African Safari, Part II–A Brief Overview of Frontier Markets

Yesterday I introduced the topic of investing in Africa and included a summary of a recent stock fact-finding trip to several small countries in western Africa. Now that you’re acquainted with the area, I’d like to focus today on the risks and rewards of investing in this region as well as tips on how to go about it.

What is a “Frontier” Market and why invest in them?

Most of the sub-Saharan African markets are termed “frontier” rather than “emerging.” To understand the difference, one has to first understand the concept of an emerging market. An emerging market, or EME, is a transitional economy, meaning they are in the process of moving from a closed to an open market economy while building accountability within the system. Examples include Russia and Eastern bloc countries as well as China and India. Emerging economies will implement economic reforms that lead to more efficiency and transparency in their capital markets. They usually receive aid from large donor countries and/or the World Bank or IMF (international money fund).

In contrast, a frontier market is even less developed. These countries have investable securities but are usually fraught with political and infrastructure problems. Most of the sub-Saharan countries fall into this category. Considering these risks, why would any sane investor want to put money in them? There are several compelling reasons why, among them being that there are frontier stocks that show stable growth, relatively low P/Es, low volatility, and offer stellar returns as well as portfolio diversification. The catch is that you have to be selective and if you can’t do that yourself, select a money manager who can. (More on that later). The reason that frontier markets are attracting investors is due in part to the rising price of commodities, improving infrastructure, increased emphasis on education (in some countries), and at least an attempt at political reform–all of which are contributing to economic growth and higher corporate profits. To be sure, political stability is yet a dream for some countries, but with the growth in education and the rise of the middle class, reforms are inevitable.

The opportunities for investing in frontier markets haven’t been lost on global investors. According to EPFR Global, a company that tracks fund flows and allocations globally, net inflows into African regional equity funds hit $650M in 2007, up about $100M from the year before. Since these markets are comparatively small, this influx of new capital has had an inflationary effect. According to Ryan Shen-Hoover (whom I mentioned yesterday), the P/E ratios of Zambia, Malawi, and Kenya have risen three to four fold in the past five years. Currently, they stand in the 15-20 range which still is quite reasonable. (In contrast, the P/E of the Vietnamese market is at 94; Bulgaria at 54; Slovenia at 42; and Romania at 36.)

Also, the US Government is getting into the act. Just last November, Treasury Secretary Paulson visited Africa and announced that rather than give aid directly, the US will supply up to $250M to jump-start three new African investment funds intended to boost development of its capital markets so that African businesses can more easily raise capital. The financing will be provided by the U.S.’s Overseas Private Investment Corp. (OPIC). Millenium Global Investments, a private investment firm, was selected to manage the portfolios. (I couldn’t find out if these funds would be open to private investors, but if you’re interested, contact either OPIC or Millenium.)

How can I invest in these frontier markets?

Unfortunately, there’s no easy way to invest in these markets. You can invest in them directly but that can be costly and paper-work intensive as Ryan Shen-Hoover outlines in his recent newsletter ( The few funds and ETFs that are available to the small investor and that cover emerging markets include little to no frontier investments. (Some of these funds include the T. Rowe Price Africa & Middle East Fund (TRAMX), and the GAF which is the Africa and Middle East SPDR.) True frontier funds are found in the hedge fund world and are only open to high net-worth individuals. (As I mentioned yesterday, Ryan Shen-Hoover is opening his own African frontier fund and he’s allocated a limited number of spaces for the smaller investor.)

So what’s an interested investor to do? At the moment, there isn’t much one can do, alas! But there is a bright spot on the horizon–the ETN, or exchange-traded note. The ETN is a bond whose value is pegged to an index such as a stock, commodity, or currency index. Barclay’s is a major player in ETNs and so is Goldman Sachs. (Bear Stearns is too but who knows what lies in store for them?) Hope is that one of these major investment firms will create an ETN that is pegged to the African frontier market. Until then, it’s a good idea to at least be acquainted with the field so that when the appropriate investment vehicles arrive, you’ll be able to know if they make sense to you and pounce on them before everyone else does.

Tomorrow we’ll return to our regularly scheduled programming, but it’s nice to take an arm-chair vacation once in a while.

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