Frontier markets: Top opportunity or too risky?
As money flows out of emerging markets on fears about an end to the U.S. Federal Reserve's bond-buying program, frontier markets have enjoyed something of a renaissance - but there can be "huge problems" for intrepid investors, analysts told CNBC.
The MSCI frontier markets index - which consists of companies from across 25 frontier markets including countries such as Argentina, Tunisia and Vietnam - is up around 15 percent (in dollar terms) over the year to date, bucking the trend of emerging and developed markets which are in the midst of a sell-off.
The executive director of research at global index compiler MSCI told CNBC that frontier markets had escaped this market flight because they were less exposed to global market factors.
"Frontier markets are very much focused on internal demand and they exhibit relatively low correlation to the more global markets… and that probably explains why we see a great performance year-to-date on the frontier markets," Sebastien Lieblich told CNBC Europe's "Squawk Box" on Tuesday.
A significant number of frontier markets are in the Middle East and four of the most heavily weighted countries in the index - Qatar, the United Arab Emirates (UAE) , Kuwait and Nigeria - belong to the wealthy Organization of the Petroleum Exporting Countries (OPEC). Earlier this year, MSCI upgraded Qatar and the UAE to emerging market status, which will be effective from May 2014.
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Despite this, Lieblich insisted their growth was not dependent on the energy sector and oil exports. "Interestingly in these countries, the oil business… is widely guarded by the government and is not open to public investment so in the index you won't find any petrol companies," he said. Rather, the index is skewed towards financials and telecoms, Lieblich added.
Samuel Vecht, portfolio manager at Blackrock, told CNBC that each frontier market had its own "peculiarities" and that the people investing in the markets were equally diverse.
"Many of the investors are local. They are very individual segregated markets which have their own investors base which isn't one, over-lapping investor base that gets worried about tapering or sequestration. That's why, if you look at the markets year-to-date, emerging markets have had a torrid time but frontier markets are up 10-20 percent."
Blackrock's top frontier market picks are Saudi Arabia, Nigeria, Bangladesh and Kazakstan, which have above-average gross domestic product (GDP) growth and a collection of growing companies that are well run, Vecht said. "That doesn't mean frontier markets don't have risks - they definitely do have risks, they're just not the same as the western or indeed, the emerging world," he added.
Correction: A previous version of this article referenced the MSCI frontier markets 100 Index in the second paragraph, it is in fact the MSCI frontier markets Index.
Longevity and politics were two of the biggest risks in frontier markets, Vecht said, adding that company valuations were crucial. "Never ignore valuations - markets can appear really attractive but if you ignore valuations you do so at your peril," he said.
A further potential pitfall for investors and businesses looking to frontier markets is reputational damage. For instance, a number of global brands were thrust into the spotlight in April, after a factory used to produce Western clothing collapsed in Bangladesh – a frontier market - killing hundreds of garment workers.
Tom Smith, head of business development at Sedex, a non-profit organization that encourages ethical business practices in global supply chains, said buyers and suppliers faced "huge problems and risks" when dealing with frontier markets.
"We categorise it, roughly speaking, into labor standards, health and safety, environment and business practices," he said. "What we're hearing from big brands, retailers and suppliers is that there are some overriding themes emerging from these frontier markets. Issues like fire safety and working hours have come up as key risk areas. But the central theme is that there is a huge variety of different risks."
Companies need to understand the supply chain to understand what risks they are exposed to in order to protect their reputations, Smith added. Around 30,000 buyers and suppliers are members of Sedex.
- By CNBC's Holly Ellyatt, follow her on Twitter @HollyEllyatt