Investors in Asia are increasingly looking beyond the region’s heavyweights and placing their bets on lesser-known frontier markets, hoping to cash in on rising tides of economic growth and maturing demographics.
The MSCI Frontier Markets (FM) Asia Index has jumped 19.4% in the 12 months to April 28 versus a 16.5% gain in the MSCI AC Asia Pacific Index. The benchmark is up 4.5% in the first four months of this year and tracks stocks from Vietnam, Bangladesh and Sri Lanka.
Pakistan has also been part of the index, but will be reclassified to emerging market status on June 1.
Mark Mobius, executive chairman of Templeton Emerging Markets Group, made the case for frontier markets on a blog entry dated May 1.
“In our view, frontier markets could offer exciting long-term investment opportunities, given robust fundamentals, including strong economic growth, access to resources and favorable demographic profiles, with additional possible benefits from improvements in technology, infrastructure and standards of governance,” he said.
“Additionally, market valuations for frontier corporations generally stand below those of their peers in developed markets.”
Following a 13.3% drop in 2015, the MSCI FM Asia Index still trades at just 14.7 times earnings despite its recent rally. By contrast, the MSCI benchmarks for the US, Germany, Australia and Japan all traded at more than 16.5 times earnings.
Concerns about political stability and the existence of proven growth opportunities elsewhere in the region have caused Asia’s frontier markets to go overlooked at times. They are emerging as a preferred portfolio component now, however, as investors look to hedge their bets amid headlines of potential economic slowdowns in other corners of the region like China and South Korea.
MSCI uses a three-tiered system of country indices with frontier markets ranking at the low-end, followed by emerging and then developed markets. Including the frontier markets in Asia, MSCI tracks 30 worldwide like Kenya and Morocco in Africa, and Lithuania and Croatia in Europe.
Frontier markets are characterized as having lower levels of liquidity, operational efficiency and foreign ownership. As a result, risk-averse investors have been reluctant to pour too much money into them.
An AT Kearney survey last month showed that upside in the segment may be too good to pass up, however, as two out of five investors planned to seek out new opportunities in frontier markets versus one in five who planned to divest from them.
Positive demographic profiles in the region offer a glimpse of the future economic growth that investors are chasing.
Vietnam, Bangladesh and Sri Lanka all boast young populations that should grow into large, productive workforces that will not overly tax their respective welfare systems.
A United Nations report in 2015 forecast the percentage population distribution of the 60+ age group in Vietnam, Bangladesh and Sri Lanka will each tally less than 30% by 2050. By contrast, China is projected to have a 36.5% share in the segment and Japan is set for 42.5%.
Consumer markets are also growing in size and influence. GDP per capita (purchasing power parity using international dollars) in Asia’s three frontier markets each grew more than 35% from 2010 to 2015, versus a 22.1% increase in the world average during the same span.
All ranked below the world level of 15,690.65, however, with just Sri Lanka topping the 10,000-level, according to World Bank data.
Buoyant consumer sentiment in Vietnam suggests that upward momentum stands to continue. It ranked fifth out of 63 countries measured in Nielsen’s fourth quarter consumer confidence index, slotting in just below Indonesia and above Thailand and China. Bangladesh and Sri Lanka were not included in the survey.
The equity rally has propped up consumer-focused stocks across the frontier markets. In Sri Lanka, Ceylon Tobacco Company traded up 24.9% so far this year at 999 rupees (US$6.55) through May 12, while Nestle Lanka has increased 12.1% during the same period. Elsewhere, Vietnam Dairy Products JSC, the country’s largest stock by market value, was up 15.3% year-to-date to 144,800 dong (US$6.38).
The universe of tradable stocks will expand in Vietnam as well, given the government’s goal of privatizing 50% of state-owned enterprises from 2015 to 2020. There have been US$392 million worth of IPOs in the country so far this year, more than in the Philippines, Malaysia or Thailand, according to Bloomberg data.
There has been a pickup in foreign investors looking to buy stocks directly through local brokerages in Vietnam. The Vietnam Securities Depository reported 20,060 foreign trading accounts in April, up 12.8% from the start of 2016.
Investors are also tapping into the region through funds. The Matthews Emerging Asia Fund, which allocates over a quarter of its holdings to Vietnam, Bangladesh and Sri Lanka, reported an average annual return of 10.5% in the past three years. The AFC Asia Frontier Fund has also been in the black each year dating back to its inception in 2012.
Aside from yielding potential long-term returns, holdings in frontier markets can also provide foreign investors with portfolio diversification benefits. On a scale of minus-1 to 1, the Vietnam HCM Stock Exchange had a correlation of 0.27, with the S&P 500 Index during a 10-year period beginning in 2006, implying there was a weak relationship between their respective share price movements, according to Matthews Asia.
Despite the disparity between developed and frontier markets, BlackRock portfolio manager Emily Fletcher said investors should remain vigilant about the potential knock-on effect of any major sell-offs in global equities.
“The performance of frontier market stocks is not typically influenced by events in the more developed world with performance instead being driven by local political and economic events,” Fletcher said. “However, in times of significant global stress, even frontier markets are not immune and it can affect performance.”