over 3 years ago • 2 mins
Frontier markets can offer higher returns than their emerging markets cousins and can, perhaps counterintuitively, act as safe havens during turbulent times.
There are three main categories of markets in the investing hierarchy: developed, emerging, and frontier. The classification depends on things such as a country’s wealth and stage of development as well as how mature its capital markets are. Frontier markets are those that are least developed but are growing really fast and include countries mainly found in the Middle East, Asia, Africa, and Eastern Europe.
Because they’re less developed, frontier markets are much smaller than their emerging brethren: frontier markets have a combined market value that’s 40 times smaller than that of emerging markets. The number of listed companies and overall trading volumes are also much smaller on frontier markets’ stock exchanges, offering fewer stocks for investors to choose from.
Despite their smaller size, frontier markets may still be worth investing in. For starters, their smaller size and faster growth mean these markets can potentially offer higher returns, albeit with higher risk. (Although frontier markets have actually underperformed their emerging counterparts over the past decade as the latter have been boosted by China’s enormous rise.)
Secondly, and counterintuitively, higher risk frontier markets can act as safe havens during turbulent times. That’s because they’re much less linked, financially, to the outside world – making them less correlated with global financial markets. And frontier markets’ geographical diversity also makes the individual countries less correlated with each other, further increasing an investor’s diversification benefits.
To actually invest in frontier markets, then, you can buy a pretty straightforward exchange-traded fund like FM or EMFM that track multiple frontier markets. The other approach is by investing in stocks located in individual frontier markets, but this can be a little tricky as some markets limit foreign access.
One strategy some investors use when investing in individual countries is to back ones they think will be upgraded to emerging markets status. And this can sometimes pay off: Pakistan’s stock market, for example, saw average annual returns of 25% in the eight years leading up to its promotion to emerging market status in 2017.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.