The latest buzz is around frontier nations—places like Nigeria, Croatia, or Bangladesh, where it’s now much easier to invest through an index or diversified mutual fund.
Almost $360 million of net new money poured into frontier market mutual funds during the first three quarters of this year, bringing total assets to almost $1.1 billion. Institutional dollars accounted for 38.4% of the total, according to Paul Herber and Nathan Rowader, co-managers of the Forward Frontier MarketStrat Fund, which invests in frontier markets.
Could frontier markets gain status soon as a diversification strategy?
The usual push to invest overseas rests on the idea that fast growth produces big returns. Not so, says Weston Wellington, a vice president at Dimensional Fund Advisors.
“There is no reliable statistical relation between a country¹s GDP growth and its stock market return.” So it’s an open question whether emerging—or frontier--markets have higher expected returns than the United States or Europe. “Honestly, there is just not enough data to really test it,” adds Marlena Lee, also at DFA.
A better argument, Lee and Wellington say, is that investing abroad adds diversification, lowering risk. And according to Herber and Rowader, frontier stocks move more independently from other major indices than any class other than commodities. The countries’ stock markets also tend to move separately from commodities and each other. The pattern “is likely to persist at least for the foreseeable future” said Herber and Rowader, making it possible that investing in a diversified group of frontier stocks could actually lower risk.
The recent returns are certainly attractive: From 2009 through the end of November, the Romanian stock market has delivered more than a 100% return, the United Arab Emirates posted more than 55% and Vietnam( 37.9%) Croatia (35.8) and Lebanon (32) were close to the S&P’s return of 35.3%. Yet the ratio of prices to earnings remain relatively low, Herber and Rowader calculate.
More investors may pile on. It’s worth recalling that as recently as 2003, Morningstar’s Diversified Emerging Markets category accounted for less than 1% of equity mutual fund assets. By 2010, that share had quadrupled.
It’s also increasingly easy to get in, with three major indices available, from MSCI, S&P and FTSE, all with more than twenty countries and virtually no overlap with emerging market indices.
More countries, such as Ghana, Jamaica, and Botswana, are poised to enter the global investing arena.
Herber and Rowader point out that the stock markets of frontier nations are small relative to their GDP. Brazil, Russia, India, and China, the “Bric” nations, now report an average equity market capitalization equivalent to nearly 84% of their Gross Domestic Product, much like that in the developed world. Frontier markets have an average equity market cap of less than 32% of GDP. In 2009, the value of stocks traded accounted for 164.8% of the GDP of the OECD nations; in the “Bric” group, the average was 89.9%. Among frontier markets, the value of stock trades averaged only 5.9% of GDP.
Meanwhile, the International Monetary Fund predicts that over the next five years frontier economies will account for a growing share of global output, as the share represented by EAFE developed nations shrinks from about 33% in 2001 to 24% in 2015. According to IMF projections, the U.S. share will fall from 23% to 18%. Over the past ten years frontier economies grew at an average annual rate of 5.1%, while the U.S. economy grew just 1.8%. While that growth may not guarantee a higher stock return, it does imply a growing share of the world economy, pushing U.S. investors out into the frontiers of investing.
