Not long ago it was regarded as the height of daring to invest in emerging markets such as Russia or Brazil. But now a whole new group of even more exotic countries have appeared on investors’ radar.

The new frontier markets, which include everything from Vietnam and Bangladesh to Kazakhstan and Colombia, take the risk-reward equation to a new level. Some companies investing in these countries, such as Tullow Oil, which operates in Ghana and Uganda, have reaped spectacular profits from their ventures.

In Tullow’s case, its dramatic growth has propelled it into the FTSE 100 index of leading companies. But others, such as Emaar, a large property developer, suffered setbacks in volatile regions, such as the Middle East.

There is no clear definition of what a frontier market is, says Bernard Moody, of Progressive Asset Management, a fund group that takes a special interest in the sector. But he adds: “They tend to be much less closely linked to the developed West than emerging markets.”

They also tend to feature a high proportion of local retail investors with little coverage or research by international investment banks. This makes for potential rich pickings for the handful of professional investors who do concentrate on these more exotic regions.

One thing that Western investors have to overcome is their often excessively negative picture of many frontier market countries, says Mark Dampier, of Hargreaves Lansdown, the independent financial adviser. “Our view of a country such as Vietnam is all too often stuck in a time warp that owes more to Apocalypse Now than any up-to-date picture of SouthEast Asia. The reality is that Vietnam is now a thriving economy and one of the most successful frontier markets.

“In the same way, many investors tend to think of the Democratic Republic of Congo as being a permanent killing field. Serious problems still remain, but it is now home to some of the most dynamic energy and mining companies in Africa.”

Some companies operating in frontier markets leapt to the forefront of investors’ attention by obtaining a listing on the London stock market. Not many people knew much about Kazakhmys, the copper mining and smelting company, until it listed in London in October 2005. Nor did they have much knowledge of Kazakhstan, the former Soviet republic, where the bulk of the company’s assets lie. If asked to name one thing about the country, most people would have said it was the home of Borat, the scary fictional TV reporter.

However, Hardeep Tamana, of Fyshe, Horton, Finney, the stock broker, is quick to point out: “The country is rich in natural resources. In addition, with the collapse of the Soviet Union, it inherited a lot of old-style industries, such as mining and smelting, which looked unpromising but have been turned around and made profitable, as in the case of Kazakhmys.”

Another much underrated frontier market is Bangladesh, says Slim Feriani, also of Progressive. He says: “It is still a poor country and subject to natural disasters, such as flooding. But financial reforms are under way and, with a population of 160 million, there is a huge untapped consumer market. Individual stocks we like include Brac, a bank focusing on retail customers and small businesses.”

The case for frontier markets is that they have fantastic potential. They tend to have higher growth rates than emerging markets, while stocks are on lower valuations. Wage rates are still very low, compared with emerging nations such as China, so there is the prospect that Western companies increasingly will outsource production to frontier nations.

John Hatherly, of Seven Investment Management, the wealth manager, says: “Buying into frontier markets today is rather like being a venture capitalist investing in a growing company. You are getting in at an early stage in development.”

However, there are also significant drawbacks, he says. The markets are much smaller and less liquid than those in more developed countries. The financial infrastructure is much less developed, corruption can be a problem and some frontier countries do not have a proper stock market.

“The majority of available local frontier stocks tend to be tiddlers, which by definition, are speculative,” he says. “To gain balanced exposure to frontier markets, you need a diverse portfolio of stocks in different countries, which is difficult for individual investors, given the potential problems of currencies, tax and lack of knowledge of various markets.”

The dangers are well illustrated by Zimbabwe. Last year it was the best-performing stock market in the world, but anyone holding Zimbabwean shares now has a virtually worthless asset because of the depreciation in the country’s currency.

Mr Dampier believes that the rapid emergence of frontier markets is set to overturn our thinking about the Third World. “There is a big bang going on involving the mass urbanisation of three billion people in developing countries,” he says. “It will dwarf what took place in the British and US industrial revolutions. It will be a rollercoaster ride, but those in at the start could make a lot of money over the next couple of decades.”

Frontier pioneers

For all but the most intrepid, investing directly in frontier market shares is virtually impossible.

The alternative way in would be through a fund, although the choice is limited.

Marcel Porcheron, of Bestinvest, the independent financial adviser, says that Progressive’s Advance Frontier Markets fund is just about the only one offering full exposure to the sector.

The Genesis Emerging Markets fund also has a reasonable slice of up to 10 per cent in frontier countries.

Other funds that have some frontier exposure include Templeton Emerging Markets and Advance Developing Markets, though the frontier element is heavily outweighed by the emerging element.

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