Dr. Mark Mobius
Executive Chairman,
Templeton Asset Management Ltd

An Insight into Frontier Markets

In the last 20 years, we have seen emerging markets grow dramatically in terms of the number of companies listed as well as the rise in market capitalization and daily turnover of those companies. Emerging markets continue to progress into a major asset class as evidenced by a plethora of major IPOs (Initial Public Offerings), high capital inflows and fund-raising activities as well as the success of initiatives such as the BRIC (Brazil, Russia, India, China) funds.

Given the continuing trend towards the adoption of market economy models and privatization of state owned enterprises, investment opportunities have been enhanced in the so-called "frontier markets". Frontier markets are typically economies at the lower end of the development spectrum. They are generally smaller and less developed than emerging markets but have the potential to grow at a fast pace and could become tomorrow's emerging markets. They are where many emerging markets were 20 years ago when we started our first emerging markets fund. China, for example, was considered to be a frontier market about 15 years ago. Its market capitalization grew from US$18 billion as of end-1992 to US$4,700 billion as of end-June 2008. We must remember that some emerging markets could fall into the frontier markets category.

By offering investors with the opportunity to invest in a "younger generation of emerging markets", frontier markets provide an attractive investment opportunity. Investors have become increasingly liberal and are open to new investment ideas. This is especially the case now where concerns of slowing growth in the US and its impact on major economies globally have led investors to look elsewhere for investment opportunities. Frontier markets could provide them with an ideal opportunity to diversify their portfolios due to its lower correlation with global markets.

Many of the characteristics that have made emerging markets fascinating to investors are now becoming increasingly evident in frontier markets. These characteristics include:

• Positive economic trends such as high growth
  Frontier markets such as Qatar and United Arab Emirates (UAE) and Panama, are forecast to grow 11.8%, 8.4% and 7.0%, respectively, in 2008, while developed markets such as the US, UK and Japan are expected to have much slower growth of 1.5%, 1.7% and 1.3%, respectively.



• High potential for capital market development and growth
  The market capitalization of frontier markets such as Bangladesh, Botswana, Estonia and Tunisia is less than US$10 billion while larger frontier markets such as Croatia, Romania and Ukraine have a market capitalization of US$50 billion to US$100 billion. These numbers pale in comparison to emerging markets such as China, India, Brazil and Russia, all of which have a market cap of greater than US$1,000 billion, with China actually surpassing US$4,000 billion. Moreover, 15 years ago, for example, China and Brazil had a market cap of just US$18 billion and US$45 billion, respectively. Thus, the potential for growth is phenomenonal.



• Low correlation to world markets due to their diversity
  The relatively low correlation of frontier markets to global markets provides investors with an opportunity to diversify their investment portfolio. As indicated in the table below, the correlation coefficient between the S&P Frontier Markets Index compared to the three major MSCI Indices, MSCI World, MSCI Europe and MSCI Emerging Markets is about 0.6.




2-year Correlation Coefficient	MSCI World	MSCI Europe	MSCI EM
Source: Factset, as at 30 June 2008 in USD; Past performance is not indicative of future performance.
S&P Frontier Markets	0.65	0.58	0.64




• Attractively valued companies
  Many companies in frontier markets are very are selling at low prices particularly considering their high growth. For example, markets such as Estonia, Kazakhstan, Latvia and Panama are all trading at a price-to-earnings (P/E) ratio of less than 8x. In comparison, the US and Japan are trading at a P/E of 17x and 16x, respectively.
  
  
• Typically under-researched
  The number of investment brokers and asset management companies that research and provide coverage for frontier markets is very low and is much lower than that for emerging markets. Thus, early investors could have an added advantage.

Frontier markets have also been outperforming developed and emerging markets despite the recent turmoil in global financial markets. In general, these markets have not been adversely affected by the credit crisis in the US or fears of a US recession and continue to benefit from investors looking to diversify away from markets such as the US. In the one-year period ended June 2008, the S&P/IFCG Bangladesh, Cote d'Ivoire and Mauritius indices returned about 60% in US$ terms while the S&P/IFCG Lebanon index returning more than 100%. Other markets such as Trinidad & Tobago, Tunisia, Kenya and the Slovak Republic all returned about 30%. In comparison, the MSCI World index declined 10% in US$ terms.

While it is clear that frontier markets offer investors with an attractive investment opportunity, one should not forget that challenges also exist. These risks include poor information, illiquid stocks and sudden government policy changes. Africa, for example, is an area that we expect to see much progress, but of course it is not for the faint hearted as there will be set backs along the way. However, the continent is rich in commodities and land and thus makes an attractive investment destination.

We as portfolio managers manage these issues by diversification, having a healthy margin for error in all the stocks we select for investment and by staying out of one or two countries where the economic and political outlook is just too difficult to predict.

The problem of obtaining the information to analyze the companies in a timely fashion is mitigated by the fact that we have analysts based in frontier markets such as Vietnam and the UAE. While investing in frontier markets is currently more challenging than researching emerging markets, it is still easier than when emerging markets started many years ago due to the experience we have gained over the years and our establishment of offices with analysts all over the world in Latin America, Africa, Asia and Eastern Europe. Nothing replaces "on the ground" company visits to gain good insights into how companies are operated.

Frontier markets are going to develop into emerging markets and we want to provide our investors with the opportunity to take advantage of their growth.

Please click for more information on the following funds:
FTIF - Templeton Asian Growth Fund
FTIF - Templeton BRIC Fund
FTIF - Templeton China Fund
FTIF - Templeton Eastern Europe Fund
FTIF - Templeton Emerging Markets Fund
FTIF - Templeton Emerging Markets Bond Fund
FTIF - Templeton Emerging Markets Smaller Companies Fund
FTIF - Templeton Japan Fund
FTIF - Templeton Korea Fund
FTIF - Templeton Latin America Fund
FTIF - Templeton Thailand Fund