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developed markets, or even other frontier markets
is very low. Each frontier market tends to have their
own opportunities, and challenges, and with their
own currency, political landscape, and natural
resources they show quite different behaviours in
stock market performance.
• Demographics tend to be favourable with
relatively young and fast-growing populations.
• Low labour costs mean that they attract industries
from developed markets, and even emerging
economies. Consider the current shift from Chinabased
manufacturing of low cost goods to Vietnam
and Bangladesh.
• Immature financial markets in frontier countries
mean that with fewer local and international
investors valuations are relatively lower than those
in emerging and developed markets. Further, these
markets are not very actively researched which
present opportunities to generate sustainable
longer term returns.
But with all the good news, frontier markets are
exposed to a number of risks too. For example,
the possibility of war and terrorism, policy shifts,
political instability, corruption and immature
financial markets can depress share prices. In
addition access to these markets can be difficult
with troublesome account opening procedures,
capital controls, low liquidity and limitations on
foreign ownership of listed companies. All of these
challenges are also seen in emerging markets, but
perhaps to a lesser extent.
Given the idiosyncratic risk involved with each
frontier market, the best way to invest in frontier
markets is to select a number of them in order to
diversify the idiosyncratic risk away and benefit
from the overall expected higher GDP growth
translating into share price performance.
Through the low correlation between the various
frontier markets, investing in a number of them
will reduce the overall volatility to a level that is
significantly lower than that of the MSCI World
Index. For example, the volatility of our AFC Asia
Frontier Fund is only 9.71% while the correlation
between the Fund and the MSCI World index since
inception nearly four years ago, is only 0.34. At the
same time, its correlation with the MSCI Emerging
Markets index stands at an even lower 0.33.
Annualised Volatility Cumulative Returns*
AFC Asia Frontier Fund 9.71% 68.22%
MSCI World Index 11.80% 19.07%
MSCI Emerging Market Index 15.30% -28.72%
MSCI BRIC Index 19.02% -34.60%
MSCI Frontier Markets Index 12.30% -2.96%
MSCI Frontier Markets Asia Index 15.24% -3.17%
How to obtain frontier market exposure
One way investors might like to get exposure to
frontier markets is through an ETF. While this may
be a good approach in developed economies, in
frontier markets this tends to be a disappointing
choice. In many cases frontier markets ETFs have a
large to very large tracking error. This is the result
of the difficulty of investing in these immature
markets, caused by low liquidity which increases
bid-offer spreads and trading costs, limits on
foreign ownership, and trading suspension
arrangements during volatile periods.
Actively managed diversified frontier funds
may be a better choice. A fund manager that can
invest in a range of frontier countries can assess
the idiosyncratic risk of each of the markets at all
times, and shift the funds to the most promising
markets. He/she could also manage currency risk
in the same fashion.
An active manager also has the capability to
select the best companies in his/her universe for
investment, and since the frontier markets are less
mature, competition for the best stocks is less,
offering more chances for undiscovered gems
and undervalued quality companies, resulting
in better chances for active managers to be able
to generate alpha compared with the developed
markets.
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