Author: Todd Millay (Forbes)
Investors searching for growth are increasingly looking beyond the more familiar emerging markets to “frontier markets.” While it was rare for family office investors to invest in even the largest emerging markets such as China and India as recently as 20 years ago, now emerging markets are an established part of most family office investment portfolios. Frontier markets will likely make the same journey over the coming decades, and investors who can bear the risks of these markets will profit. For investors with long-term investment horizons who can withstand volatility and liquidity, frontier markets can provide access to attractive growth potential and offer portfolio diversification benefits.
Frontier markets consist of rapidly growing and industrializing countries with less developed capital markets such as Kuwait, Argentina, Vietnam, and Nigeria. These countries are in earlier stages of economic development than their emerging market neighbors and have fewer investable companies. Frontier markets can be found all around the world, from Africa and the Middle East, to developing markets in Asia, Eastern Europe and Latin America.
Frontier markets are characterized by a lower degree of market openness and political stability than emerging market countries. According to the IMF, frontier market countries (as defined by MSCI) have roughly 900 million people and make up roughly 12% of the global population, the majority of which is young. This creates enormous potential as this wave of population begins to enter their most productive years without the burden of a large elderly population to support.
Here’s what wealthy family office investors know about frontier markets that you should too.
- •An undiscovered gem. According to the index provider MSCI, emerging markets made up approximately 1% of global market capitalization 30 years ago. By 2015, emerging markets had increased to nearly 10%. Similarly, frontier markets in 2015 made up less than 1% of global market capitalization and could follow a similar growth trajectory. While they are becoming popular with family offices, frontier markets are still relatively undiscovered by most retail investors, with only a handful of mutual funds currently available.
- •Patience yields profits. Liquidity is an important issue for investors in frontier markets. Companies tend to have more restrictions on foreign investors, and trading volume is much lower than in developed markets. This can make both entering and exiting positions more challenging, especially in times of market stress. This is an asset class where patience is necessary to capitalize on the long-term theme.
- • Frontier today, emerging tomorrow. While frontier markets are risky, many are now in periods of relative stability, with political reform and greater democracy allowing for further development and investment in infrastructure and a more favorable business environment for investors. Frontier markets typically trade at cheaper valuations than their more developed peers and have higher dividend yield. The support of population and policy should translate into stronger GDP growth for frontier markets. The ultimate path for a frontier market is to grow into an emerging market. Both the United Arab Emirates and Qatar recently graduated from frontier to emerging market status.
- •Uniqueness brings diversification. Not only do frontier markets have low correlations with developed and emerging markets, but they have very little correlations amongst each other as well. Individual frontier market countries are quite distinct from each other. For example, Kuwait is one of the larger countries in the frontier market index, and is classified as a high-income country by the World Bank, while another large index country, Nigeria, is classified as lower middle income. The issues are impacting Nigeria today due to low oil prices have very little impact on Argentina or Pakistan, and investing in a broad range of frontier markets reduces the volatility and risk of investing in any individual frontier market in isolation. Argentina has just been through a major election and is in the process of enacting sweeping political reforms.
While many frontier markets are positioned for long-term growth, capitalizing on the demographic and resource potential requires supportive policies and economic investment. The risk remains that policy mistakes could limit future returns. Like emerging markets, not all will converge on the same path and several will likely see setbacks along the way. Still, for patient investors there is a compelling case for future returns.
Source: (Forbes)
