An Established Case and Emerging Trends for Frontier Markets Equity Investing
The terminology ‘Frontier Markets’ inspires images of exotic geographies, colourful politics and investor adventurism. Yet the investment outcome for a globally diversified and liquidity focused FM portfolio is much more predictable and reliable; underpinned by over two decades of proof statement. If the idea of investing in markets that have historically produced strong long-term US dollar returns (higher than Emerging Markets) with lower correlation to global markets and less volatility sounds attractive, then read on. This paper starts by summarising the well-founded advantages of investing in Frontier Markets and small Emerging Markets (abbreviated here and typically also in the industry simply as ‘Frontier Markets’), before turning to more recent drivers that are set to continue to transform the investment opportunity.
The proof statement for Frontier Markets investing
The long established investment case for Frontier Markets (FM) can be framed around four interrelated structural drivers:
1 | An incubator for future Emerging Markets FM is a diverse and global universe that is undergoing periods of structural change and economic reform. In short, it comprises Frontier Asia and Europe, the Middle East, Andean countries and Africa. Each country has their own balance of domestic growth drivers and are each at their own stage of development. In common is their often-earlier stage of development than core Emerging Markets (EM) and their typically overlooked nature. Consequently, one way of considering FM in a global allocation is a ‘portfolio that considers all the markets you do not already own’ or the ‘next wave of EM’.
PROOF STATEMENT: The last decade has seen several FM reclassified to EM reflecting their success implementing reform, institutionalising their capital markets and meeting international regulatory standards. For example, the UAE, Qatar, Pakistan and Kuwait, with potentially Iceland and Vietnam next to follow suit.
2 | Strong historic US dollar returns FM companies have generated sustainably high return on equity, above that of EM, given the underpenetrated nature of sectors of their economy as well as their often-oligopolistic position in the local market. This structurally high ROE, above and beyond that of the cost of capital, has historically produced strong stock US dollar market returns.