Globalization is shrinking the world, noted Speidell. Today it is easier for knowledge, outsourcing, and other opportunities to reach the frontier markets. Young, rapidly growing populations are another plus. All of these make it more likely that frontier markets will follow the successful paths of their emerging market brethren.

Frontier markets have two important risk characteristics for the overall portfolio:

1. As a group, frontier markets’ overall volatility is low—much lower than that of the traditional emerging markets and sometimes lower than the S&P 500 and EAFE (see graph below) because individual frontier markets are loosely correlated with one another.
   

Source: Frontier Market Asset Management

2. Frontier markets have low correlations with developed markets—and their correlations are much lower than emerging markets’ correlation with developed markets (see graph below).

Source: Frontier Market Asset Management

Incorporating a diversified group of frontier market stocks into a broader portfolio can potentially reduce portfolio volatility.

Frontier markets can be risky on a country-by-country basis because these countries tend toward volatile political and economic environments. Also, access to their stock markets can be cumbersome, liquidity can vary, custody can be a challenge, and IPO allocations can be discriminatory.

But this is where Speidell’s optimism comes in. He sees improvements in the ways frontier market governments and economies function. Also, access to stock markets and to company information is improving. In the meantime, Speidell said, “There’s a big payoff for those practicing good financial analysis.”

How much to invest?

“If you are an optimist, you can put 25% of the equity portion of your portfolio into frontier market stocks,” said Speidell. That’s how he has invested personally, with his frontier investments complemented by 25% in traditional emerging markets, 30% in the U.S., and 20% in non-U.S. developed markets.

“High net worth investors will tone down that allocation,” acknowledged Speidell. He suggested they put one-third of their emerging market allocation into frontier markets. They should be long-term investors in these markets, he said, because trading costs are high and these markets will mature over long time horizons.

At State Street Global Advisors, Managing Director George Hoguet suggested that individual investors put no more than 1% of their equity investments into frontier markets. “Frontier markets will be volatile,” he said. They’re also illiquid, with big political risks, and they could suffer significant periods of underperformance.

Still, Hoguet likes frontier markets because some of them, like the Middle Eastern countries and other oil producers, are benefiting from an economic boom. Frontier markets also offer the possibility of return enhancement, diversification, and a broader opportunity set. In addition, “They may follow the evolution of emerging markets,” he said. If that happens, there could be an advantage for those who invest early.

Display article as PDF for printing.

Would you like to send this article to a friend?