In the early 1990s, Russia emerged from decades of socialism
into the world economy as an undercapitalized new target for investors. Those investors who were willing to accept
the risks Russia presented during its decade of transition were able to earn large
returns on their investments. Today,
Russia is no longer such a “frontier market” and is now seen by most economists
as one of the world’s premier emerging markets.
A similar
story may be told about all developed countries today. The United States was a country of marginal
economic relevance to the rest of the world before its development began in
earnest.
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| Common Frontier Markets (MSCI FM Index Countries) |
Across the globe, there are dozens
of countries poised to begin the process of major development and emergence
into the global economy. Categorically,
these frontier markets (or “pre-emerging” markets in some analyses) are
countries with an investible stock market and relatively low market
capitalization. Common features of these
countries include underdeveloped financial infrastructure, poor quality
regulation, and inadequate reporting requirements.
Despite these risky features of
frontier markets, an upsurge in manufacturing in these countries has caught the
attention of investors. The workforce in these countries is generally young,
relatively well educated, and cheaper to employ than its emerging or developed
market counterparts. Several
multinational corporations are beginning to recognize this and are relocating
their manufacturing operations to these emerging markets.
Risk remains an ever present
concern however for investors in frontier markets. In addition to the risk factors already
mention, foreign companies face the risk of nationalization especially as these
countries undergo political transition parallel to economic emergence. The most prominent risk in frontier markets
is illiquidity. Because of
undercapitalization and low trading volume, investors can find themselves stuck
with a souring investment in some circumstances. The return offered by emerging markets can
offset this risk if investors are willing to bear this risk.
Frontier markets can also serve to
further diversify a portfolio.
Generally, frontier markets are uncorrelated with developed or even
emerging markets. Given this
characteristic, it should be no surprise that hedge funds are among the largest
investors in frontier markets.
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| Blue=Frontier Market MSCI Index Orange=World minus US Index Green=G7 MSCI Index *Note the lack of correlation between the FM index and developed world indices |
There is of course no guarantee
that these new markets will develop like Russia or any one of the BRIC
nations. Within the MSCI frontier market
index there are 23 heterogeneous countries.
These countries all have different economic histories, laws, politics,
and geography. Investors must as always
carefully select investments based on fundamentals and personal goals within
the context of reasonable expectations.
Whether or not frontier markets
will offer windfall returns to brave investors remains to be seen. Investors interested in more information
about frontier market should consult with their financial advisor to find a
specific investment that is right for them.
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