Insight

Frontier markets offer high growth and low valuations

Investors’ nerves were tested in 2018 in what proved to be a challenging year for markets across the globe. And frontier markets – developing economies that are considered less mature than emerging markets – were no exception. In 2018 MSCI Emerging Markets index fell 9.2 per cent, MSCI Frontier Markets index dropped 11.2 per cent and FTSE All World index fell 3.4 per cent, in sterling terms.

Frontier markets include countries such as Kenya, Nigeria and Vietnam, and are described by some investors as “emerging emerging markets”. They offer exposure to a number of countries that are experiencing higher economic growth than emerging markets and their developed counterparts. And as frontier markets are smaller and less efficient, companies based there can be under-researched and as a result mispriced. This creates investment opportunities for savvy investors who are willing to do their research, and have a strong grasp of the dynamics affecting these markets and their underlying economies.
Although developed markets shrugged off negative investor sentiment in the first quarter of 2018, and performed well in the second and third quarters, emerging markets came under pressure in 2018 as a result of dollar strength, concerns about higher interest rates in the US, and trade tensions between the US and China. Emerging and frontier markets trended downwards between June and October, and sold off sharply in line with developed markets in October. They then staged a recovery between November and mid-December, only to get hit once again by the sell-off in developed markets.
But since the start of 2019 things have improved. MSCI Emerging Markets index is up 3.4 per cent, MSCI Frontier Markets index is up 1 per cent and FTSE All World is up 2.8 per cent. And after a difficult year in 2018, emerging and frontier markets appear to be on attractive valuations.

Appetite for risk
Although frontier markets offer some good opportunities these come with considerable risks. These markets are less liquid, typically have lower standards of corporate governance and can experience periods of political instability. If you are considering allocating money to frontier markets you need to work out whether you are likely to receive enough in the way of returns to compensate for the extra risk, advises Andrew Wilson, chief investment officer at wealth manager Lockhart Capital Management.
“Each individual investor has to include a notional risk premium or margin of safety when investing in this asset class and comparing it to others,” he says. “This is because there is enhanced political, regulatory and liquidity risk involved, and this needs to be accounted for.
While 2018 was a challenging year for most asset classes, not least frontier markets, some commentators argue that fewer inflows and outflows into frontier economies makes them less susceptible to the big risk-on and risk-off flows that happen in other markets. Despite this, any investor considering investing in frontier markets should still have an appetite for risk and a long-term investment horizon. The developments taking place in these economies are likely to take years, so patience is key.

But Mr Wilson says: “I suspect that most investors don’t need the hassle of frontier markets, as there is not that much that is unique that it’s worth the risk.”

Written by Danielle Levy (Investors Chronicle) 31 January 2019