Brad Durham is a managing director at EPFR Global, a US-based firm that tracks the fund flows and asset allocations of more than 15,000 equity, fixed-income, and hedge funds domiciled globally with $11 trillion in total assets. He shared his views with AsianInvestor about frontier markets, which make up a very small portion of the fund flows EPFR Global tracks.

Do you think the frontier markets have lived up to expectations or has it turned out to be more hype than reality?

Durham: They have lived up to expectations mainly, since they have proven themselves to be part of an asset class that is largely uncorrelated with global markets, with other emerging markets, and also are uncorrelated among themselves. That's been a big draw for institutional investors in the last couple of years, especially since the advent of the subprime and toxic credit crisis when investors are looking for places to hide. And the low correlation argument is real, rather than hype. For example, the S&P Frontier index correlation to the S&P500 is 0.123, compared to 0.337 for the MSCI EM Index.

Their performance has also lived up, or even exceeded, expectations. Over the past five years frontier markets have outperformed emerging markets and developed markets handily. The S&P/IFC Frontier Index has returned an average of 37% per annum over the past five years, compared to the 25% per annum return of the MSCI Emerging Markets Index. Economic growth rates are also faster in frontier markets (7.3% in 2007) than in emerging markets, which have attracted interest from investors.

There have been individual disappointments, such as Vietnam recently which after so much promise is cratering due to the government's somewhat ham-fisted approaches to combating inflation.

Does EPFR track fund flow data for frontier markets as a whole or only for specific frontier markets?

We have two ways of tracking fund flows. There is the traditional investor flows that we track, showing net flows into individual country fund groups and some regional fund groups that are comprised of frontier markets.

The frontier fund groups that we track would include Africa regional funds, Middle East funds, Middle East and Africa funds, Europe/Middle East/Africa funds, Vietnam, Kuwait, Oman, Qatar, UAE, and Ukraine funds). There has to be sizable assets in trackable funds for individual markets for us to track flows for those country funds, which is why we don't track country funds for many of the frontiers.

We are introducing new fund groups as soon as we are able to gather data on a critical mass of funds. We'll be rolling out Pakistan funds shortly for example.

Other funds that we track with exposure to frontier markets include global emerging market equity funds, Asia ex-Japan equity funds, Latin America equity funds, and EMEA equity funds.

Is there a significant demand for frontier markets data?

There is increasing demand for frontier market data from our clients, which is why we are expanding our coverage. For example, last month we were able to increase coverage of Middle East and Africa equity funds from $3 billion to $8.5 billion in total assets. But we're not there yet in tracking total flows for frontier markets.

We have another data set, called equity fund net buy-sell by country, which from a proxy group of 1,000 equity funds with about $1 trillion in assets tracks fund manager net buying-selling by country each month. This data includes more of the frontier markets below but the asset coverage is limited.

How much money is going into frontier markets compared to total fund flows globally?

Year-to-date, the combined emerging market equity funds that we track have had outflows of $5.3 billion. Outflows from US equity funds amount to $61.7 billion, $35.1 billion from Europe equity funds, and $5.9 billion from Japan equity funds. Frontier market funds, conversely, have taken in $2.5 billion of net inflows year-to-date.

What are the challenges you face when gathering data on frontier markets?

Finding enough funds in a market that are sufficiently transparent enough and are willing to provide timely data with a high frequency for the fund flows data to be representative of flows for that particular frontier market.

At this point, have frontier markets still maintained their "frontier" status in the sense that fund managers have not yet crowded out each other?

I don't think fund managers are anywhere near crowding each other out in these markets. Total market cap in frontier markets globally is a mere $465 billion, which is less than half that of either India or Russia's capital markets. And it's less than the total market cap of Exxon Mobil. The market cap of frontier markets does include about 5,000 companies, so there is some breadth for fund managers to own a range of stocks within each market. And since most stocks, and some countries all stocks, are not covered by equity analysts then fund managers are not as focused on a few large caps like in some markets.

What are the main opportunities available to investors who want to start investing in frontier markets?

Look for companies that are in the process of being discovered by sell-side analysts, since these companies tend to rise strongly during this discovery phase. Investors are also being offered a new range of diversified funds investing in frontier markets that are benchmarked against the S&P/IFC and MSCI indices. That gives investors an opportunity to reduce risk by getting broad geographic exposure. Frontier markets are also currently enjoying strong investor flows, which should provide some upward momentum going forward, and favourable investor sentiment as an asset class that is generating positive absolute performances in a very volatile and difficult global market environment.

But a note of caution is warranted. Since many of the frontier markets are commodity exporters, they have a strong correlation with the commodities cycle. If things turn sour for commodity prices, then these markets could get into trouble.

For an in-depth look at frontier markets, see the July 2008 issue of AsianInvestor magazine.