• Finding new frontiers in mutual fund investing
     | May 03,2014

    NEW YORK — Finding stocks that zig when others zag is a key goal for investors, and mutual fund managers say they’re finding candidates in places that may be unfamiliar. They’re delving deeper into less-developed economies, buying stock in Nigerian breweries, banks in Kazakhstan and cement companies in Colombia.

    Trading in such markets is more difficult and the threat of big losses is higher. But proponents of so-called frontier markets say they are where Brazil, China, India and other big emerging markets were 20 years ago. And while investing in stocks from those countries may have seemed wild then, today they’re just a de rigueur part of an emerging-markets portfolio.

    Frontier-market investing covers a wide range of economies from huge countries like Pakistan, one of the world’s 10 largest by population, to Mauritius, which has fewer people than Idaho. What they have in common are economies or stock markets that are less developed than traditional emerging markets, such as China and Brazil, which are themselves less developed than the U.S., Japan or Germany.

    Because of their smaller size and increased risk, conventional wisdom said that frontier-market stocks should behave like emerging-market stocks on steroids: They should have higher highs and lower lows. But over the last year, frontier-market stocks haven’t been dragged down by worries dogging large emerging markets.

    Over the 12 months ended in April, the MSCI Frontier Markets index returned 27.9 percent in U.S. dollar terms, including dividends. China, Brazil and other more established emerging markets, meanwhile, lost 1.5 percent as measured by the MSCI Emerging Markets index.

    Part of the allure is that frontier markets aren’t yet fully part of the global economy. They don’t have big exporters like South Korea’s Samsung, whose revenue depends heavily on the global economy’s strength. That means the direction of a frontier market’s stocks is more heavily reliant upon the strength of its own economy. And expectations for many frontier economies are high.

    The focus on the growth of the local economy can lead to big differences in performance. Consider the United Arab Emirates. Through the end of April it surged 40.4 percent. Kazakhstan, also a member of the frontier index, fell 7.1 percent.

    Such differences are a positive for investors, says Rick Schmidt, portfolio manager at Harding Loevner’s Frontier Emerging Markets fund (HLMOX), which has returned 18.8 percent over the last year.

    “The individual country risk is very high: You can have a coup over here and an invasion over there,” Schmidt says. “But because none of them affects what happens in other markets, when you own a portfolio of those, you’re actually reducing risk.”

    To be sure, as frontier markets grow, their ties to the global economy will likely strengthen. That means their stock markets would eventually move more in sync with other global markets. But investors now are noticing the strong performance and diversification that frontier markets have recently provided.

    Big institutional clients and financial advisers are asking more often whether they need to be in frontier markets, Schmidt says. So, what’s the answer?

    “If you can handle the risks and hold through this thing for five years, frontier is an asset class that is very exciting,” he says.

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