How to make frontier market investments

Although frontier markets can be very dangerous, they provide access to exotic stocks in nations that are developing quickly

The world of investing enjoys placing stocks and bonds in tidy, uncomplicated "boxes." However, labels can be deceptive at times, and frontier markets are no exception. The concept appears straightforward. The "frontier" is represented by these exotic investment destination nations, which even have benchmark indices of their own, like the MSCI Frontier Markets index. However, a closer look reveals that the definition of frontiers appears to be arbitrary. A stock market must be "reasonably" liquid, open, and reasonably transparent in order to qualify for the emerging-markets index.

It might be moved from the emerging-markets sector to the frontier one if it doesn't meet all of those requirements, even though some of the nations in the latter group seem out of place. Consider Vietnam as an example. Although I was only there last month, I didn't notice many differences between Vietnam, the Philippines, Malaysia, and Indonesia. These three proudly capitalist and Asian nations are officially classified as emerging markets, while Vietnam isn't.

The distinction between frontier and emerging markets.

In actuality, frontier markets comprise a diverse range of nations that do not align with the definition of emerging markets. This emphasizes a key characteristic of frontier markets: they exhibit returns that are specific to a given nation rather than being heavily impacted by external factors. The correlation between frontier markets and global markets is generally lower, and the connection to China, the rival global economic hegemon, is also less clear.

In addition to their favorable demographics (they have three billion people), frontier markets also have surprisingly strong fiscal governance and low debt levels. Many are also underowned and understudied. How many individuals do you know who invest in Kazakhstan or Romania, two countries that are considered frontiers but are, to be honest, not all that different from Poland, an emerging market?

This does not imply that frontier markets are not worth investing in. You have the option to invest using an MSCI or SandP index. The popular MSCI benchmark carefully examines a market's quantity of listings, turnover, and level of interest from foreign investors. 216 distinct companies from 28 countries make up the index; their average market value is only £570 million. With 25% of the index, Vietnam is the largest nation, followed by Kazakhstan, Romania, and Morocco, each of which has about 12%. Notably, Iceland is among the top five holdings as well.

Performance has been passable but not very impressive. For ten of the thirteen years since 2011, the Frontiers index has underperformed the MSCI ACWI (All Country World index), which includes both developed and emerging markets, and it has only outperformed it three times (until 2024). In comparison to the MSCI global ACWI's 6.5 percent and the MSCI EM index's 3.64 percent, the annualized returns over the past ten years have been a pitiful 2.6 percent.

Even so, the index's countries, stocks, and ancillary funds are inexpensive, with a price-to-earnings (p/e) ratio of only 10:5, as opposed to the ACWI's nearly 22 times earnings. Furthermore, although there is a lot more turnover in the index, frontier markets are generally less volatile than many of their global counterparts (possibly because they are less correlated with, say, emerging markets, particularly China).

The finance sector dominates the frontier index. Energy stocks make up 10% of the index, followed by banks (large Kazakh and Romanian ones) at nearly 40%. At less than 1 percent, IT hardly receives any attention. Though the quality of what is available is surprisingly high, there aren't many funds (or London-listed stocks) that offer exposure to frontiers. All stocks are invested in by a single exchange-traded fund (ETF) from Xtrackers, the S&P Select Frontier Swap (LSE: XSFR). However, because investing in many markets can be challenging, it uses swaps to obtain pure exposure. The fund's total expense ratio (TER), which ranges from 0 to 95 percent, is also slightly higher than that of the majority of EM trackers.

However, the most well-liked method of increasing exposure to frontier markets is through the 300 million-dollar BlackRock Frontiers Investment Trust (LSE: BRFI). This business has a yield of slightly less than 5% and is trading at an 8% discount to net asset value (NAV). It has generated remarkable returns in recent years and is based on a strategy that Sam Vecht, Emily Fletcher, and Sudaif Niaz co-manage.

The fund's total return over the last five years (until November 2024) was 45%; since its inception, it has surpassed all benchmarks by a total of 150%. However, it makes investments in smaller emerging markets like Indonesia and Poland in addition to frontier nations like Saudi Arabia, Vietnam, and the United Arab Emirates. The eight biggest emerging markets are to be ignored.

Furthermore, it takes a bottom-up, stock-specific strategy, meaning that among its top holdings are stocks like those of US-listed IT company Epam Systems, which owns Singapore's Sea consumer internet company and has significant East European interests. Its managers are upbeat about the future of frontier markets, pointing out that "rate cuts have started to materialize in some countries as inflation has fallen across many countries within our sector." The conditions are favorable for a cyclical recovery in domestically focused economies.

Going further along the frontier, London also has a few Georgian stocks, including the trust that owns a significant portion of Bank of Georgia (LSE: BGEO) and the private-equity firm Georgia Capital (LSE: CGEO). In recent years, both London-listed stocks have performed well as Georgia looks to the West and modernizes. However, because of recent political unrest, both have seen that positive momentum falter. Georgia Capital, however, is trading at a substantial 52 percent discount to NAV in spite of its recent strong trading results.