The search for yield in frontier markets

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Roy Scheepe (pictured), Senior Client Portfolio Manager at ING Investment Management Frontier Market Debt discusses why investors are increasingly looking to frontier markets in the hunt for higher-yielding assets.

Seeking to replicate the high returns achieved in emerging markets over the last decade, investors are turning to new geographies – the frontier markets. Having many of the same characteristics that emerging markets did when they were first identified in 1988, frontier markets present a relatively new opportunity set for investors. As emerging market maturity drives down risk premiums, the long-term growth potential and diversification benefits of frontier markets have made this asset class a compelling investment opportunity. With a yield of 6.76% the Frontier Market Debt index is looking increasingly attractive compared to other high-yielding asset classes, such as the European High Yield (5.04%) or EMD Hard Currency (5.30%).

Looking ahead, I believe the rise of inflows into this asset class is likely to continue for several key reasons. Firstly, frontier markets have relatively high rates of economic growth, with 23 out of the 25 fastest growing economies over the past decade being in the frontier market category. Secondly, the IMF is forecasting average growth in 6-7% for African and South Asian economies over the next five years. Frontier markets are growing at a faster rate than emerging economies, so their importance in the world economy will also grow over time. ING Investment Management expect frontier markets to continue to outperform both emerging and developed markets – due to these markets having attractive long-term prospects given their early stages of economic development.

An important driving force behind frontier markets’ economic performance are favourable demographics, as these markets have benefited from strong population growth and increasing work age population, which are set to continue boosting economic activity over the next couple of decades. In addition, the underdeveloped financial markets of this asset class have meant the liquidity, size and duration of their debt has been lower in comparison with the overall emerging markets universe. External debt as a percentage of GDP is 18% in frontier markets, compared to 29% for emerging markets and 117% of the G7 economies.

With the vast potential for increased production from a young workforce, alongside improvements in institutional infrastructures and increasing levels of FDI, investors’ interest for frontier markets is set to grow. High levels of corporate investments in Africa, including an ever increasing Chinese presence in the continent, illustrate this interest.

Yet, along with potential for high rewards, investing in frontier markets comes with higher levels of risk. Many frontier market countries share turbulent pasts however, provided that political stability is maintained, the investment potential of frontier markets remains strong.  A good example of this is the Ivory Coast, where the combination of an overall economic turnaround and gradually improving political stability has made this West African country one of the most attractive investment opportunities within the frontier markets universe. A country, which has been through a civil war and several crises, the Ivory Coast has emerged to pursue an ambitious reform agenda. Supported by the IMF alongside key lenders including China, Europe and North America, the Ivory Coast has invested in infrastructure, and construction, while also developing its vast agricultural potential. Provided that political stability is maintained, GDP is expected to grow at 7.4% in 2014, and 6.6% on average for the following three years.

To dip into the world of opportunities that frontier markets present, we introduced the Frontier Market Debt strategy in December 2013, with the launch of the IMG IM Frontier Markets Debt Hard Currency fund, which offers clients the opportunity to capture a significant yield advantage and gain exposure in countries with higher economic growth. And while we acknowledge that frontier markets are susceptible to volatility in the short-term, we also believe that they have a solid long-term performance. As an asset class, frontier market debt offers investors the opportunity to invest in an under-owned and under-researched asset class, creating risk premiums and alpha opportunities.

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