Rick Welch: Dollars and $ense

Frontier Markets – The Wild West

Looking for a bit of adventure? How about adding some excitement to the opening of your investment portfolio statement each month? If you are comfortable venturing into uncharted territory without the benefit of a track record and are looking to match potential high returns with greater risk, then the frontier markets might be for you. Please proceed, however, with due caution as frontier market securities are subject to loss and should be evaluated carefully before investing.

 Frontier markets are often referred to as “pre-emerging” or the “new emerging markets”.  These markets, which are a subset (about 3.5%) of the emerging market asset class, offer low correlation with most developed global markets and the potential for significant returns over the long term.  Frontier markets are less transparent and have lower market capitalization and liquidity than the more developed emerging markets.  Typically, a market is categorized as frontier if it is too small, too restrictive (either by choice or limited capacity) to foreign investment or simply less developed than those markets considered to be emerging ones.  Most investors are familiar with the main risks associated with frontier markets, which include political instability, poor public infrastructure (roads, public transportation networks and modern sanitary services) and ineffective court systems.  What frontier markets often do have are young and growing populations, abundant natural resources, cheap labor costs and high single or double digit economic growth potential.

During this past summer most emerging markets declined due to weak economic growth and fears about the effects of an anticipated reduction in risk-supporting monetary policy here in the United States.  Year-to-date stock price performance has left much to be desired as most emerging market benchmarks are reporting losses of about -3.0%.  This downward slide has been led by the main stays of this category, the BRICs, with Brazil (-8.6%), Russia (-2.4%), India (-5.4%) and China (-4.7%) all contributing to period losses.  In contrast, the frontier markets were quite strong as seen in a +18.5% climb in the benchmark MSCI Frontier Markets Index.  Most analysts believe that frontier markets have been less impacted by US monetary policy because they have realized little of the benefit of the unprecedented support of asset prices seen here at home. Sebastien Lieblich, a research director of index compiler MSCI, recently said it best. “Frontier markets are very much focused on internal demand and they exhibit relatively low correlation to the more global markets…and that probably explains why we see a great performance year-to-date in the frontier markets.”

The growth of the frontier markets today reminds many investors of the growth experienced by the BRICs in the early 2000s.  Examples of these new emerging markets can be found in all parts of the globe starting in the west in the Americas (Argentina, Jamaica and Trinidad and Tobago), moving east to Europe and the former Soviet republics (Bulgaria, Croatia, Estonia and Ukraine) then to Africa (Kenya, Nigeria and Zimbabwe), to the Middle East (Jordan, Kuwait and Qatar) and finally to Asia (Bangladesh, Pakistan and Vietnam).  Indices for this asset class are relatively new with the first index being launched in 2007. Though the competing indices (S&P, MSCI and FTSE) have wide variation, common themes are seen in largest market weightings (Argentina, Kenya and Nigeria) and largest sector weightings (Banking and Industrials).

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