Sunday, October 16, 2016

Dimitrijević, Frontier Investor

If you’re considering expanding the global reach of your portfolio, Marko Dimitrijević’s Frontier Investor: How to Prosper in the Next Emerging Markets (Columbia University Press, 2016) is an excellent place to start.

First, a definition. What is a frontier market? Of the 193 members of the UN plus Hong Kong and Taiwan, 30 are developed markets and 14 (Brazil, Chile, China, India, Indonesia, Korea, Malaysia, Mexico, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey) are what the author calls mainstream emerging markets. The remaining 151 are frontier markets. Measured by purchasing power parity-adjusted GDP, frontier market countries generate 19% of the world’s PPP-adjusted GDP. By way of comparison, the United States and China each generates 16%; developed Europe, 15%.

Why go to the frontier? Because many of them are likely to be the next wave of emerging markets. Their economies are expected to expand an average of 50% faster than developed market economies over the five years through 2020, and this growth is structural. “With many frontier markets, investors can purchase a Turkey, Indonesia, or Brazil—not of today, but of twenty years ago, when policy and structural changes drove growth. … As a group, frontier markets exhibit the elements that create an auspicious economic outlook: manageable current account deficits (and sometimes surpluses); low levels of government and private debt; moderate inflation; and growing foreign direct investment.” They also have favorable demographics.

That, in a nutshell, is the top-down story. But “even with run-ups in 2013 and early 2014, frontier market equities are still cheap on an absolute and relative basis, especially given their expected growth. And most frontier equity markets are inefficient, which means they may hold undiscovered bargains that the frontier market investor can take advantage of. This market inefficiency also helps explain the low correlation of frontier equities as a whole with other asset classes, as well as the low correlations between individual frontier markets, making frontier markets an attractive portfolio diversification tool.”

So, how do you go about investing in frontier markets? For a variety of reasons Dimitrijević is not a fan of passive investing. To mention just one problem, passive investors are stuck with the index constituents. Active investors, on the other hand, “can use a combined top-down and bottom-up approach to not only pick better companies from those countries already in an index but also to expand their universe to encompass countries with strong and improving fundamentals that are implementing structural reforms.”

Dimitrijević gives tips for the do-it-yourself investor. For bond investors, he has a chapter on special situations in distressed debt. He also explains the opportunities available in privatizations, saying that they “can offer outstanding bargains to those willing to do the additional work.”

Of course, there are risks in frontier markets that the average retail investor may not be aware of. Dimitrijević outlines the most important risks, such as political risk, currency risk, and market liquidity risk.

Frontier Investor is a well-researched book, complete with detailed examples. It belongs in the library of every global investor.

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