Feeling brave? Then head to the frontier

Investing in frontier stocks is of course risky, says Sarah Moore. But these two markets could hold rewards for the brave.

Investing in countries at an early stage of development is fraught with risk. The path of progress from being an impoverished rural economy to an industrialised, urban, capitalist nation is neither straight nor one-way. Many countries get stuck at one stage or another and some even regress. But the rewards for those who invest early in the success stories can be huge.

That's the appeal of frontier markets countries deemed "less developed" than even emerging markets (such as India or Brazil), due to factors such as demographics, political instability and liquidity (the ease of buying and selling assets).

Examples include Vietnam, Nigeria, Myanmar, Iran and Mongolia. Yet despite their classification, many of these countries offer investors several very attractive features large working-age populations, abundant natural resources, fast-growing urbanisation, and increasing investment in infrastructure.

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Myanmar and Iran are both prime examples of frontier markets which have recently opened up to foreign investment. Myanmar's newly liberal government (following decades under military rule) allowed foreign banks into the country for the first time in October 2014, including the Australia and New Zealand Banking Group.

In January of this year, the government approved the "Condominium Law", which allows foreigners to buy property in the country for the first time. And it finally launched its stock exchange last month currently hosting just one member, conglomerate First Myanmar Investment.

As for Iran its economy is already larger than Australia's, but it is only now, with international sanctions lifted, that outsiders are able to take advantage of this potential. Iran's stockmarket has more than 300 listed companies, with a collective market cap of around $100bn and since January, it has already gone up by 28%. The population is young, entrepreneurial and well-educated (60% are under-35, and the literacy rate is over 85%). "Iran is a G20 country in waiting," says Bart Helg of Iran-focused investment firm ACL.

But investing in frontier markets is of course risky. Stocks are often illiquid, and volatility and corruption can be problematic. Myanmar is ranked 147 of 167 in the world for corruption, and the political situation, though much-improved, remains unstable. There is also no guarantee Myanmar won't close itself off to foreign investment in the future.

Iran, meanwhile, could easily face further economic sanctions should relations freeze again, and accessing the market isn't easy many Iranian companies publish financial statements only in Persian, for example.

If you're looking to invest in these sorts of areas, you need to be able to hang on for the long term, and you should only invest a relatively small proportion of your portfolio. There are funds that invest directly in Iran, but the best bet for most investors those without portfolios that are large enough to justify a single-country bet is to find a decent frontier markets investment trust.

BlackRock's Frontier Investment Trust (LSE: BRFI) is one of the best performers in the sector over one and five years, according to the Association of Investment Companies. It currently yields around 4%, and trades at a 3% premium to net asset value (NAV). The BlackRock fund has just under a third of its portfolio invested across Argentina (which has come back into favour with investors following the election of a more business-friendly government), Pakistan and Romania, and significant holdings in Bangladesh and Kazakhstan.

Aberdeen Frontier Markets (LSE: AFMC) previously Advance Frontier Markets has been another solid performer over the past five years, and is trading at around an 8% discount to NAV. Its top three countries in terms of asset allocation are Pakistan, Vietnam and Argentina, with Romania and Nigeria making up the top five.

Sarah is MoneyWeek's investment editor. She graduated from the University of Southampton with a BA in English and History, before going on to complete a graduate diploma in law at the College of Law in Guildford. She joined MoneyWeek in 2014 and writes on funds, personal finance, pensions and property.