Frontier Markets – Investing in brave new worlds

Frontier markets – emerging but not yet emerged – are the 18 stock markets that the International Finance Corporation, the Washington-based private sector arm of the World Bank, has placed on ‘watch’ to become the world’s newest emerging markets. The IFC has some credibility in this area because it can lay claim to the fact it created emerging markets as an asset class.

The concept of frontier markets was first launched in late 1996 and since then countries such as Russia, Egypt, Morocco, and Slovakia have emerged while Estonia, Latvia, Romania and Ukraine have become new frontiers for investors.

The frontier markets are a brave new world for investors willing to take the risk of investing in countries whose stock markets are now at a formative stage of development. Their regulatory, legal, disclosure, reporting and trading infrastructure is still evolving, making investment decisions challenging and difficult.

Generally, frontier markets are illiquid, have a small number of listed companies and are undercapitalized. Barring Romania which has an unusually high number of listings (5,707), the remaining 17 frontier markets had a total of only 923 listed companies at Sept 30. While Romania has a large number of public companies mainly because of privatization of small state enterprises, its market cap is more than three times smaller than that of Trinidad & Tobago, which has the largest market cap (US$4.1 billion) among the frontier markets, with only 24 listed companies.

While the risk of investing in frontier markets is greater, the rewards can be phenomenal. In 1995, for example, the Ivory Coast was the best performing market in the world with a return of 140.8% in US$ on the IFC Global Composite Index. The following year, Bangladesh gained a staggering 196%, making it the leading market. The performance of the frontier markets is usually fuelled by a few stocks which produce outstanding returns.

Last year, frontier markets slumped as emerging markets lost favour with investors on the back of the Asian crisis.

The IFC Global Composite Index lost 22.2%, with the biggest loss (82.3%) registered by Ukraine which was dragged down by the Russian crisis. Slovenia, which emerged out of the breakup of Yugoslavia, was the leading market with a gain of 19%. It rose on gains made by new share offerings and on merger and acquisition activity. Trinidad and Tobago, up 17.5%, was the next best performing market. Their government is engaged in a massive incentive program to attract investments in its leading petroleum-based as well as other primary sectors.

Among other gainers on the IFC Global Index last year were three African markets — Ghana, Kenya and Botswana. African markets are now being regarded as the last important frontier for emerging market investors.

For emerging market investors who believe that the greatest gains are made by those who are among the forerunners, frontier markets potentially offer the biggest challenge, rewards and risk.

Dwarka Lakhan

Dwarka Lakhan is a pioneer in emerging markets journalism in Canada. His first emerging markets article, “Africa Joins Ranks of the Emerging,” appeared in Investment Executive, Canada’s leading newspaper for financial advisors, in September 1994. Since then he has written hundreds of articles on the full spectrum of emerging markets and has conducted more than two thousand interviews with emerging and frontier markets investment professionals.

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