3 Small Frontier Markets Could Leap Forward This Year

 | Jan 26, 2017 | 8:00 AM EST
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With President Donald Trump's attack on China's trade policies and his signing of an executive order to start building the Great Wall of Mexico (let's call it that for now, for lack of a better moniker), investors would be forgiven for thinking that emerging markets are getting out of fashion.

Still, to expand on a point I made yesterday, the differences in terms of business environment between developed and developing countries are narrowing, and not in a good way: developed markets are slipping, rather than emerging markets progressing.

In this context, investors should take advantage of the reality that sentiment around emerging and frontier markets is weak because of Trump's stance and look for opportunities for longer-term growth.

Tina Byles Williams, portfolio manager, CIO and CEO at asset manager FIS Group, has flagged that MSCI might promote three countries from frontier market status to emerging market status in the course of this year. This means more money would pour into their assets because they would qualify for funds that invest in emerging markets. The three are Argentina, Romania and Pakistan.

Argentina shows "reasonable valuations, continued market reforms, added liquidity, and falling inflation and interest rates all," Williams said in her outlook for the first quarter. Her fund is long Argentina.

U.S. investors seeking exposure to the Latin American country could look at the Global X MSCI Argentina ETF (ARGT) , which tracks a market-cap weighted index of at least 25 companies either headquartered or listed in Argentina and that carry out most of their operations there.

The ETF is tilted heavily toward energy (31.71%), technology (19.46%) and financials (16.99%), sectors that are in favor currently due to an environment of higher oil prices and rising interest rates.

Romania is not such a clearly bullish case. The country is in the grip of a struggle between the government, dominated by former communist social democrats, and the president, a liberal. At the heart of the struggle is the push by the former communists for legislation that in effect would pardon officials condemned for corruption.

There have been massive street protests against the government's measures, which the president has joined; the situation is far from resolution. Still, according to Williams, "improving eurozone growth and sentiment will soon trickle out of the euro area into the cheaper, faster-growing markets in Eastern Europe, especially Romania."

There is no direct way for U.S. investors to gain exposure to the country's stock market short of opening an account with a Bucharest-based broker, which probably would be time-consuming. However, there may be an easier route -- via London. Fondul Proprietatea, a fund set up to pay damages to the victims of the communist regime, is listed on the London Stock Exchange under the symbol FP and offers exposure to the biggest companies in Romania.

Alternatively, investors could take a look at the New-York listed ADRs of the biggest international companies operating in the country. French retailer Carrefour  (CRRFY) , Austrian energy company OMV (OMVKY) and Austrian banks Erste (EBKOF) and Raiffeisen (RAIFF) are some of these.

On Pakistan, Williams noted that the MSCI Pakistan surged 41.5% last year, driven almost exclusively by demand from local investors, as foreign investors were net sellers during the year. This means there is a "much more organic and sustainable turn in the Pakistani market," she said.

Pakistan's interest rates are at their lowest level in more than 30 years and companies' earnings are set to benefit from tax cuts as the government lowered corporation tax to 30% from 35% in 2015.

U.S. investors can get direct exposure via the Global X MSCI Pakistan ETF (PAK) , which is dominated by energy, banking and materials firms.

Frontier markets are a big gamble, as they often are plagued by political and social crisis and their markets are not as liquid as those of more established emerging markets. However, if these three countries are set to make the jump from frontier to emerging market status, investors could benefit.

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