Recent months have seen a burst of interest in Asian "frontier markets" – countries where stock markets are so small they fail to qualify as emerging markets, and that are difficult for foreign investors to buy into, but have potential to grow rapidly.
Countries such as Kazakhstan, Sri Lanka, Vietnam and Mongolia, and even Indian Ocean island states such as the Maldives and Mauritius, are on Asian investors' radar. (Mauritius may be physically closer to Africa but its population is largely Indian, and the economy is increasingly integrated with Asia.)
Many may suffer political upheavals, weak corporate governance, unstable economic growth and illiquid capital markets.
But such risks could mean big rewards, say supporters of frontier market investing.
The term "frontier market" is not new. Twenty years ago, the terms "frontier" and "emerging" were often interchangeable.
Now emerging market investing is mainstream, and many of the risky looking bets then, such as South Korea, are relatively mature and developed. They have also become increasingly correlated with big markets, and that makes them less attractive as a way to diversify risk.
The S&P/IFC Frontier Index, which tracks 22 frontier countries, is a decade old. It showed a total return of 40.8 per cent in dollar terms in the first 10 months of 2007.
"As long as global markets do not spend all year in a nervous state, 2008 could be the year when Asia's frontier markets come of age," says Garry Evans, Asia-Pacific equity strategist for HSBC in Hong Kong.
"It is true these markets remain small. The largest of them, Pakistan, has a market cap of only $73bn [£37bn], compared with more than $200bn for both the Philippines and Thailand.
"Liquidity for some of these markets is not bad: Pakistan has an average daily turnover almost three times bigger than the Philippines, and Vietnam is not far behind Manila. However, the smallest markets are laughably tiny."
Nevertheless, Mr Evans says, Asian investors are becoming more adventurous and are prepared to look outside the 12 main markets in the region. He expects several launches of frontier funds in the first half of the year.
Big players are increasingly interested. MSCI Barra last year gave the idea of frontier markets more credibility when it launched a family of tradable frontier markets indices covering 19 countries, including Sri Lanka and Vietnam.
"There is so much liquidity in the world, and much of it is trying to find new investment opportunities," says Rajendra Nair, one of the managers of JF Asset Management's Asia New Frontiers Fund. It was launched in Hong Kong in November, and is aimed at retail investors. So far, it is investing in five markets: Pakistan, Vietnam, Kazakhstan, Sri Lanka and Bangladesh.
"In many cases they have underperformed mainstream markets and are trading at a substantial discount to them - with good reason. But regardless of that, we believe there is an opportunity in these markets," Mr Nair says. All of them have relatively steady economic growth and attractive demographics, he adds, which can insulate stock markets from political instability.
"Take Bangladesh," he says. "Last year the democratic government was overthrown by a military coup. There's martial law and political uncertainty. But guess what: [by November] that market was up 80 per cent. It has outperformed MSCI Asia Pacific indices by a wide margin."
Franklin Templeton has attracted more than $320m to its emerging markets smaller companies fund since its launch in Hong Kong in October. (There is also a US version.) The fund is not marketed as a frontier market fund, but most of its investments are in such countries.
"One must not get carried away with the hype and pay excessive prices," says Mark Mobius, executive chairman, who has been involved in emerging markets for two decades. "Take Vietnam, for example. While we believe that the market has good potential, its valuations are currently high."
But Peter Bartlett, managing director of Exotix fund managers in London, is sceptical. "Some might say Asia, Vietnam and Mongolia are frontier markets. But they're not in our terms. We are looking to set up an account in Vietnam," he says. "But it's not very exotic any more. It's quite mainstream."
Exotix manages about £6m of funds and is investing in places such as Cuba, North Korea and some of the smaller Pacific islands such as Nauru and Fiji.
Mr Bartlett thinks "frontier" is just a buzzword for fund managers trying to differentiate themselves from emerging market, long-only and hedge funds to attract customers.
"Frankly, a lot of people who are using the phrase are paying lip-service to their investors," he says. "They don't really know what they are talking about."Source: ft.com