In the end, the team concluded that while emerging markets were expected to continue to do well in the coming years, replicating their outperformance of the past quarter century would be difficult. Instead, they suggested investors should look to new geographies — the frontier markets — arguing that these markets had many of the same characteristics that emerging markets did when they were first identified as an investable group back in 1988.
Fast forward nearly two years and the frontier market story has matured with frontier equity markets outperforming both their larger emerging market peers and developed markets, accompanied by strong fund inflows with assets under management nearly doubling in that time period. As investor interest continues to increase, we thought it was timely to revisit the original arguments as to why frontier markets would be the new generation of emerging markets.
The long-term catch-up and convergence story for frontier markets remains intact. These countries tend to be less economically developed than their emerging peers, have a higher degree of political risk, and despite recent performance, their stock markets are smaller than they should be given the size of the population and potential economic output of the countries in which they are based.
In this report, there are three sets of drivers that have been identified as underpinning the frontier markets story: economic, financial and business. Economic growth in frontier markets is being helped by favorable demographics and rising productivity while foreign direct investment, an improvement in institutional quality, and debt levels which have not been inflated are helping to drive expansion. As investor interest grows, frontier financial markets’ depth and breadth should continue to converge towards emerging market levels. Opportunities for corporates tend to be greater in frontier markets due to lower penetration levels of a range of goods and services, the rising demand for infrastructure and the significant barriers to entry in many industries.
But of course an investment in frontier markets comes with substantially higher risks than an investment in developed or emerging markets. Political risk in particular has been a defining characteristic of frontier markets and the report takes a close look at how shifting and more volatile public opinion — Vox Populi — poses a new and powerful risk to the investment environment. Finally, the report revisits two major economies — Nigeria and Vietnam — which represent the best of what the frontier markets have to offer but also face what we believe are fairly typical challenges for the asset class.