The thin line between frontier and emerging markets
Since the emerging markets offer greater liquidity than frontier markets, the bigger emerging markets are now crowded with investors. This has made it harder to find bargains on rapidly growing stocks which was what attracted people to emerging markets. Also, some emerging markets have matured to the point that they fail to provide the level of diversification that they once did. This is where frontier markets have slowly but surely started to step in and fill the gap. Going to frontier markets offers more of an opportunity to discover the most overlooked companies.
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Frontier markets outperforming emerging markets
The last year has been a standout year for frontier markets in relation to the emerging markets. The iShares MSCI Emerging Markets ETF (EEM) returned over 20% from January 2, 2013, to January 2, 2014, and thrashed the iShares MSCI Frontier 100 ETF (FM) negative return of -11%. EEM has its major holdings in companies like Tencent Holdings Ltd. (TCEHY), Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), and China Mobile Ltd. (CHL).
Moreover, the MSCI Frontier Index has been less volatile than the MSCI Emerging Markets Index. Part of this is attributable to the fact that individual frontier countries have low correlations with each other. Another reason could be the relatively low level of foreign ownership of frontier-markets stocks. Also, since the emerging markets are more closely correlated to the U.S. markets, taper announcements may have contributed to the increase in volatility. The previous chart shows peaks in volatility in June, 2013, when the Fed first announced its intentions to taper its asset purchase program, and in mid-December, 2013, when the Fed announced that it would start tapering from January, 2014.
Is “frontier” the new emerging?
There are many reasons to believe that frontier market economies will soon shift to the emerging markets category, especially looking at the rate at which these economies have grown and developed in the recent years. Frontier countries such as Vietnam and Nigeria, though at an earlier stage of development relative to emerging-markets countries, are entering a period of mid- to high-single-digit growth, thanks to favorable demographics, infrastructure spending, and an improving business environment.
However, many resource-rich countries like Qatar and the United Arab Emirates (or UAE) have effectively been able to channel some revenues from the export of commodities into infrastructure and social spending.
The next part of this series will focus on the advantages and disadvantages of investing in the frontier and emerging markets.