Frontier Markets Investment
Emerging markets are developing and investors continue to look for earlier stage country investment opportunities. That next stage is in a category called “frontier markets”. Those are countries with investable public securities markets, but not sufficiently evolved to be considered emerging.
Frontier markets are fraught with risks such as illiquidity, non-transparency, inadequate regulation, substandard financial reporting, and similar hazards. They are at the very edge of the investable public securities universe.
The potential for return is high as is the risk of permanent loss.
The major indexing companies have been developing their own frontier market indices. MSCI recently announced their 19 country frontier universe which includes: Bulgaria, Croatia, Estonia, Kazakhstan, Romania, Slovenia, Ukraine, Kenya, Mauritius, Nigeria, Tunisia, Bahrain, Kuwait, Oman, Qatar, U.A.E., Lebanon, Sri Lanka, and Vietnam.
These countries have tiny stock markets and U.S. investors have an extremely small portion of their total foreign equity investments in frontier markets — less than 1/10th of 1%, as a matter of fact based on year-end 2006 figures from the U.S. Treasury. That compares to over 15% of U.S. investor foreign equity in the United Kingdom, nearly 13% in Japan, about 2% in each of Mexico and Brazil, 1% in each of Russia and India, and nearly 2% in China.
The image below details the U.S. investment in private and public equities of each MSCI frontier country and several other developed and emerging countries for comparison [click image to enlarge].
Click image to enlarge
The next image details the income per capita (on a purchasing power parity basis), the inflation rate and the real rate of GDP growth in each of the 19 MSCI frontier market countries, along with several other developed and emerging countries for comparison [click image to enlarge].
The table shows the generally high real GDP growth rates of the frontier markets, which is part of their attraction.
Unfortunately, there are no public investment funds available yet for U.S. investors to participate in frontier markets. There are private investment funds, but they are predominantly out of London and not available to U.S. persons.
This is really the perfect kind of situation for an ETN (exchange traded note).
Some institution capable of investing in frontier markets could issue ETNs (bonds varying in value with an index) pegged to a frontier markets index such as the MSCI or other frontier index to conveniently open those market to retail investors. Our prediction is that is not a distant day.
Barclays (BCS) has been the innovative leader in the ETN field with an India exchange traded note (INP), and several commodity ETNs dominated by one pegged to the Dow Jones - AIG commodity index (DJP) and several single currency ETNs such as for the Euro (ERO).
Goldman Sachs (GS) and Bear Stearns (BSC) have followed and may grow their portfolio of ETNs.
Barclays or Goldman Sachs are the most likely to bring frontier markets to U.S. retail investors in our opinion.
Smaller ETF sponsors are not likely to enter the ETN field, because the products are effectively bonds and a major, solid credit such as Barclays or Goldman is needed as issuer. The issuers also must possess the requisite international investing skills to invest in frontier countries to match their frontier markets ETN liabilities.
Even though you cannot invest in public frontier market securities today, it is a good idea to begin to study them now so that when the funds do arrive, you will be able to tell if they make sense for you.
Win or lose, they will be a true phenomenon when they arrive.
Richard Shaw
QVM Group LLC