The Difference Between Emerging And Frontier Markets

Every investor knows the prevailing advice to buy low and sell high. But those who seek substantial returns on their capital may have to wait for months or years to see their money grow exponentially, especially when investing in blue chip stocks such as IBM Corp., Coco-Cola Co., and Microsoft.

Therefore, aggressive investors may decide to invest in the stocks of smaller companies that trade in less-developed, international markets as a way of reaping larger capital gains. These companies are often located in countries with frontier and emerging market economies. However, there are key differences to be aware of between frontier and emerging market economies.

Key Takeaways

  • Aggressive investors may decide to invest in the stocks of smaller companies that trade in less-developed, international markets–known as emerging and frontier markets–as a way of reaping larger capital gains.
  • Emerging markets include countries that are in the process of becoming a developed economy; frontier markets are less advanced economies in the developing world.
  • Emerging markets can still provide higher returns on capital with less risk and greater liquidity than frontier market holdings, despite the increasing correlation of emerging markets with the U.S. market.

Emerging Markets

Countries with an emerging market economy used to be referred to as “less economically developed countries" (LEDCs). These are countries that do not currently have the economic strength of countries like the U.S. or Japan but are in the process of becoming a developed economy. Some examples of emerging market economies are India, Mexico, Russia, Pakistan, and Saudi Arabia.

Emerging markets offer greater liquidity and stability than frontier markets. However, some financial analysts believe that certain emerging markets have matured to the point where they move at least somewhat in tandem with the U.S. market. As a result, they fail to provide the level of diversification they once promised. Frontier markets are now filling this gap for long-term investors seeking a return on their capital that is largely uncorrelated with the rest of the global economy.

Frontier Markets

Frontier markets are less advanced economies in the developing world. A frontier market is less established than an emerging market. Many frontier markets do not have developed stock markets, and while they are smaller, less accessible and riskier than emerging markets, they are still considered viable investments.

However, investors who invest in frontier markets face certain risks, such as political instability, poor liquidity, inadequate regulation, substandard financial reporting, and large currency fluctuations.

Advantages and Disadvantages of Frontier and Emerging Markets

While frontier markets come with some substantial risks, they may also offer the kind of returns that emerging markets once did, especially during the 1990s and early 2000s. The population of the economies that make up the frontier market accounts for approximately one-fifth to one-third of the world’s population and includes several exponentially-growing economies. However, frontier markets still remain a very small slice of the global economy.

Some economists believe that the companies that are part of the frontier market in Africa will experience the next major world economic boom. Regardless of their projected growth, emerging markets can still provide higher returns on capital with less risk and greater liquidity than frontier market holdings, despite their increasing correlation with the U.S. market. Aggressive investors could profit in the long-run by allocating equally into each of these sectors.

How Investors Can Access These Markets

Several exchange-traded funds (ETFs) and mutual funds invest in emerging markets. There are also a small number of ETFs that focus on frontier markets. Morgan Stanley Capital International offers the iShares MSCI Emerging Markets Index (MSCI), which consists of 26 developing economies, including Brazil, China, Egypt, Greece, India, Mexico, Pakistan, Russia, Saudi Arabia, and South Africa. Morgan Stanley also offers a frontier markets ETF, the iShares MSCI Frontier Markets 100 (FM). Guggenheim offers a broad-based ETF that includes nearly every country classified as part of the frontier market (FRN). Powershares offers several ETFs that focus on specific segments of the frontier markets, such as the MENA Frontier Countries Portfolio (PMNA) which concentrates on the Middle Eastern and North African regions. Other ETFs invest in the stock exchanges of individual countries, for example, the iShares MSCI Mexico Investable Market Index Fund (EWW).

These securities can be analyzed in the same way as any other investment offering. At the same time, investors should thoroughly research the types of risk they would be taking on with each of these instruments. For the most part, investors should be willing to commit their money for long periods of time. Depending upon global economic factors, frontier and emerging markets may not always move in tandem with each other. It's recommended that investors who seek broad diversification and less risk divide the aggressive portion of their portfolios between these two sectors.

Frontier and Emerging Markets Offer Broad Diversification

Investing in emerging and frontier markets both offer the prospect of higher returns and higher risk, but emerging market economies are more stable and developed than frontier markets. The economies of emerging market countries have achieved a rudimentary level of development, while frontier markets represent the least economically developed nations in the global marketplace. This lack of development provides a level of investment diversification that cannot be duplicated in more mature markets. Both types of markets also carry several types of investment risk, including market, political, and currency risk, as well as the risk of nationalization.

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