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Why Venture into Frontier Markets

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Morningstar Ibbotson Conference, and I'm here with Larry Speidell. Larry is the CEO of Frontier Markets Asset Management. Larry, you just gave a presentation about frontier markets, and first I'm hoping you can define for our viewers what a frontier market is?

Larry Speidell: Sure, Christine. We are all now familiar with emerging markets and especially with the BRICs: Brazil, Russia, India, China. There are about 60 stock markets that are not in that emerging markets universe. And many of them are in Sub-Saharan Africa or Central Asia or Southeast Asia or Latin America. And many of them are wonderful.

Benz: So you define a frontier market as anything that's not in the MSCI Emerging Markets Index?

Speidell: That's correct.

Benz: OK. So talk about what you perceive to be the big positive attributes for investing in frontier markets.

Speidell: Well, they're unloved. They're illiquid. They're inefficient. And yet they're populated by over a billion people who are enthusiastic, optimistic, and hardworking. So our belief is that over the next 10 years these people and these markets will prosper, and we hope to be a part of that.

Benz: So it seems like there is some data at least for the emerging markets that would indicate that the economic growth has been very strong, but in some cases the market returns haven't been quite as compelling as the economies have grown. How about for frontier markets? Is there a similar disconnect?

Speidell: This is a very important controversy, and there's a lot of study going on about it, because if you look at some places--let's say in Southeast Asia at some of the Tigers, growth has been high. But P/E multiples have been high, and stock market returns haven't been great.

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Benz: Right.

Speidell: If you look at China, what you find in China is very interesting--that it's dilution of the stock market that has caused investors to fail to keep up with the growth in the market capitalization of the market or for that matter the economy.

But the most interesting thing I think is a recent study that showed that the real relationship is with stock markets anticipating GDP growth--not lagging it. And so you want to go, as Wayne Gretzky said, "where the puck's going to be." [laughs] You want to go where the GDP growth is going to be high and not just chase those markets, which we all know where the GDP growth has been high.

Benz: So that's one reason you think these frontier markets, in terms of an investing opportunity, could be more exciting than what one would get with an emerging market.

Speidell: That's what I love about them.

Benz: OK. So the risks obviously are huge, though. You've got political risks. In some cases the transparency for investors and the investor protections just wouldn't be there, right? So how do you get around that, and how would an investor mitigate those risks if he or she were interested in getting some exposure to frontier markets?

Speidell: Well, I don't want to minimize risks, but I want to put them in some perspective. And in that case you can go to the Heritage Foundation and look at economic freedom as one measure of business risk, if you will. In fact, frontier countries and emerging countries are all in the same general area of risk: those kinds of risks that you mentioned--political risk and corruption risk and shareholder treatment.

So what we believe is that you diversify, and we do all of our best due diligence, but we must be humble and admit that we will never know everything. We believe that overall, a universe of 10 or 20 of these frontier countries is going to prove extremely rewarding in the same way that it has for a universe of 10 or 20 emerging countries over the last 10 years.

Only if you went back 10 years ago, you would have asked the same question about the risks that you really can't do anything about. This is a risky world. We've learned a lot about that in the last two years. But diversify and capture opportunities before other people get there.

Benz: So, last question. I know that your investment is a limited partnership, so it's not available to many smaller investors. For a smaller investor who was considering an investment in this area, how would they go about doing it?

Speidell: Well, of course one approach is to travel to an emerging country, take your passport, and go and open an account. I did this in five minutes in Uzbekistan, for example. So if you're on holiday and want to go to a frontier country, just call us and we'll tell you what the good ones are and have some fun with that.

Other than that, there are some ETFs. Some of them are regional, but you have to look carefully to see if it's an Africa focus or if it's got a lot of emerging market countries in it. And I think there will be some mutual funds for the broad frontier. A few Africa funds are actually out there now, so you can Google on that continent in particular.

Our belief is that there are real benefits going beyond just one continent. And so as with emerging markets, we recommend a global approach, not a regional approach.

Benz: And stay diversified. Well, thanks, Larry. Those are interesting insights. Great research. Thanks for being here.