Hidden gems - frontier markets!
Frontier markets - those considered too risky, illiquid or small to enter most emerging markets indexes - can offer huge rewards for those investors brave enough to go exploring!
Investors' nerves were tested in 2018 as global markets plummeted, with news headlines dominated by the escalating tensions between the US and China. Frontier markets were no exception.
The MSCI Frontier Markets index experienced a larger decline than its developed peers, dropping 11.2% versus a fall of 9.2% for MSCI Emerging Markets and 3.2% for the FTSE All World, in sterling terms.
The magnitude of this fall was particularly surprising, since frontier markets usually have a low correlation to other global stock markets. Frontier markets are developing economies which are considered too small, risky or illiquid to be classed a fully-fledged emerging market.
As a result, they have unique growth drivers and different risk characteristics compared to global peers. They are also often under-researched, meaning they trade at attractive valuations even if they display strong growth prospects.
James Johnstone, co-head of emerging & frontier markets at RWC Partners, said:
"Smaller emerging economies and larger, more liquid frontier markets are offering a compelling investment opportunity similar to that which we saw in larger emerging markets 10-15 years ago".
"They have low correlations to both developed markets and each other, offering investors a truly diversified range of companies and countries."
Low correlations
These low correlations are a key reason to consider adding frontier markets to a diversified portfolio.
A 2014 study by FTSE Russell found the correlation between frontier and developed markets over a five-year period was 0.58, while the correlation of emerging and developed markets was 0.88.
Separate academic research1 also revealed that while developed markets historically outperform when their central banks pursue expansive monetary policies, frontier markets enjoy higher returns in the opposite circumstances.
Rob Gleeson, head of research at FE, said:
"The diversification is key. If you can find markets that will make gains and losses at a different time to the rest of the portfolio it is very valuable, as most assets move in the same direction at any given time."
Although 2018 saw losses for frontier and developed market alike, historically frontiers often outperform global equities during downturns.
"You have to remember that not every sell-off is the same,"
said Gleeson.
"The escalation of trade wars is a singular event which affected all markets equally, but what about when interest rates go up, or GDP figures come in weak? Markets don't go up and down in isolation. The long-term trends are correlated, but the short-term events are random."
Country selection
However, due to the diverse nature of the frontier market investment universe, being selective is of key importance when investing in the region.
Index provider MSCI classifies 33 countries as frontier, including
Argentina,
Kuwait,
Kenya,
Morocco,
Oman
Vietnam
Many of which have different growth drivers and economic prospects, so returns can vary greatly.
List of Frontier markets below - worth to notice Estonia and Lithuania which are booming, and are underestimated because of the size of the country. However, those 2, IMHO, can lead the innovations in EU, which Estonia already is doing!
* Frontier Markets countries include: 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
Source: Investment Week MSCI and MSCI classification