Practical analysis for investment professionals
04 September 2013

Frontier Markets Faring Better than Emerging Markets

It may not compare with the “Great Rotation,” but mutual funds that invest in emerging markets have reportedly seen more than $2 billion in outflows so far in 2013, while funds focused on frontier markets, often referred to as “pre-emerging” markets, have seen assets under management swell by more than $1.5 billion in the year to date. What explains this divergence in fortunes?

Performance-chasing investors have no doubt noticed that the MSCI Frontier Market Indices have returned 10.5% through August of this year while the MSCI Emerging Markets Indices have returned −11.9% over the same period. Look beyond the numbers, however, and the answer seems to be related to the comparative degree of integration into the global economy and the appetite for foreign capital.

The current turmoil in emerging markets can be traced back to May, when the US Federal Reserve first indicated that it would begin to “taper” its bond buying program. It was the loose monetary policies and low interest rates of the US, as well as other developed nations, including the United Kingdom and Japan, that sent yield-starved investors in search of higher returns in emerging economies. This capital, along with strong demand from China, helped to fuel economic booms in emerging market darlings like Brazil, India, Indonesia, and Turkey. For these same countries, the reversal of this capital flow has resulted in currency weakness, rising interest rates, and slower growth. More recently, concerns about further destabilization in the Middle East and rising oil prices have served to further undermine prospects for emerging market economies.

Frontier markets have managed to escape some of the problems facing emerging markets in part due to neglect; that is, they are too small to matter to most investors. Representing just 20% of the world’s population and only 10% of global GDP, frontier stocks comprise just 2% of global market capitalization. Because of their relatively small size and limited liquidity, frontier equity markets don’t attract “fast” money. Frontier market investors tend to be specialized managers who, by necessity, take a long-term view. While frontier market equities were not beneficiaries of the huge wave of liquidity that spilled into emerging market stocks, they also avoided the sell-off when this tide began to reverse course.

Despite the perception that frontier stock markets are dominated by commodity producers heavily reliant on demand from China and other fast-growing economies, financial firms make up over half of the MSCI Frontier Markets Indices. Many of the major energy and resource firms are global multinational companies or government-owned, with smaller firms often listed in London or Toronto. Whereas the stocks of emerging market firms are often leveraged to the fortunes of the developed world, frontier market equities tend to more pure plays on the growth of their home countries.

The unrest in the Middle East and the corresponding spike in oil prices have undoubtedly caught the attention of consumers and investors in those developed and emerging markets that are net importers of oil. This problem is only compounded in the case of countries with weakening currencies, most notably India. With frontier stock markets dominated by financial, telecommunications, and consumer stocks, the impact of rising energy prices is comparatively benign.

Zambian-born economist Dambisa Moyo, author of Winner Take All: China’s Race for Resources and What It Means for the World, sees significant opportunity in frontier markets, noting the solid capital base, young labor pool, and improving productivity that is characteristic of these markets, particularly those in Africa. She also points to the lack of correlation with the economies of developed and emerging markets as another selling point for frontier stocks, though she acknowledges deepening economic ties to China make them vulnerable to a slowing Chinese economy.

Charles Robertson, global chief economist at Renaissance Capital and lead author of The Fastest Billion: The Story Behind Africa’s Economic Revolution, is also bullish on Africa’s prospects. He thinks sub-Saharan Africa will overtake China and India as the economic growth story of the future. Renaissance predicts that Africa’s economy will grow from $2 trillion to $29 trillion by 2050 — greater than the current economic output of both the US and eurozone.

Of course, frontier markets are not without risks. In Frontier Market Equity Investing: Finding the Winners of the Future, Larry Speidell, CFA, sees opportunities in frontier markets — he’s also keen on sub-Saharan Africa — but potential pitfalls as well. Local politics must be understood, and there are pockets of corruption and instability. Further, liquidity is scarce, transaction costs can be steep, and currency risk is real. As if that’s not enough to worry about, there’s also the risk of nationalization.

While frontier markets have delivered for equity investors so far this year, offer the allure of potential great growth, and have until now avoided many of the troubles plaguing emerging markets, they remain suitable only for investors with the expertise to navigate the many risks and the fortitude to stay for the long haul.

(Note: Charles Robertson will be speaking at the upcoming CFA Institute European Investment Conference.)

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

13 thoughts on “Frontier Markets Faring Better than Emerging Markets”

  1. Sub-Saharan Africa could be the growth story of the future, but there are some major hurdles it must clear along the way to make that happen. The biggest hurdle in its future is the same thing that has propelled its position today – its reliance on China. It will rise and fall with the Chinese economy, and could be seen as a levered play on China in the near-intermediate term. If the Chinese growth story continues, Africa will grow with it, and will be able to extend its influence and diversify its supply route. Meanwhile, there are frontier stories all over the world that have just as much potential for growth. Because of the globalization of the world’s economies and amount of interest in emerging & frontier markets (with and without QE), there will be a growing interest in retail structures that target regions of emerging economies, and themes that spread across multiple borders. Globalization is breaking down borders and creating a “sources vs best uses” world. Frontier markets may be the fastest growing region in China, the fishing industry in the Philippines/Indonesia, or the hospitality sector in Mexico/Venezuela/Cuba. As interest in Frontier Markets grows, so will the possibilities.

