At a time when investors are worried about Chinese banks, Brazilian riots and emerging markets (EM) in general, investing in the riskiest areas of the emerging world seems counterintuitive.
Yet, surprisingly, so-called frontier markets – those markets that are still at a very early stage of development — have been among the best performers in 2013, outperforming global markets year to date.
While these exotic markets are not for everyone, more aggressive investors should consider having a small strategic allocation to the frontier. I last highlighted the reasons why back in May. But in light of the market volatility since then, here’s an updated list of four reasons why to consider exploring the frontier.
1. Momentum. Frontier markets have been remarkably resilient to the EM travails. The MSCI Frontier Markets 100 Index is up approximately 15% year to date in dollar-terms. While frontier markets did get hit during the June sell-off, their pull back – of around 10% – was much shallower than that of EM and their subsequent rebound has been much stronger.
2. Value. Despite the strong performance, frontier markets still look relatively cheap. The price-to-book ratio of the MSCI Frontier Markets 100 index is currently around 1.3, below the roughly 1.5 of the comparable EM index.
3. Growth. Frontier markets are concentrated in the Middle East and Africa. Given recent unrest in that part of the world, investing in the frontier may seem like a bad idea. But while this region is volatile, it’s also one of the fastest growing areas in the world. In addition, the Middle East is, obviously, the big beneficiary of higher oil prices.
4. Diversification. EM stocks performed particularly weak during the most recent sell-off. Part of their relative under-performance can be attributed to fundamental issues such as concerns over Chinese banks. However, EM equities were also negatively impacted by their high correlation to the global stock market. Frontier markets tend to trade differently. Because they are less developed, they are less tied to the global economy and less correlated with the global market. As such, frontier stocks don’t always move in lockstep with the rest of the world.
My suggestion to consider frontier markets comes with a few important caveats. While the asset class has been less volatile than emerging markets overall, it still is volatile, and much more so than US stocks. In addition, frontier markets are a relatively new asset class, meaning its liquidity is still a work in progress and it’s not an asset class you want to trade in and out of. That said, in a world where even emerging market growth is slowing, many investors should consider broadening their definition of emerging market stocks to include some allocation to frontier markets, which are accessible through the iShares MSCI Frontier 100 ETF (FM).
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.
Disclosure: Author is long FM.