Are Frontier Markets the future Emerging Markets?

A recurring question in the investment community is whether frontier markets will become the future emerging markets.

We have touched on this before, looking at whether investors should turn to frontier markets in 2011, for example.

With some emerging market economies starting to display more modest levels of economic growth than before, it is little surprise that investors are considering frontier markets.

These could well follow a similar growth and development path to emerging markets, with lower valuations and high dividend yields making them a compelling investment opportunity, relative to emerging markets.

A new briefing note from Sam Vecht, Investment Manager of the BlackRock Frontiers Investment Trust, highlights the strong investment case for frontier markets as an asset class.

“Frontier Markets represents some of the world’s fastest growing economies, offering growth at inexpensive valuations without the burden of high leverage or excessive hot money.

“These markets also stand out for their low levels of indebtedness, high dividend yields, better demographic profiles than both Emerging and Developed markets and improving corporate governance.

“Whilst Emerging Markets are not suffering the same levels of debt burden as the Developed Markets, Frontier Markets have seen even lower levels of debt.

“Moreover, where an ageing population will limit long-term rates of return in the Western world, and even parts of the Emerging world, Frontier countries’ demographic profiles provide strong backdrops for future economic growth.”

Explained like this, it’s a compelling argument.

But should investors be flocking to frontier markets or do the risks associated with this asset class outweigh the potential benefits?

When you consider some of the countries included in the frontier markets asset class – places such as Côte d’Ivoire, Pakistan and Kenya – the potential political risks for investors become clearer.

Any allocation to the ‘new emerging markets’ should probably be small, with the allocation well diversified across a variety of countries to reduce the exposure to any single area or small number of areas.

Active fund management should enable investors to avoid political hot spots.

As a long-term investment where investors are rewarded for the risks they are taking, it might be worth considering frontier markets as a replacement for traditional exposure to emerging markets.