Strategies for Investing in Emerging Economies: An Insight into Frontier Markets
Venturing into the world of investments can be like navigating a jungle, with various countries labeled as stocks and bonds in neat little "boxes." One such box that doesn't quite fit its label is the frontier market. Initially, these seem like exotic investment destinations, with their own benchmark indices like the MSCI Frontier Markets index. However, upon closer inspection, it becomes clear that the line between frontier and emerging markets is rather haphazard.
For a market to qualify as emerging, its stock market must meet certain criteria: it needs to be reasonably liquid, open, and somewhat transparent. If it doesn't meet all these conditions, it gets placed in the frontier market category, even if some of the countries in question seem like they should be labeled otherwise. Take Vietnam, for instance. Despite its striking similarities to countries like the Philippines, Malaysia, and Indonesia, it finds itself relegated to the frontier market category.
Frontier Markets: More Than Just a Label
In essence, frontier markets represent an eclectic mix of countries that are on the cusp of becoming emerging markets. What sets them apart is their country-specific returns, as opposed to being significantly influenced by global factors. Consequently, they typically exhibit a lower correlation with worldwide markets, and their connection to the economic powerhouse of China is far less pronounced.
These markets also have some compelling characteristics. With a population of three billion, they demonstrate favorable demographics, boast surprisingly robust fiscal governance with low levels of debt, and are often under-researched and under-owned. Have you ever heard anyone investing in Romania, a frontier country, or Kazakhstan? If not, you're not alone.
Investing in frontier markets can be done through various indexes, such as the MSCI Frontier Markets index, which meticulously analyzes whether a market is liquid enough, has a sufficient number of listings, and has attracted foreign investor interest. The index consists of 28 countries and 216 individual companies, with an average market value of just $570 million. Vietnam is the index's biggest country, with 25% of the index, followed by Romania and Morocco, which both make up around 12%, and Kazakhstan.
While the performance of frontier markets has been adequate, it can be somewhat underwhelming compared to other indices. Since 2011, the Frontiers index has lagged the MSCI ACWI (All Country World Index) in ten of the 13 years, only outperforming in three. The annualized returns over the last decade are a modest 2.6%, in contrast to the MSCI global ACWI's return of 6.5% and the MSCI EM index's 3.64%. However, the stocks and countries in the index are still relatively cheap, trading at a price/earnings ratio of just 10.5.
The frontier index is dominated by financials, with banks comprising nearly 40% of the index, followed by energy stocks at 10%. IT barely gets a look-in, accounting for less than 1% of the index. There aren't many funds that offer exposure to frontier markets, but the quality of what is available is surprisingly high. One popular option is the BlackRock Frontiers Investment Trust, a fund that invests not only in frontier countries like Vietnam, Saudi Arabia, and UAE, but also in smaller emerging markets like Indonesia and Poland. The fund has produced impressive returns over recent years, with a total return of 45% since launch.
- The frontier market category, housing countries like Vietnam, Romania, and Kazakhstan, comprises emerging markets on the verge of growth, often characterized by diverse, country-specific returns and a lower correlation with global markets.
- Investing in frontier markets can provide unique opportunities, as these under-researched and under-owned countries, such as Romania or Kazakhstan, demonstrate favorable demographics, robust fiscal governance, and low debt levels, offering potential for growth in the technology, finance, and other sectors.
