As always, while rewards can be unlimited, risk and volatility loom
Investing in new emerging markets, and the even less-developed frontier markets, can be a hugely appealing opportunity for any investor.
As per capita income rises in the BRICS & MINT (Mexico, Indonesia, Nigeria & Turkey) countries and beyond, the increase in demand for luxury goods and services can often be astounding and prove extremely lucrative. Unlike the United States and other mature markets, citizens in developing nations are now purchasing non-necessity and luxury products for the very first time.
While the producers selling products in developed nations struggle to steal market share from one another – often pouring money into R&D, advertising campaigns, and even offering deep discounts to acquire loyal customers – those who venture into less developed nations can be handsomely rewarded with strong market demand and relatively low competition.
In recent years, growth rates of emerging market economies have far outshone the economies of any developed nation. Since early 2009, the FTSE Emerging All-Cap Equity Index has outperformed the United States, United Kingdom, and all-world indices by more than 75%.
But as any seasoned investor knows, huge returns only come with a requisite amount of risk – during the 2008 financial crisis, the index fell by more than twice as much as any of the other indices.
So while the rewards for investing in new markets can be almost unlimited, it is not without risk or volatility. So if you are an investor that might jump ship at any sign of a loss or downtick, be wary of selling off your investment too soon and missing out on the opportunities that present themselves while investing on a longer timeline. It is important to honestly assess your own tolerance for risk in order to determine whether or not involvement in emerging and frontier markets meets your personal investment criteria.
Investors considering allocating part of their portfolio to an emerging or frontier market should carefully consider these three common pitfalls in order to reap the greatest possible reward, and avoid any unnecessary or unexpected risks while investing in these new and upcoming economies:
- Do Not Invest Directly
Unless you are highly experienced in emerging market investing and knowledgeable of the geopolitics of the area, you’ll need to research and invest with a General Partner of an Emerging and Frontier markets private equity fund who is an expert in the specific geographic region in which you are interested in investing.They will select the appropriate projects and investments and manage those investments on your behalf.Critically, you will of course need to carry out due diligence on selecting an Emerging/Frontier markets General Partner from the best private equity firms, just as you would in any other investment situation. - Beware Lack of Liquidity
Compared to the more developed economies, emerging and frontier markets are highly illiquid. Accordingly, it’s important to ensure that you understand your General Partner’s exit strategy, timelines and their ability and strategy to repatriate investments from a foreign currency out of the countries involved to the fund and ultimately, you. There are private equity advisors who are highly knowledgeable of the timeframes, hurdles, and loopholes involved in emerging and frontier market investing and can assist you in your selection process. - Cultural Differences
While most established economies have countless studies on the specific consumer preferences and demands of their populations, emerging and frontier economies have not been studied to nearly the same extent. While some might mistakenly assume that a one-size-fits-all approach is adequate, the truth is that many multinational corporations have failed miserably while trying to enter foreign markets.Compared to the more developed economies, emerging and frontier markets are highly illiquid. Accordingly, it’s important to ensure that you understand your General Partner’s exit strategyJust ask Groupon, who attempted to bring their discount and coupon service to mainland China in 2011, without properly researching the market conditions beforehand[i] After less than a year the company closed their 13 locations and fired over 400 staff members. What had seemed like a match made in heaven – connecting a very price-conscious population with an easy way to get coupons and discounts – became a financial nightmare both for the company, and its investors.
The first-mover advantage gained by being the first brand established in an economy can be huge – just look at a brand such as Kleenex, who have become synonymous with “facial tissues” in the United States and indeed elsewhere.
The brand recognition and consumer loyalty that can be achieved by a corporation with the guts to enter a new market can potentially pay dividends for decades to come. However, investors should be aware that the short-term investment returns that can be gained by purchasing stock or other financial instruments in those corporations can often fall short of the expectations set by other successful private equity advisors.
Emerging and frontier markets can hardly be considered a sure-thing in any way imaginable, they are much more susceptible to political and legal corruption, fluctuating currencies, and quickly-changing regulations. Nationalization of oil profits in Venezuela in the early 2000s[ii] serves as a prime example of just how quickly an appealing investment can turn sour due to political volatility and changing regulations.
Just because an investment looks sound today doesn’t mean it will always be that way. Things can change in developing markets without warning, and investors must be wary of getting caught out in a shifting political environment. Investors should thoroughly educate themselves on the many risks and liabilities that come with private equity investment in emerging and frontier markets, and work closely with General Partners and private equity advisors specializing in the region in which they choose to invest to spread their risk evenly across various geographic areas and investment vehicles.
Borrowing from an old adage, you don’t want to put all of your emerging markets eggs in one basket.
R. Scott Arnell is a founding partner of Geneva Capital S.A., an advisory firm based in Geneva, Switzerland specializing in alternative investments, including advising investors on socially responsible investment opportunities with a high concentration in private equity in emerging and frontier markets. He may be reached online at www.genevacapitalsa.com.
