The idea of investing is always about choosing the dark horse. Many people go towards emerging markets because they offer higher awards, but with greater risk.
So this naturally brings up the question: what about frontier markets? Countries like Kazakhstan and Sri Lanka, where the markets are too small to be classed as emerging could be a very useful approach to investing. Let’s dive into it.
What Are Frontier Markets?
There are three different types of markets, developed markets for these would include the UK or the US, emerging markets like China and Russia, and then Frontiers markets.
There are many Frontier markets investments and there are approximately 30 frontier markets mainly focused on Africa, Asia and the Middle East. To be classed as a frontier market, it needs to meet a sufficient level of subjective criteria, such as having two companies worth $700 million each (approx £500 million).
What Makes Frontier Markets So Special?
The reason they are so appealing to investors is the small-scale of it all. When you compare the market value of an emerging market stock which is around the 20 trillion-dollar mark (approx £14 trillion), but frontier markets have a combined market value the proximity $510 billion (approx £366 billion), this means that the trading volume is smaller, and the number of companies is fewer.
As the participation is less widespread in comparison to emerging markets this becomes a usually contested battleground. Additionally, there are tighter restrictions on who can own the shares.
Because they have limited links to the outside world, the less developed aspects of frontier markets make them very appealing. Many frontier nations can be prone to specific risks, for example, hyperinflation or investments getting locked up because of meltdowns in currency.
This means that the stocks are less volatile and lose less value in the face of a global crisis. For example, the frontier markets lost approximately 50% value in 2008, compared to other markets that lost a lot more!
Should We Invest in Frontier Markets?
As many state and local investors invest in frontier markets, it becomes a very hotly contested market. One of the biggest attractions with this is that you can get there before all the crowds. If you invest in frontier markets, get there before they become upgraded to emerging markets.
For example, a country like Pakistan grew so much that it got promoted to emerging market status at the end of 2016, although it struggled to hold on to its status in 2019.
As a result, these markets have been very rewarding to long-term investors. And if you are looking for a profitable investment, it certainly is a very enticing prospect, but you have to recognise that with any investment, there is always a gamble. This could depend on political crises, for example, in Sri Lanka, this stock index fell 10% at the end of 2018.
Frontier markets certainly are a great investment but the market does shrink because many countries are graduating to become an emerging market. If you are looking to start in frontier markets, it’s best to get in quickly.
