While the group of markets we call emerging markets (EMs) are expected to continue to do well in the coming years, we believe that replicating their outperformance of the past quarter century will be difficult. The EM's have evolved, both in terms of their size and the pace of their growth, versus the world as a whole. Greater political stability, improvements in infrastructure, a growth in consumerism, and a rapid expansion in trade have driven dramatic changes in the fabric of emerging market countries. As EMs have matured and become less risky places, the expected returns form investing in them have almost certainly converged downward.
Replicating the higher returns of EMs past may require investors to look to new geographies: the Frontier Markets. These markets have relatively small/illiquid equity markets compared with emerging markets, and tend to be less economically developed. An essential element of our argument is that frontier markets are smaller than they should be given the size of population and potential economic output of the country in which they are based.
In this report, we focus on 15 countries in particular - our "Frontier-15" - which have the potential to generate the kind of returns for equity investors over the coming decades that the emerging markets themselves have produced over the past quarter-century. These are Argentina, Bangladesh, Egypt, Ghana, Iraq, Kazakhstan, Kenya, Mongolia, Nigeria, Pakistan, Romania, Sri Lanka, Ukraine, Venezuela, and Vietnam.
In addition, we look in more detail at the economic outlook for two of the economies that rank among the fastest long-term growers within the Global Growth Generators (3G) growth framework: Nigeria and Vietnam. Despite headwinds for both countries, the opportunity for each economy is undeniable given the presence of key ingredients to economic growth: large, young populations; low per capita incomes; greater openness to trade; in the case of Nigeria, a large natural resource base, in the case of Vietnam, fast-growing, industrializing neighbors.
There are plenty of near-term challenges to both economic and financial market success in these countries. Developing economies benefit from global trade and capital flows, and as such will not be immune to economic instability stemming from the Eurozone's troubles. Institutions tend to be weak, and policies uncertain. Looking beyond the near term, however, we believe that frontier markets will achieve some degree of convergence with both emerging and developed markets. A range of economic and financial factors, as well as features of the business environment should support this. Over time, the frontier markets are likely to adopt many of the changes implemented by their more successful peers - the emerging markets - while doing their best to avoid their own more egregious mistakes of the past. Given their starting point, even modest improvements can yield significant results. Such has been the story with emerging markets, and indeed the developed markets before them. The frontier beckons.