This article is part of Your Guide to Emerging Markets. All this week, we are focusing on emerging markets, sharing their potential pitfalls – and where you can make a pretty penny.
Frontier markets are countries that because of demographics, development, politics and liquidity are considered less mature than emerging markets.
There are 29 countries currently considered frontier markets by indexer MSCI. These are Argentina, Bahrain, Bangladesh, Burkina Faso, Benin, Croatia, Estonia, Guinea-Bissau, Ivory Coast, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Mali, Morocco, Niger, Nigeria, Oman, Romania, Serbia, Senegal, Slovenia, Sri Lanka, Togo, Tunisia and Vietnam.
Unfortunately for those trying to get their head around frontier markets, there's no universally embraced definition of what constitutes a developed, emerging, or frontier market. Classification systems vary widely between indexers and benchmarks.
MSCI examines each country’s economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. The World Bank focuses on a country's economy and, in particular, its relative level of wealth per capita. Countries with high levels of per capita income are classified as developed. Meanwhile those countries with low, middle, and upper-middle incomes per capita, relative to incomes in other countries around the globe, are classed as developing, or emerging.
Countries with even lower levels of income per capita are deemed frontier markets. These tend to have more volatile, less diverse stock markets and the companies have poorer levels of shareholder and corporate governance.
Many of the Middle Eastern stock markets for example are dominated by oil-related stocks, while the Argentinian equity market is equally commodity heavy.
The lack of transparency and information available to investors in frontier markets can mean that a wide disparity between a company’s value and potential for growth and its current share price. This can result in considerable returns for investors. Similarly, because it can be difficult for foreign investors to access these regions, you can make significant losses.
The macro backdrop to frontier markets can be more uncertain, with many regions suffering from civil unrest or engaged in war. These factors are unpredictable and can cause even high-quality stocks to underperform. While the potential rewards for investing in frontier markets are significantly higher than those in developed markets, so too are the risks.
For this reason, frontier markets should only make up a small part of a well-diversified investment portfolio. However, because of the disparate and heterogenous nature of individual frontier markets, experts argue you can experience less volatility in a fund which invests across the sector.