  2. Dave Larrabee says:


    Thanks for visiting our blog and sharing your thoughts. I agree that many frontier markets are not immune to a slowdown in China. Your points on globalization are also well-taken and appreciated.


  3. Ankit says:

    Hello Dave,

    I wanted to know on what basis countries are define as Frontier or Emerging markets?


  4. Dave Larrabee says:

    Hi Ankit,

    The definition of a frontier country varies. Standard & Poor’s, Russell and MSCI have different methodologies for determining which markets are classified as “frontier,” but there is considerable overlap in the constituents of their respective frontier indices. The common criteria (besides not being already classified as developed or emerging) seem to include accessibility to foreign investors, economic and political stability, and some minimum level of liquidity.

    The websites of each of these index providers have more details on their respective index construction methodologies.

    Thanks for visiting our blog!


  5. Mudassar Ali Khan says:

    Hi Dave,

    I am a resident of Pakistan and CFA Level II passed and would like to know that how do u see the role of Pakistani stock market in the MSCI Frontier Market index?

    Do u think Pakistani Stock market share will increase in MSCI Frontier Market Index as in recent months Pakistani stocks have shown a rapid growth.


    Mudassar Ali Khan FCCA

    1. Dave Larrabee says:


      Pakistani stocks have been among the strongest performers of the frontier equity markets this year. From my distant perspective, they seem to be responding to political stability (a fair election and smooth transition of government) and capital inflows, in part due to an amnesty program, begun in 2012 and set to expire in 2014, that allowed investors to invest in stocks with no questions asked from tax authorities about the source of funds.

      If this relative performance trend were to continue, it is likely that Pakistan would be given a larger weight in the MSCI Frontier Market Index.

      Thanks for visiting our blog!


  6. Anand Bhandari says:

    Dear Dave

    Good day,

    I appreciate your blog post and agree with the content.

    Do you foresee the current selloff in the Emerging Market will continue, and whether the EM currency will depreciate further?


  7. Dave Larrabee says:


    I wouldn’t hazard a guess as to when the selloff in emerging market stocks and currencies ends, but as this year has certainly demonstrated, most emerging markets are reliant on developed markets to help drive their growth.


  8. Adedapo ADEDIRAN says:

    Thanks for the article.

    Growth is most likely going to come from Africa in the next decade(s). This will be driven by favorable demographics, increase in income (albeit from a low base) and corresponding increase in consumption (propensity to save is low in some of the economies), and increase in both consumer and business sophistication. These will help to both stimulate demand and institute profitable supply channels.

    However, there are few areas of caution: first, investors will need to keep an eye on the political landscape as mentioned in the article.

    Second, investor need to ensure that the businesses they are investing in are configured to circumvent the hurdles infrastructural deficits pose. Business models and strategies that could circumvent the deficits are important because of three things- first, they reduce the cost structure of the firms significantly. Second, they often give firms with them competitive reach. Third, the infrastructural deficits are key barriers to entry which increases the long term productivity of industries in the markets. By playing with such models and strategies, the firms at play tend to capture the inherent profitability.

    Finally, investors should make sure that effective corporate governance mechanisms are in place in businesses where they invest.


  9. Dave Larrabee says:


    Your observations and advice on Africa are both valid and appreciated. Thanks for visiting our blog and adding to the conversation!


  10. Cho Zenwan says:

    The key is to be comfortable with the frontier market (FM) that you are investing in. Many FM indexes are heavily weighted in the Gulf States – Gulf Cooperative Council (GCC). So, pick a GCC only ETF, like MES, and then pick the country specific ETF’s that look like winners. In any event, over the long term, if you pick your countries and you don’t overweight GCC – FM will increase risk adjusted returns to any diversified portfolio.

  11. megzari says:

    Do you have an Idea of asset under managment benchmarked to the MSCI frontier markerts ?

  12. Currently it is easier to play “Frontier Markets” using a combination of strategies. If you believe in the rise of the middle class then you can place your bets through multinational FMCG companies as well as large infrastructure equipment suppliers. Coca-Cola, Unilever, Diageo, Philip Morris, Nestle, Siemens….You get the point. South African companies have also already made large inroads to Sub-Saharan Africa. Another problem is the fragmentation of these markets coupled with the lack of infrastructure. While the demographics are ripe for a major growth phase in Africa the legal and social infrastructure coupled with this fragmentation is likely to impede any real advancement. Vietnam, Pakistan and the like are more likely to advance at a faster clip until some of these problems in Africa can be overcome.

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