Where opportunity lies
Most foreign investment in these markets is typically concentrated in the few biggest stocks, which trade at high valuations similar to their peers in developed markets.
The opportunities lie not in these companies but in the smaller, under-researched companies where foreign ownership is still low but has scope to increase significantly.
Frontier markets are a classic area where investing via an active manager with the necessary expertise and resources makes much more sense than via a passive exchange-traded fund.
The latter will track an index that is inevitably backward-looking, which is a disadvantage in fast-growing economies and capital markets.
The index will also comprise only the largest, most liquid companies, which in frontier markets are often not where the best opportunities lie.
Finally, the distinction between the smallest countries in the emerging market indices and those classified as frontier markets is somewhat arbitrary for the purposes of an investor.
The same type of opportunities can exist in both, and an active fund that is benchmark agnostic and has a remit to invest in both areas, has distinct advantages.
The Magna New Frontiers fund run by Fiera Capita is one example.
The manager has a long track record of investing in the region, focusing on undervalued, under-researched companies with strong growth potential.
A major attraction of frontier markets therefore is the potential to find stocks at cheap valuations with good long-term earnings growth prospects.
Diversification
Frontier markets are also a good way of diversifying one’s equity exposure.
Their correlation to both emerging and developed market equities in recent years has been relatively low at around 0.55 and 0.50, respectively.
This reflects the fact that the investor base for these stocks is primarily the domestic investor who is generally motivated by factors quite different to those driving investors in mainstream equity markets.
Despite their clear, long-term attraction, the fact is that following a strong run in 2016 and 2017, frontier markets have underperformed developed and emerging markets in the past couple of years. This, however, in the main just echoes the underperformance of value stocks across the investment universe.
Frontier market valuations are now down to a 10-year low and rising foreign ownership levels could well provide a catalyst for a re-rating over the coming year or two.
Frontier markets may well once again have their day in the sun.
Rupert Thompson is chief investment officer at Kingswood
