How to Invest Inside Frontier Markets

by Bob Adams, Minyanville staff writer

In my last commentary at Minyanville, I discussed a redefinition of three related terms: the First, Second, and Third Worlds. The old definitions reflected a reality of the 20th century, but fail to reflect the reality of the second decade of the 21st century. If, as so many agree, we need "outside the box" thinking to deal successfully with today's world, then we must begin by re-examining the terminology we employ when it remains in common use, but is no longer useful.

I want to expand on that theme today. However, terminology again needs redefinition. In this case, I am concerned with three newer terms: Developed Markets (DMs), Emerging Markets (EMs), and Frontier Markets (FMs). At first glance, these may appear to be simply replacements for the three "Worlds." To the extent they are used in this fashion, they are simply a new coat of paint on an old shack. They have one value however: They allow people in North America and Europe to continue to think of themselves as superior.
The term Developed Market is certainly misleading. Like its predecessor, "developed nation," it implies finality. There is nothing more to do. The nation is developed. What more can it be? The hubris is obvious. At least in one respect, the DMs are indeed developed. They have developed huge debts. They have combined these huge debts with a lack of domestic consensus, a failure to forthrightly confront their debt recessions, a dependency on central banks for anything approaching real action, a failure to identify a common goal allowing for a common DM response, and the resulting weak domestic and international leadership.

Seen from outside, they are sad at best, pathetic at worst. We are now entering our sixth year since public awareness of another term, "sub-prime," and the beginning of a crisis first felt in the US mortgage sector that spread to engulf the North Atlantic. As the years pass with one promise of near- or mid-term recovery after another failing to be realized, their embarrassment becomes humiliation, whether they have the good sense to realize that or not.

Europe has taken this to an extreme that would have bordered on pulp fiction a decade ago. It is painful to watch. It is beyond melodrama. It is a tragedy unfolding before us today. There is nothing any of us outside Europe can do about it, with one possible exception for investors. Trading stocks and the euro on the basis of this week's official announcement of progress is no way to earn a living if you want to sleep at night. I think it is best to simply step aside and wait for whatever results are delivered. Until then, it is a gambling den for those foolish enough to think they can predict an unpredictable future and who, as a result, serve Lady Luck.

The US, as many have noted, looks good only in comparison to Europe. It also has a big plus in the exploitation of shale oil that is already having a substantial positive economic impact, one that will likely grow throughout this decade. But Americans have one problem very much in common with the European Union and the eurozone. The nation is divided and has been for at least a decade. I believe the similarities between George W. Bush's policies and those of Barack Obama are several, but there is one similarity that is especially striking and based on hard fact.

Both presidents were in serious trouble when they ran for reelection and their oppositions launched something skin to a "holy crusade " in an attempt to defeat them. Both were reelected. But the really striking similarity is seen in the popular vote. George W. Bush received 50.74% of the popular vote. Barack Obama received 50.85% of the popular vote. Both presidents overcame serious obstacles to win reelection and both succeeded, but neither received a mandate for change. They were simply given permission to try again, and barely so at that. Lady Luck has her hands full.

I won't belabor the EMs. My prior commentary regarding the "New Second World" will suffice. In brief, these are large nations with large populations and large potential, but also with large problems. Their primary challenges are to deal with domestic pressures for more, more, more, while dealing with pressure from the DMs. In their all-absorbing desperation to survive the crisis they have created for themselves, the DMs will tend to drag the EMs down with them. But for today, an additional suggestion I would make is to be the first in your neighborhood to understand that "emerging" is the wrong word. They have emerged. Deal with it.

This brings me to the Frontier Markets. These are the nations where investing is most difficult. Many of their stock markets are too small, too illiquid, and too rarely followed to be of any use to DM investors whose "trading floor" is their computer monitor. Their companies that do trade locally are too small. In my new home nation, Panama, the local stock likely to draw attention from the DMs is COPA Airlines CPA, a rapidly-growing and very profitable regional airline, but you can trade COPA on the NYSE. Everything else gets ignored.

And yet, there is a lot of money being made now and yet to be made in many FMs that make them as attractive or more attractive than the EMs or DMs. Some people think that FMs are dirt-poor by definition. Wrong. In Panama, our 2011 per capita GDP (PPP) was $14,100. Brazil? $11,800. China? $8,400. India? $3,700. Only Russia leads us ($16,700) and, you can definitely trust me on this, no one in Panama is interested in trading economies or our young, modestly growing population with their aging, declining population, among many other things. Our continued double-digit GDP growth rate doesn't hurt either. Panama may be better off than many FMs, but it is not alone. From Mongolia to Sri Lanka, there are many options and they are bustling.

So how do you invest in FMs for maximum return? You don't. You invest inside an FM of your choice. You research, you visit, you choose, you move, you live where you will invest. If you are not part of the first wave, you can be part of the second and learn off the first. As I mentioned in my last commentary, my firm's surveys clearly indicate that you will not be alone as far as relocation is concerned. However, if you are a real investor, you will still be in a small minority and the potential can be far greater than in the DMs or EMs. But it is not a walk in the park.

This requires real work. If trading on a monitor is your sole approach to investing, this is not going to work for you. If your time frame for making the big bucks is measured in weeks or months, best to stay at home. If you can look out at least three years, preferably more, you greatly increase the odds of success. You are not there for the weather or the cost of living, you are there to personally research, visit, and inspect potential investments and still be there afterwards to monitor their progress. You are there to live and profit, but you have to contribute. For their sake and everyone else's, armchair analysts should remain firmly rooted to their armchairs.

There are certainly risks involved in investing inside FMs, but if you think you live in a risk-free environment now, think again. And the risks are declining as many FMs grow. The really good news is that with the profound ignorance or, at best, out-dated 20th century understanding of the FMs on the part of so many in the DMs, the competition is nowhere near as severe as in the DMs and EMs. As a result, the odds of an excellent return on investment are declining more slowly.

That's another way of saying that if very few of you decide to seriously consider this approach, I will shed no tears. The fewer who follow this advice, the greater the rewards for those of us who do. But if it sounds intriguing enough to act on, you’re welcome to join us.

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