Diversification: Finally, companies in frontier markets tend to just focus on demand in their local countries and thus are less tied to the global economy than emerging markets like China and Brazil. As my colleagues Del Stafford and Daniel Morillo pointed out last fall in blog posts, this means frontier markets have exhibited a low correlation to emerging and developed markets and can add some diversification to a portfolio.
Market Realist – The graph above shows the correlation coefficient between frontier markets (FM), emerging markets (EEM)(VWO), the S&P 500 (SPY)(IVV), and high-yield bonds (JNK)(HYG). The graph shows that frontier markets have low correlations with other asset classes.
The correlation between frontier markets and the S&P 500, considering monthly returns for ten years, is 0.41 compared to 0.82 for the S&P 500 and emerging markets. The correlation between frontier markets and the U.S. index is even lower than the correlation between high yield bonds and the S&P 500, which stands at 0.79.
This means that frontier markets add diversification benefits to a portfolio containing only U.S. stocks and even a portfolio containing emerging markets and high yield bonds.
Please read the next part of this series to learn the caveats associated with investing in frontier markets.