How many investors have heard of frontier markets? Investors looking for a greater return will often look outside core Western markets at Emerging markets. Although there is an overlap between Emerging and Frontier markets, they are different due to one being more established and recognised. The lack of coverage of frontier markets offers greater returns as companies are supported by faster growing economies.
The distinction between Emerging and Frontier markets
Why they are attractive to invest in
How you can invest in Frontier markets
Frontier markets are smaller, riskier and less liquid than other markets. Emerging markets are bigger and more liquid than frontier ones. Examples of countries included in Frontier markets would be Pakistan, Peru, Poland and Vietnam.
Although these are countries that many have heard of, few will have thought of them as places to invest in. Their stock markets are smaller and less liquid than their more famous larger more established rivals.
The largest 8 emerging market economies include China, Brazil and India among others. You can see the difference in size compared to the aforementioned Frontier market countries. You could consider Frontier markets as a sub sector of emerging markets. One often under-appreciated attraction, is they tend to have less Geo-political risk. Although these countries will have regional tensions, they are unlikely to be involved in an international political crisis. The same cannot be said of India and China. The latter in particular has been caught up in a trade war with the USA. As a result, Chinese stocks sometimes have the hallmarks of the most volatile stocks.
Domestic politics are a key part of the success of its constituent stocks. This can be attractive due to the diversification benefits. A company listed in Peru will rarely be affected by the same political events as in Pakistan. This also applies economically – their economies are uncorrelated.
More specifically, many of these countries have young populations who are ambitious. They are likely to create wealth, which companies based in these markets can tap into.
As Frontier markets are often overlooked by Western investors, they do not contain as many overvalued stocks. This means you can find growing undervalued stocks paying attractive yields. Growth with income can create a powerful compounding effect.
It would be easy to assume that creative accounting is the norm in such less regulated countries.
The only fraud they have seen was in the UK!
Interestingly they do not. according to the managers of the Blackrock Frontier Investment Trust the only fraud they have seen were UK based!These were UK listed foreign owned companies whose business took place in Frontier countries.
UK investors have the aforementioned Blackrock Frontier Investment Trust. Blackrock owns the iShares brand. You therefore benefit from Blackrock’s huge research department. A slightly more exotic Frontier market available for UK investors is iShares Saudi Arabia.
US investors have an iShare offering: iShares MSCI Frontier 100 ETF which seeks to track an index of frontier market equities. Again for those wanting to venture of the beaten track, Van Eck has an offering covering Vietnam. Vietnam has attracted plaudits for the development of its economy.
Although foreign portfolio investment is a sensible form of diversification, you should be aware of the risks. Systematic risk will have a greater negative impact on less developed countries. Indeed a global sell off will likely cause greater volatility in these shares.
Covid-19 is disproportionately affecting less developed countries. Many of these are in Frontier markets. This will have some affect on their economies. In turn this may well stop companies growing their profits.
The roll out of Covid-19 vaccines will be slower, and may only take place in 2022. A margin of safety is therefore advisable. You can achieve this by limiting the size of your exposure to 2% of your portfolio.
Thematic investing has a habit of moving on to the latest theme, which can lead to sector rotations. This could be a chance for you to invest before others do. Although Covid-19 will hold back some Frontier countries, good quality companies will adapt and profit. By ignoring these markets, you are failing to appreciate upside risk that these markets present!