Frontier Markets  

Fund Review: Frontier markets as a diversification tool

Fund Review: Frontier markets as a diversification tool
 Performance of MSCI Frontier Markets versus world indices in the past 12 months

Emerging markets may have seen a bounce in investor sentiment in the past year, but frontier markets have lagged their more developed counterparts.

The MSCI Frontier Markets index covers large- and mid-cap stocks with a total market cap of $111bn (£89bn) across 30 frontier countries. These include Kuwait, which is the largest weighting at 18.7 per cent, and others such as Argentina, Pakistan and Morocco. In contrast, the MSCI Emerging Markets index has a market cap of $4.4trn across large- and mid-cap stocks in just 23 countries, including China, India and South Korea. 

While the MSCI Emerging Markets has delivered a respectable gain of 37.6 per cent, in sterling terms, in the 12 months to March 30 2017, the MSCI Frontier Markets benchmark lags behind, with a rise of just 31.2 per cent, data from FE Analytics shows. 

But there are some incentives for investors willing to take on these smaller markets. 

James Carthew, head of research at QuotedData, points out: “As money has flowed out of emerging and frontier markets, this has suppressed valuations. The impact has been more muted in frontier markets as these are dominated by domestic investors. The high GDP growth rates of such economies and low correlation to other developed and emerging market equities are some of the attractions for investing in frontier markets.”

Didier Saint-Georges, managing director at Carmignac, says frontier markets can act as an effective portfolio diversification tool, as well as offering new opportunities.

He adds: “Consequential shifts occur in frontier markets experiencing political upheaval, such as Argentina. After Mauricio Macri’s surprise victory, the new government made the wise choice of lifting capital controls introduced in 2011. Domestic loans to the private sector account for a mere 16 per cent of GDP, putting Argentina among frontier markets with the lowest stock of private credit in the emerging world, implying decades of growth ahead.” 

Meanwhile, James Johnstone, emerging markets portfolio manager at RWC, says that while the asset class has continued to recover in the past 18 months, investors should be aware they are a “disparate group of economies”. 

He notes the light manufacturing economies of frontier Asia have performed well in the past few years as their oil import bill has declined significantly, boosting domestic disposable income while job creation has continued to boom. 

“The ongoing economic success across Vietnam and Bangladesh is likely to be repeated in new frontier economies over the next decade, such as Myanmar, Cambodia and ultimately parts of East Africa including Ethiopia,” Mr Johnstone explains.

“At the other extreme, commodity-linked economies have [suffered] from lower metal and oil prices. Equity markets in countries as geographically diverse as Saudi Arabia, Nigeria and Colombia are all trading at multi-year lows in US dollar terms. Several economies have been forced to endure 1997-style currency devaluations as their external imbalances reached breaking point. 

“However, just as the currency crises in emerging markets heralded a significant economic recovery, we believe there is a very exciting opportunity to revisit the equity markets of Africa, the Middle East and Latin America,” he adds.