What Are Frontier Markets?
Frontier markets are less advanced capital markets in the developing world. A frontier market is a country that is more established than the least developed countries (LDCs) but still less established than the emerging markets because it is too small, carries too much inherent risk, or is too illiquid to be considered an emerging market. Frontier markets are also known as "pre-emerging markets."
The term “frontier markets” was coined in 1992 by Farida Khambata while she was the World Bank; Khambata is currently cofounder of Cartica. While they are smaller, less accessible, and somewhat riskier than more established markets, frontier markets are still investable. They are considered desirable by investors looking for substantial long-term returns since these markets have the potential to grow much more stable and established over the course of decades. However, it is also possible for a more established, emerging market to regress to frontier market status, so investing in these markets is still risky.
- Frontier markets are less advanced than capital markets.
- Frontier markets are smaller and less accessible.
- Risks of frontier markets include poor liquidity and substandard financial reporting.
How Frontier Markets Work
Investors pursue frontier, or pre-emerging, equity markets to seek potentially high returns. As many frontier markets do not have developed stock markets, investments are often private or direct in startups and infrastructure. Although it’s possible to achieve strong results from investing in frontier markets, investors must also accept higher risks than in the United States or Europe, for example (or any other of the G7 nations).
Some of the risks investors face in frontier markets are political instability, poor liquidity, inadequate regulation, substandard financial reporting, and large currency fluctuations. In addition, many markets are overly dependent on volatile commodities.
Frontier Markets and Lesser Developed Countries
Frontier markets are ahead of lesser developed countries although similar risks can apply for investors. The UN currently lists 46 least developed countries that face significant structural challenges to sustainable growth. This includes being extremely vulnerable to economic and environmental shocks. This leads LDCs to be able to access specific international support measures and financial aid that are not available to more developed nations.
The CDP Secretariat of DPAD/DESA regularly reviews the status of LDCs to determine if and when they will graduate from the category. For example, in March 2018, the Committee for Development Policy (CDP) announced their recommendation that the nations of Bhutan, Kiribati, São Tomé and Príncipe and Solomon Islands should graduate from the LDC category. However, as of May 2021, this hasn't been approved.
Frontier Markets and Portfolio Management
Frontier market investments can have a low correlation to developed markets and thus can provide additional diversification to an equity portfolio. In portfolio management investors must balance the strengths, weaknesses, opportunities, and threats of certain choices, making tradeoffs and placing bets among debt, equity, domestic, international, growth, and safer options.
It’s important to maximize a portfolio’s return, given the investor’s appetite for risk. Adding investments in frontier markets to a portfolio is not always suitable for certain investors. Those looking for stability, safety, and/or steady streams of income might steer clear of high-risk bets in these areas. However, if you do have the appetite and ability for risk (i.e., you can withstand losses in your portfolio), allocating a small portion of your assets to frontier markets could prove fruitful and add a new challenge.