In the 25 years since World Bank economist Antoine van Agtmael wrote an article for Euromoney magazine titled "Emerging Securities Markets," investors have grown increasingly comfortable with the idea of allocating part of their portfolio to India, Mexico, Thailand, or Turkey. Such is the current popularity of emerging market investing that dozens of emerging market mutual and exchange traded funds are now available to U.S. investors, including bond and equity funds, regional and country funds, sector and style funds, and they have been among the top performers in 2009.
As emerging markets become a mainstream investment option, it's hardly surprising that investors endowed with enough pioneer spirit would start venturing farther afield to "frontier" markets with even smaller, less developed economies. Several frontier markets, particularly those in Asia and Latin America, have turned in blazing performances recently, drawing still more investor interest.
It has not been until recently, however, that professionally-managed funds targeting frontier markets have been readily accessible for individual investors. In 2007, Standard & Poor's and MSCI/BARRA sparked a mini-boom in frontier market ETFs when they began publishing indices composed of companies that were not already represented in their increasingly popular emerging market indices, using stocks from countries such as Botswana, Croatia, Jordan, and Kazakhstan.
Frontier markets are synonymous with risk, says Alec Young, international equity strategist with Standard & Poor's Equity Research. "It's the asset class with the least transparency and information available," he says. While these markets offer the possibility of outsized returns if they are able to achieve and maintain high levels of economic growth as emerging markets such as China and India have done, Young warns that they suffer from sometimes poor disclosure of pertinent information, low liquidity, weak regulation, and high degrees of economic and political risk.
There is no widely accepted definition of exactly what a frontier market is, so funds have some wiggle room when it comes to which companies they will actually invest in. Only two funds specifically bill themselves as "frontier market funds," though others offer significant exposure to both emerging and frontier markets. Three single-country funds from frontier markets have sprung up as well.
Most frontier funds have high sector concentrations that reflect their local economies. They are often heavily weighted to financial, materials, and energy stocks, since those are often the largest companies in the country. While far from perfect, these funds offer one of the only convenient ways to invest in markets still largely untouched by Western capital.
