Frontier markets on the verge of emerging

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  • Frontier markets are similar to emerging markets, only they're smaller and less liquid.
  • Countries in frontier markets grow faster relative to those in developed markets.
  • Not all analysts advocate investing in these markets due to their risk and volatility.

Investors who aren't content with opportunities in emerging markets are now turning to "emerging emerging markets," known as frontier markets.

Frontier markets, which include countries such as Kenya and Vietnam, have economic characteristics similar to emerging markets, particularly rapid growth in gross domestic product. However, the stock markets in the frontier countries are smaller and less liquid than in their emerging-market counterparts. That creates more profitable investment opportunities than in emerging markets, though it also entails greater risk.

The MSCI Frontier Markets Index consists of 25 countries in Latin America, Europe, Asia and Africa. Market capitalizations are much smaller than in the U.S. For example, Bao Viet Holdings, Vietnam's largest insurance company, recently had a market cap of $2.5 billion, compared to $55 billion for American International Group, the biggest U.S. insurer.

You can easily find price information for the biggest frontier market stocks, such as Bao Viet Holdings, on the Internet. But for smaller stocks in smaller countries, prices aren't as transparent. Trading volume for frontier market stocks is generally lower than in the U.S., producing more volatility. And don't count on international financial accounting standards.

As for economic growth, Africa expanded 11 percent annually over the last decade. The International Monetary Fund forecast an economic expansion of 5.8 percent for sub-Saharan Africa this year, compared to 1.1 percent for the developed world, says Adam King, an investment analyst for Signature, a financial advisory firm in Charlottesville, Va.

When it comes to market valuations, the Standard & Poor's Frontier Broad Market Index, excluding the Gulf Cooperation Council for the Arab states of the Gulf, has a price-earnings ratio of 8.6, compared to 10.7 for the emerging-market index, King says. The lower prices relative to earnings make it a better value from an investing viewpoint.

Frontier markets: 'Particularly attractive'

"We think frontier markets are a particularly attractive emerging asset class," says Asha Mehta, portfolio manager at Acadian Asset Management, which invests mainly on behalf of institutions. "They offer inexpensive valuations first and foremost. They also have low correlations with other asset classes, including emerging markets, and offer prosperous long-term economic and earnings growth."

Low correlations among asset classes help diversify a portfolio. However, diversification does not guarantee less portfolio volatility.

So are frontier markets something individual investors should consider? King says yes. But analysts at Morningstar research are less enthusiastic.

If you do want to invest in frontier markets, don't try buying stocks directly. That's difficult, expensive and dangerous. Instead, consider investing in one of about 10 mutual funds or exchange-traded funds, or ETFs, that focuses on this sector.

"I'm not a big believer that an average individual investor needs to buy one," says Morningstar analyst Bill Rocco.

Rocco says you're best off in a diversified emerging-markets fund. If you buy a good one, it probably already has top-quality frontier market shares in it, he says.

"The best and most liquid ideas will eventually get on the screens of emerging-market funds. They're looking for new opportunities, so there's a natural evolution to a broader sphere of markets," Rocco says. "Emerging-market managers will buy the best ones (frontier-market stocks)."


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