“A brave world, Sir, full of religion, knavery, and change: we shall shortly see better days.” Aphra Behn ‘The Roundheads’ act 1, sc. 1
In a homogenised world, asset class definitions are seemingly less relevant. Tencent is more an equal to Facebook and Google than heir; per capita GDP is higher in Korea than Spain1; and developed and emerging market demographics have begun to look increasingly similar (the birth rate in Switzerland is higher than Thailand2). Development curves have plateaued. Investors looking for unchartered territories need to look further: to frontier markets.
MSCI first put together an index of frontier markets in 2007. Comprising of twenty-six markets across Asia, Eastern Europe, Africa, Latin America and the Middle East (which accounts for approximately 60% of the universe), these countries generally have little in common: more a set of individual opportunities experiencing either positive or negative economic cycles. Wealthy Middle Eastern countries suffering from an oil shock, restructured Latin American countries aspiring to former glories and burgeoning African states. In some ways they offer what Emerging Markets did in the 1980s: 21 of the 25 fastest growing countries are frontier markets3. Whilst this does not necessarily translate directly to stock market returns, it creates an environment for sustained earnings and cash flow growth. These are key tenets of Mobius Capital Partners’ investment philosophy and these markets have already thrown up a host of exciting stock specific opportunities.
Frontier markets also offer immensely positive demographics. This ‘card’ is frequently played but at Mobius, we believe there are two central benefits of a growing population. One is direct: a large, productive workforce. More workers mean more income, more taxes and more consumption by their families. The other is indirect (and perhaps more powerful): more income means more saving. More saving means more investing and – in theory, although not always in practice – more stable, self-funding capital markets. This stable base of domestic capital creates a fertile ground for credit creation, lowers the cost of capital and encourages domestic investment. Chile is a fantastic example of the benefits a concerted government effort to support the pension system can have on the local capital market. Frontier markets would be wise to follow.
There are some severe drawbacks to rapidly changing demographics. Large populations and low productivity can burden governments, driving fiscal and monetary policy mistakes. Large numbers of low or unskilled citizens out of work is a social or economic problem that can rapidly become a political one.
Indeed, like their emerging market forebears, frontiers face a host of challenges – both economic and political. Central bank policies are frequently interfered with, exchange rates volatile and many of these nations face the poisoned chalice of natural resource wealth, a frequent excuse to under-invest in other sectors or avoid difficult supply-side reforms. An obvious example is Nigeria, which has felt the full force of an exogenous shock (lower oil price) against an ill-prepared and poorly diversified economy. Nigeria’s currency collapse and capital controls have been a feature of the space, but this is slowly being addressed. Saudi Arabia suffered similarly but their efforts to reform are encouraging, if nascent. Democracies – if and where they exist in frontier markets – are often young. In Africa, for example, the rapid democratization process (“second liberation”) began only in the first half of the 1990s: after the 1950s and 1960s heralded freedom from European colonisers, escaping the clutches of despots came later to many African countries.
There are some powerful differences between now and the 1980s, which strongly support the case for frontier markets. Most obvious are the shifts in technology. High-speed communications and the widespread availability of cheap hard- and software means every teenager who can save $30 is walking around with a computer in his pocket multiples times more powerful than those in at the Federal Reserve in 19804.
Added to this are cloud computing and devolved processing power. The opportunities are huge for citizens in frontier markets to learn, do business and innovate. Indeed, the technology businesses we have seen from Argentina to Kenya are exciting prospects both commercially and socially. Standing on the shoulders of (FAN)Giants5 in 2018 is no bad place to be for the entrepreneurially minded citizens of frontier nations. The feedback loops are immensely powerful too: lower capital intensity and higher GDP contribution from services. For a frontier government, creating an environment-friendly to technology investment enjoys potentially high returns. So the eclectic mix of the frontier market presents the risks and opportunities of their emerging forebears, but with an entrepreneurial technology angle which can create idiosyncratic opportunities. Our job is to identify them.
- $29.7k in Korea vs. $28.1k in Spain, World Bank 2017
- 1.54 births/woman in Switzerland vs. 1.48 births/woman in Thailand, World Bank 2016
- IMF World Economic Outlook (April 2018) Real GDP Growth
- IBM PC in 1981 had an Intel 8088 processor at 4.77MHz. A 2010 dual-core third generation Snapdragon chip from Qualcomm has 1.2GHz – more than 250 times as powerful.
- Facebook, Amazon, Netflix and Google.