If you’ve never heard of frontier markets, then get ready. You are likely to do so a lot more over the coming years.
In the meantime, there is potential for savvy investors to profit.
“These frontier markets are the next generation of economic leaders,” says David Dali, a portfolio strategist at Matthews Asia. “Frontier markets may be small, but the prospects for growth are not.”
The category includes countries such as Saudi Arabia, Bangladesh, Kenya, Jordan and Sri Lanka.
Dali says that while the growth in emerging markets, like China, has now started to slow down, the frontier markets are more likely to power ahead. (The slowdown in emerging market growth is a natural phenomenon — as countries get bigger and more developed they have to decelerate, at least from their previous pace of growth. China grew as much as 10 to 15 percent a year in the early 1990s versus less than 7 percent recently.)
[See: 9 International ETFs That Are Off the Beaten Path.]
When compared to developed markets, like Western Europe, and emerging markets, frontier markets are the least economically developed of the three.
“These market classifications were created by index providers, such as MSCI and S&P, based on the level of economic development and accessibility of their capital markets,” says Jay Jacobs, director of research at Global X in New York.
The index companies have different lists of frontier countries, but there is plenty of overlap.
Typically, frontier market economies might not be very diversified, perhaps relying on a single industry. For instance, Kuwait relies on energy for 90 percent of its government revenues, and 92 percent of the country’s exports come from the same sector.
And sometimes countries might have stringent capital controls, Jacobs says. Frontier market countries with a recent history of controlling the cash entering or leaving include Argentina and Nigeria. Such restrictions tend to deter investors from investing in such economies because they worry that they won’t be able to get their cash out when they either need it or want it.
Room to grow. But these countries also have something that emerging markets are losing — the potential for fast growth.
“The growing consumer base in these frontier markets is extremely strong,” Dali says.
People are entering the middle class at a rapid rate, plus the populations of many such countries have a low median age, which means there is a rapidly expanding workforce, Dali says.
Because of that investors are likely to do well.
“Over the next 10 to 15 years it’s likely that they could deliver growth ahead of any other equity class,” says Robert Harvey, a portfolio manager at Matthews Asia.
[See: The Best Energy Stocks to Buy for 2017.]
Remember the risks. That potentially high growth comes with risk. Investing in such markets will likely mean more price volatility than investing in more developed markets. That’s normal. Big rewards tend to go hand in glove with larger price swings. Anyone wanting to invest in the sector should be prepared to take a long-term view. That means thinking about what will happen to the investment in 10 to 15 years, not 10 to 15 months.
Also, it is probably best for most investors to make such an investment within a diversified portfolio of assets, says Stephen Wood, chief market strategist at Russell Investments in New York. In addition to holding frontier markets stocks, investors should also own other asset classes such as bonds and stocks from developed markets.
What to buy? Small investors should consider funds rather than trying to invest directly in local markets. Funds help spread the risk over a variety of companies and countries.
Consider the following exchange-traded funds:
Guggenheim Frontier Markets ETF (ticker: FRN) tries to match the performance of the BNY Mellon New Frontier Index, an index of frontier market stocks. It isn’t broadly invested, with the top five holdings accounting for around 25 percent of total assets compared to around 12 percent for the SPDR S&P 500 ETF (SPY). The fund has expenses of 0.7 percent a year, or $70 per $10,000 invested.
iShares MSCI Frontier 100 ETF (FM) tracks the MSCI Frontier Markets 100 Index. Like the Guggenheim fund, with around 21 percent of assets in the top five holdings, it is concentrated. Expenses are 0.79 percent a year, or $79 per $10,000 invested.
Global X Next Emerging & Frontier ETF (EMFM) is a hybrid of stocks from emerging markets and frontier markets but notably doesn’t include securities from the so-called BRIC countries — Brazil, Russia, India and China. It has much broader holdings than the other two ETFs, with the top five holdings accounting for around a 10th of the assets. The Global X fund tracks the Solactive Next Emerging & Frontier Index and has annual expenses of 0.56 percent, or $56 per $10,000 invested.
[See: 9 ETFs to Capture China’s Red-Hot Growth.]
Mutual fund buyers could try looking at the Morgan Stanley Frontier Markets (MFMPX), which is an actively managed fund and has annual expenses of 2.03 percent, or $203 per $10,000 invested. Like the Guggenheim and iShares funds mentioned, it has a concentrated portfolio with around 22 percent of assets held in its top five holdings.
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Why You Should Consider Frontier Markets originally appeared on usnews.com
