Emerging markets are a great investment, but frontier markets have even higher growth potential. Here are seven reasons they’re not as risky as you think.
Don’t get me wrong. I admire those of you following and investing in the 25 countries in the MSCI Emerging Market index (EEM). They will continue to offer outsized growth opportunities. But risk capital is increasingly pushing the envelope to even higher risk-reward stock markets – often referred to as frontier markets.
Where does the “frontier” theme actually come from?
In 1893, historian Frederick Jackson Turner gave a talk to the American Historical Society stressing the image of the frontier as defining the American idea. The edge of growth that kept moving westward across the continent has, with today’s global economy, spread to every region of the world.
How big are these frontier markets? The top 26 countries that comprise the MSCI Frontier 100 index (FM) have a total population of more than 850 million. The remaining 75 have a combined population of about 800 million. In total, that’s roughly 25% of the world’s population.
These are countries that have less developed, less liquid stock markets and normally smaller economies. Frontier markets are also completely off the radar screen of Wall Street analysts and the financial pundits.
Here are seven reasons for you to get ahead of the game by leapfrogging to frontier market growth.
The Frontier Markets Edge
1. Faster Economic Growth
Thirty-nine of the 45 countries projected to grow 6-7% over the next five years are frontier markets. A study by Everest Capital puts 17 of the 20 fastest-growing economies in the world in the frontier camp.
2. Favorable Demographics
A young population means lower financial burdens for government and a dynamic consumer class catching up to the west. About 40% of the world’s 15-to-24-year-olds live in frontier countries, versus less than 10% in North America, Japan and Europe
3. Low Debt
The government debt in these markets averages around 45% of GDP – half that of developed countries.
4. Integration with the Global Economy
Due to breakthroughs in communications and rising demand from multinationals for low-cost labor, resources and new consumer markets, frontier economies have gone from being out of the loop to smack in the middle of it.
5. Attractive Market Valuations
Because listed frontier market companies remain hidden to many investors, bargains abound.
Frontier markets account for 25% of the world’s population and 12% of the global economy but less than 3% of the market value of all companies trading on world stock markets. This gap will eventually close.
And because frontier markets have been out of favor, valuations look particularly attractive. One private frontier-market fund I follow reports a portfolio with a trailing price-to-earnings ratio of 6.6, a price/book of 1.2, a dividend yield of 6.5%, and a return on equity of 25%.
6. Inefficient Markets
While this cuts both ways, one could argue that because frontier markets are small and less liquid, high-quality companies sometimes can be picked up at bargain prices by alert investors.
For example, fueled by Mongolia’s globally significant copper and gold deposits, investors bid up Mongolia’s stock market 900% in dollar terms from its 2009 low to its 2011 high.
Unfortunately, eight years on, that market is 69% below that high.
7. Low Correlation to Other Markets
Blending in some frontier stocks to your portfolio will actually lower your portfolio risk and volatility since these markets tend to march to the beat of a different drum. When developed or emerging markets head south, frontier market stocks can go the other way—their fates are not intertwined with the more developed markets.
Studies show that the frontier market index only moves with the MSCI World index or MSCI Emerging Markets index 35% of the time.
In short, these markets offer you the opportunities that emerging markets like China offered 20 or more years ago. To put this in perspective, China’s total exports in 1980 were equal to one day of exports in the China of 2010.
In 1990, China’s economy was equal to that of Taiwan; it is more than 15 times bigger!
The Frontier Market Challenge
It is not easy to find the right way to capture frontier market growth. With only a few exceptions, frontier market companies do not normally trade on major U.S. exchanges. And most frontier funds are private due to the high costs of following these markets.
Vietnam (VNM) is the only frontier market with a country ETF, and even then you must weigh its tremendous opportunities offered by its industrious, dynamic, fast-growing middle class against poor fiscal policies and the dead hand of its government.
A more efficient way to invest in frontier markets is via either the iShares MSCI Frontier 100 ETF (FM) or the Global X Next Emerging & Frontier ETF (EMFM), which is are up 21% and 8% respectively so far this year and have exposure to countries like Argentina, Kuwait and Peru.
These markets are not for the faint-hearted, but adding even a little exposure could add some high-reward punch to your portfolio.
*This post has been updated from a previously published version.