Like emerging markets, many frontier markets are also aggressively investing in infrastructure so that they can better compete in a global marketplace. may clamor for frontier investments.
But as recent events in the Ukraine illustrate, venturing into frontier investment can entail considerably more risk than emerging markets, which is a point that advisors should be ready to explain to their clients.
Nevertheless, frontier markets have outperformed emerging markets over various time frames in recent history and may be appropriate for some clients.
Understanding Frontier Markets
Frontier markets can be described as economies that have reached a level of maturity that emerging markets reached 20 to 30 years ago. That applies to political stability (or instability), liquidity of capital markets, diversity of sectors, and fiscal strength.
Since frontier markets have yet to reach the more advanced stages characterized by emerging markets, they can represent considerable risk.
The Ukraine, which is typically labeled as a frontier market, illustrates this point. Ukraine officials are lobbying the international anti-terrorist group Interpol to charge former Ukraine president Viktor Yanukovych with murder and abuse of power as Russia is flexing it military might in the country’s Crimea region and seeking to have the region fall under its governance.
Crimea is important to the Ukraine as it includes shipping ports to the Black Sea and other commerce assets. As the geopolitical crisis has continued, Ukraine’s currency has declined by more than 30% and the stock prices of many companies based in the Ukraine have also dropped precipitously.
Despite the inherent issues with frontier markets, the asset class has generated attractive returns, especially when compared to emerging markets. For the one-year period ended at the end of February, the MSCI Frontier Index was up 17.76% compared with the 7.96% decline of the MSCI Emerging Markets Index, according to MoneyWeb’s Investment Insights.
For the three year period, frontier markets generated an annualized return of 3.36% compared with the 4.32% annualized return of emerging markets. MoneyWeb points out, however, that emerging markets generated stronger returns following the market lows that were reached during the subprime mortgage crisis.
Take on Risk
Strong performance aside, investors should take note of the risks associated by frontier markets. This concern hasn’t been overlooked by regulators.
The Financial Industry Regulatory Authority, for example, has issued a warning that risks associated with emerging markets are generally magnified in frontier markets. The warning adds that the markets can have limited investment opportunities, less liquidity and lower investor protection.
With that in mind, it includes frontier markets on its list or products that it is concerned over regarding brokers’ marketing practices. Even managers of frontier market funds acknowledge that the asset class entails risk.
Mark Mobius, who is the skipper of more than $40 billion in assets, including frontier markets equities, at Franklin Templeton, has recently said that this is a good time to investment in frontier markets. Yet, he acknowledges that liquidity can be a problem.
In the past, the firm has closed certain funds to new investors in what may be a response to liquidity concerns. Like other asset classes, frontier markets may help diversify portfolios. And, like other asset classes, advisors should carefully assess if frontier markets are appropriate for each clients’ investment time horizon and willingness to ride out volatility.Last modified on Saturday, 08 March 2014