Do you want to invest in small economies that offer the potential for explosive growth? Consider putting part of your portfolio into frontier markets.
These are typically underdeveloped third-world countries. Think places like Kenya, Vietnam, Jamaica, Bangladesh, or Morocco. They also usually have strong GDP growth and fast-growing populations.
These are “emerging emerging markets.” The MSCI Frontier Markets Index tracks 25 of them in Europe, Asia, Latin America, and Africa.
So should you invest in this speculative area? That depends. Frontier markets offer potentially overlooked opportunities. They are typically less crowded with global investors. So, they offer the potential for gain . . . but they are risky and speculative investments.
Let’s look at some of the main benefits of investing in them.
1. Good Value
These countries can be hard to invest in so they haven’t had a big influx of foreign money yet. That can mean reasonable valuations. Now, not all investments in frontier markets are worthwhile, but there can be hidden gems.
2. Low Correlation
Increasing correlation between asset classes makes truly diversified asset allocation tough. Frontier markets have lower correlation with other assets, including emerging markets.
3. Rapid GDP Growth
Most of these countries have booming populations and growing GDPs. These countries have millions of potential consumers who strive to live middle-class lifestyles. And this translates to potential capital gains for foreign investors.
At the same time, investing in this part of the market has its risks. What are the cons?
Most publicly-traded stocks in this area are small or micro-caps. That small size means they can be really volatile.
Investing directly into small markets can be risky. Thinly-traded issues might make it hard to sell your investment when you want to cash out.
3. Lack of Transparency
Some of the bigger frontier market stocks trade on exchanges. But things are not always transparent. It can be hard to get solid financial information on smaller companies.
4. Geopolitical Risk
Argentina and Zimbabwe are two examples that present extreme political risk to foreign investors. For example, Argentina nationalized a Spanish oil company. That just shows how investing this part of the market can be potentially dangerous.
ETFs and Mutual Funds
So, how can you buy into frontier markets?
You could buy individual stocks. But due to the risk factors, that is probably not a great idea — unless you’re an extremely sophisticated investor. Buying individual frontier market stocks requires some serious research, and taking on that level of risk might be unacceptable to many investors.
Most investors would probably do well to stick with more diversified investments like mutual funds and ETFs. Here are some frontier market ETFs and funds to choose from:
- The Guggenheim Frontier Markets ETF (FRN). This ETF has an expense ratio of 0.70%, which is slightly higher than the industry average of 0.64%. According to the fund website, this ETF “corresponds generally” to the BNY Mellon New Frontier DR Index.
- Another option is the iShares MSCI Frontier 100 ETF (index fund) (FM). It has net assets of around $65 million but it’s pretty well diversified since it tracks the 100 stock index. It has a 0.79% expense ratio.
- The T. Rowe Price Africa & Middle East (TRAMX) mutual fund offers exposure to both emerging and frontier markets. Its 1.52% expense ratio is a bit high. The ETFs are probably better bets.
Another option is concentrated ETFs. There are several to choose from. I’ll highlight a few newer ones here:
- Global X recently introduced two new ETFs focused on Mongolia/Central Asia and Nigeria. These countries used to be unavailable to most individual investors (FM and FRN have some exposure).
- The Central Asia/Mongolia Index ETF (AZIA) invests in Mongolia as well as several other central Asian countries including Kazakstan and Uzbekistan.
- Another new issue by Global X is the Nigeria Index ETF (NGE). It invests in Africa’s most populous country. Nigeria is oil-rich and a major oil exporter. Its story is typical of the sector: an emerging middle class, exploding domestic consumption, and GDP growth. It also has the largest population in Africa.
So these are just examples, there are other ETFs and mutual funds out there. Obviously, investing in this area is risky. And investors should use caution when getting into these markets. But with global investors hungry for new investment opportunities, watch for new frontier market ETFs to be introduced.
One underexplored sector are countries that might be considered super-frontier markets. These include places like Burma, which has no country ETF. There is no way to invest directly in that country — investors who want to get into nations like this will have to go there directly, if possible. Even then, they may need connections to get a foot in the door. But the potential is there for those willing to take additional risks.
When looking at investment options outside of the West, many investors think of developed and emerging foreign markets as the only ways to go. But frontier markets offer potential rewards for those who are willing to take on the extra risk. They offer unique opportunity, and in some cases they may have a place in a well-diversified portfolio.
What are your thoughts on investing in frontier markets?