Frontier markets are back in fashion. These stockmarkets, too small and underdeveloped to be included in major indices, are “tomorrow’s emerging markets”, says Credit Suisse. They have their own index, the MSCI Frontier Markets Index. It reflects companies in 26 countries, ranging from Bangladesh and Qatar to Estonia and Nigeria.
While these are highly risky, due to problems such as dodgy corporate governance, political instability and poor liquidity, investors keen to beef up returns have been piling in. Fund-flow tracker EPFR Global says inflows into frontier funds are at record levels.
The long-term picture is certainly compelling. Frontier economies boast similar growth rates to emerging ones.
They have become increasingly business-friendly in recent years, judging by their ranking in the World Bank’s Ease of Doing Business Index, says Credit Suisse. Deregulation and the privatisation of state industries, which increases the size of stockmarkets, are also on the rise.
Africa is particularly popular. Management consultancy McKinsey notes that growth has more than doubled to an average of nearly 5% a year in the past decade, compared to 2.4% in the previous ten years. A tenfold increase in trade with commodity-hungry China has helped. There are more middle-class families in Africa than in India and they are “underpenetrated in every conceivable area”, says Fiona Rintoul in the FT.
No wonder private-sector credit in East Africa is expanding by 15%-20% a year, according to one banker. Meanwhile, now that hyperinflation is over, Zimbabwe is “starting to grow again for the first time in ten years”, says Mark Harris of Henderson Global Investors.
This does not, however, seem a good time to load up on risk. During bouts of global risk aversion, investors tend to ditch their riskiest assets first. This in turns hits frontier stocks, as the 50% slump in the MSCI Frontier Index between July and December 2008 shows. Emerging markets can’t shake off global trends in bad times. The index fell by 12% in just six weeks this spring amid the sovereign-debt crisis and is barely up for the year. With the global economic outlook darkening and Europe’s crisis far from over, frontier markets look unappealing for now.