict. But the case for the region and frontier markets elsewhere is precisely that they have just set out on the path to economic and social progress and still have a long way to go. That is the same journey made by the big emerging economies of today. It’s barely four decades since Chinese farms were decollectivized, for instance, and less than two decades since Brazilian inflation was running at more than 40 percent a month. “Frontier markets are often in a much earlier state of economic development than larger emerging markets and may have only recently opened to foreign investing,” said Mark Mobius, one of the pioneers of investing in the developing world, who directs emerging-market operations at Franklin Templeton, the fund management company. “This helps explain their high growth potential. Newer markets typically have more room to grow, and the search for growth potential amid acute global volatility is encouraging many investors to expand their horizons.” A recent report by Citigroup identified 11 economies expected to show exceptional growth through the middle of the century, including two of the usual suspects, China and India. Most of the others are frontier markets — Bangladesh, Iraq, Mongolia, Nigeria, Sri Lanka and Vietnam — or else minor emerging markets that managers of frontier portfolios sometimes invest in, like Egypt and the Philippines. Advocates of investing in places like these expect them to become the markets of tomorrow. As for today and yesterday, well, that’s a different story. The MSCI frontier markets index lost about two-thirds of its value during the global collapse of 2008 and 2009. That is slightly worse than MSCI’s indexes of global emerging and mature markets, but where frontier markets really suffer in comparison is in the period since then. The recovery in frontier markets has been much shallower, leaving the index at less than half of its 2008 high, while the other two indexes have recovered nearly all of their lost ground. Pradipta Chakrabortty, a manager of the Harding Loevner Frontier Emerging Markets Fund, attributes the weakness, particularly in Africa, to the political turmoil of the Arab Spring revolts and to a run of economic and financial hardship, not there but to the north. “Africa has a lot of capital coming in from Europe,” he explained. “In 2010 it started flowing into frontier markets, but the recovery got nipped in the bud because of the sovereign debt crisis.” Mr. Chakrabortty pointed out, though, that some deep-pocketed investors continued to funnel money into frontier markets. Chinese enterprises are making huge purchases of industrial and agricultural assets in places like Africa and Vietnam. Whenever other investors decide to join them, there are three themes that fund managers expect to drive returns for years to come: growth of a middle-class consumer society, with all the products and services that are its trappings; production and export of natural resources; and development of infrastructure, including the transportation and communication networks required for the success of companies involved in the other two themes. Mr. Chakrabortty finds some of the best opportunities these days in Africa and the Middle East and in Vietnam and Bangladesh, where labor is less expensive than elsewhere in Asia. His portfolio is heavily invested in consumer-oriented stocks like Safaricom, a Kenyan telephone service provider, and Equity Bank, also in Kenya. Other selections include Squire Pharmaceuticals in Bangladesh and First Bank of Nigeria. Mr. Mobius sees encouraging prospects for frontier markets pretty much everywhere. He said he was “optimistic about the long-term growth potential in many countries” in Africa and added that “we must not overlook Latin American countries such as Colombia and Peru, the countries in Eastern Europe, such as Romania, and countries in Asia such as Vietnam, Pakistan and Sri Lanka.” Mr. Seruma focuses on Africa, but he does not feel the need to invest there to capture the continent’s promise. His portfolio includes holdings like African Oil, which has discovered reserves in Kenya but has a stock listed in Canada, and Tullow Oil, which is listed in Britain and has energy assets in Ghana and Uganda. His fund also owns developed-frontier hybrids like East African Breweries, which is half owned by the global beverage conglomerate Diageo, and Nestlé Nigeria. Among the pure African stocks he favors are Guaranty Trust Bank in Nigeria and Flour Mills of Nigeria, a producer of basic foods. “As more capital gets employed” in the markets he follows, “you’re going to see returns catch up with the rest of the world,” Mr. Seruma predicted. As for how long it will take for them to become a big thing, he is uncertain. “You have to focus on the long-term growth story,” he said, “and be a patient investor.”
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