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Are frontier markets worth the risk?

Frontier markets offer a huge pool of natural resources for investors to tap in to, but political and geographical uncertainty add plenty of risk to the potential reward

Oil Barrel Crude Shipping Fuel 480

This month’s hostage crisis in Algeria made headlines around the world. The terrorist attack on the natural gas facility is another reminder of the security issues at many oil and gas sites.

Social and political unrest is also being seen in neighbouring Mali and the ongoing Arab Spring has seen a revolutionary wave of demonstrations and protests that have forced rulers from power in Tunisia, Egypt, Libya and Yemen.

Despite the unrest, it is impossible to ignore the natural resources such as oil, gas and coal that make these countries attractive to investors who are happy to take higher levels of risk.

Chinese oil firm Sinopec has excav­ation rights to Algeria’s Zarzaitine oil field and the gas field of Tiguentourine is run by Algerian energy group Sona­trach, partnering with BP and Statoil.

BlackRock director of emerging mar­kets Sam Vecht remains positive on frontier markets. Vecht’s £85m Black­­Rock Frontiers Investment Trust has exposure to 20 frontier markets inc­luding the United Arab Emirates, Saudi Arabia, Kazakhstan, Croatia, Kuwait, Ukraine, Qatar, Nigeria and Algeria.

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Vecht says there are 160 countries classed as frontier markets and despite the political unrest he remains adamant there is huge investment potential.

Vecht says: “The key thing is not to pack and run every time something hits the news. It is worth thinking what may happen ahead of time. We have been pretty negative on Mali for some time, long before the recent unrest.”

Vecht says BlackRock has analysts on the ground in all the frontier markets where it invests. The Frontiers Investment Trust has 2.4 per cent exposure to Algeria through a holding in a telecom company.

Vecht says: “I am bullish for 2013 and in the last 13 years I have not often been bullish. I think the global environment is improving, the US is clearly recovering and I would advocate having a relatively aggressive portfolio.

“We continue to be positive on frontier markets. There is a wonderful combination of strong GDP growth and less debt than emerging markets, stocks with high dividend yields, stocks at low valuations and stocks that have low volatility. We think 2013 will be a very good year for frontier markets.”

Vecht says 10 per cent of his port­folio is exposed to energy and he views energy companies in Iraq and Kazakhstan as attractive investments.

He says: “Iraq is clearly a place where there is political risk, but there is also potential for massive upsize of energy production.”

Thames River co-head of multi-manager Gary Potter believes the macro outlook for natural resources is weak and therefore he does not hold any natural resource funds.

He says: “We have held natural resource funds in the past but we do not at the moment, partly because the macro outlook is relatively weak.

“If you look at F&C year-end figures, oil is down 2.6 per cent over the last year. We are not excited about oil.”

However, Potter concedes there is plenty of investment activity in Africa and off its coastline.

He says: “There is a lot of Chinese money going into Africa to places like Rwanda and Congo, where natural resources are pretty good. Accessing a pool of natural resource stocks through a capable fund manager is the best way to invest in this area.”

Sector Investment Managers chief executive Angelos Damaskos, who runs the Sector Investment Managers £17.7m Junior Gold and £35.5m Junior Oils trust funds, says the Brent oil price may see a sharp spike if tensions in the Middle East between Israel and Iran continue to mount.

Damaskos says: “We have been saying since last year the situation in North Africa and in the Middle East has meant the Brent oil price is staying at higher levels. It is likely to trend higher in 2013 – that is our view. We believe the Brent oil price will remain [at] $110 to $125 a barrel.

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“The Algerian unrest is further testament to our view that the geopolitical problems in North Africa and the Middle East are unlikely to be resolved in the near term.”

Skerritt Consultants head of investments Andy Merricks says: “I am nervous of frontier markets – emerging markets in general, but particularly frontier. If you look at the correlation between emerging markets in general and commodities over the past 10 years, it is almost identical.”

Merricks suggests a slowdown in China’s growth will have an impact on the global demand for commodities.

“If growth in China is slowing, which I think it is, the demand will slow in China, which will knock on to the frontier markets,” he says.

Hargreaves Lansdown senior investment manager Adrian Lowcock is also wary of the frontier markets investment story.

He says: “The markets are underdeveloped and quite new so they tend to have lower regulatory and compliance requirements.”

He says any frontier markets exposure should be from fund managers “on the ground” with expert local knowledge. He also stresses the need to diversify investments across countries with an expectation of high localised volatility.

“Blips and volatility are part of the game in frontier markets,” he says.

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