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Frontier Markets: a Comparative Analysis by Cliff Quisenberry, CFA®

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Frontier Markets: a Comparative Analysis by Cliff Quisenberry, CFA® A reprinted article from November/December 2018 Frontier Markets: A Comparative Analysis By Cliff Quisenberry, CFA® © 2018 Investments & Wealth Institute®, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE 2018 Frontier Markets: A Comparative Analysis By Cliff Quisenberry, CFA® merging-market investing has (UAE) that had GNI per capita measures have one of their own,6 the number of grown substantially in the past two greater than the United States but were countries with access to a stock decades, but investors have yet considered frontier by most index pro- exchange exceeds 150, of which more E 2 to widely adopt its smaller counterpart, viders until fairly recently. Instead, the than half would be considered frontier. frontier-market investing. Yet frontier main frontier index providers MSCI, markets share many positive attributes FTSE Russell, and S&P Dow Jones3 (for- One driver of investor interest in that have attracted long-term investors merly S&P/IFC) have various methods emerging-market equities has been the to emerging markets such as fast- to define whether a country is a frontier, prospect of capturing the growth of these growing economies, relatively cheaper emerging, or developed market based markets’ underlying economies. In that valuations, and a source of diversification upon criteria including foreign investor regard, the average frontier country to U.S. equity investments. However, access, size and liquidity of the market, shares similar growth prospects as its frontier markets also exhibit unique custody, and the results of consultations larger emerging-market counterpart, characteristics and challenges that set with institutional investors. and both beat the developed markets by them apart. For investors who have a good margin (see figure 1).7 In fact, of made the decision to invest in emerging For the purpose of this article, a frontier the top 20 fastest-growing economies in markets as an asset class, understanding market is defined as any country covered the world, 16 would fall within a broad the similarities and differences, and the by the three index providers that is not definition of a frontier country, of which pros and cons, can help them decide defined as either developed or emerging 12 have a functioning stock exchange or what role, if any, frontier markets should by two of the three (see table 1).4 For access to a regional one.8 Of the remain- play in their investment decision-making example, only one index provider, FTSE, der, three are emerging markets (India, and allocation. includes Kuwait as an emerging market Philippines, and China) and one is at this time, so it remains a frontier. Brunei Darussalam, a wealthy and devel- One of the difficulties in discussing Korea, on the other hand, is considered oped country.9 Each of these 20 is frontier markets is that there is limited by two of the index providers as a devel- projected to grow real gross domestic consensus among index providers and oped market and so it is defined as such, product (GDP) at the rate of at least investors about what does and does not and not emerging as defined by MSCI. 6 percent annually for the next five years. constitute a “frontier market” versus an This methodology provides 39 frontiers, “emerging market.” When “emerging 24 emerging, and 25 developed coun- Investors may be attracted to investing in markets” as a term was first coined by tries as a reasonable set for comparison. fast-growing economies, but there is a the International Finance Corporation However, there exist many more frontier general lack of evidence from academic (IFC) in 1981,1 they were defined as countries with their own stock exchanges research or empirical studies to support those countries that fell within the than the 39 defined as frontier here, the relationship of a country’s aggregate World Bank’s “middle-income” and from Armenia and Bhutan to Papua stock market performance to its GDP “low-income” categories based on gross New Guinea and Uruguay, to name a growth. However, an argument can be national income (GNI) per capita. few. The CIA Factbook lists 120 stock made, at the very least, that faster- However, when the IFC introduced its exchanges in the world,5 but even this is growing economies provide a richer frontier equity indexes in 1996, it not a complete list. Including exchanges opportunity set for selective investors to became apparent that such a simplistic simply not covered by the CIA, and find companies with earnings that do definition could not capture countries adding countries that are members of directly benefit from faster economic such as Qatar and United Arab Emirates regional stock exchanges but do not development. A case in point are 20 INVESTMENTS & WEALTH MONITOR © 2018 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. FEATURE | Frontier MARkets: A COMPARATIVE Analysis Table COUNTRY CATEGORIZATION BY THE MAJOR INDEX PROVIDERS 1 Frontier (39) Emerging (24) Developed (25) S&P S&P S&P FTSE MSCI DJI FTSE MSCI DJI FTSE MSCI DJI Argentinaa ✓ ✓ ✓ Brazil ✓ ✓ ✓ Australia ✓ ✓ ✓ Bahrain ✓ ✓ ✓ Chile ✓ ✓ ✓ Austria ✓ ✓ ✓ Bangladesh ✓ ✓ ✓ China ✓ ✓ ✓ Belgiumb ✓ ✓ ✓ Botswanaf ✓ ✓ ✓ Colombia ✓ ✓ ✓ Canada ✓ ✓ ✓ Bulgariaf ✓ ✓ ✓ Czech Republic ✓ ✓ ✓ Denmark ✓ ✓ ✓ Burkina Fasoc ✓ Egypt ✓ ✓ ✓ Finland ✓ ✓ ✓ Cote d’Ivoirec ✓ ✓ ✓ Greece ✓ ✓ ✓ France ✓ ✓ ✓ Croatia ✓ ✓ ✓ Hungary ✓ ✓ ✓ Germany ✓ ✓ ✓ Cyprus ✓ ✓ India ✓ ✓ ✓ Hong Kong ✓ ✓ ✓ Ecuador ✓ Indonesia ✓ ✓ ✓ Ireland ✓ ✓ ✓ Estonia ✓ ✓ ✓ Malaysia ✓ ✓ ✓ Israel ✓ ✓ ✓ Ghanaf ✓ ✓ ✓ Mexico ✓ ✓ ✓ Italy ✓ ✓ ✓ Jamaicaf ✓ ✓ Pakistan ✓ ✓ ✓ Japan ✓ ✓ ✓ Jordan ✓ ✓ ✓ Peru ✓ ✓ ✓ Korea ✓ ✓ Kazakhstan ✓ ✓ ✓ Philippines ✓ ✓ ✓ Luxembourgb ✓ ✓ ✓ Kenya ✓ ✓ ✓ Polandd ✓ ✓ ✓ Netherlands ✓ ✓ ✓ Kuwait ✓ ✓ Qatar ✓ ✓ ✓ New Zealand ✓ ✓ ✓ Latvia ✓ ✓ Russia ✓ ✓ ✓ Norway ✓ ✓ ✓ Lebanon ✓ ✓ Saudi Arabiae ✓ ✓ ✓ Portugal ✓ ✓ ✓ Lithuania ✓ ✓ ✓ South Africa ✓ ✓ ✓ Singapore ✓ ✓ ✓ Macedonia ✓ Taiwan ✓ ✓ ✓ Spain ✓ ✓ ✓ Malta ✓ Thailand ✓ ✓ ✓ Sweden ✓ ✓ ✓ Mauritius ✓ ✓ ✓ Turkey ✓ ✓ ✓ Switzerland ✓ ✓ ✓ Morocco ✓ ✓ ✓ U.A.E. ✓ ✓ ✓ United Kingdom ✓ ✓ ✓ Namibia ✓ United States ✓ ✓ ✓ Nigeria ✓ ✓ ✓ ✓ Oman ✓ ✓ ✓ Denotes that country is covered by that index provider as a stand-alone index Palestinef ✓ ✓ a. MSCI currently includes Argentina as a Frontier but will upgrade to Emerging effective June 2019. Panamaf ✓ ✓ b. FTSE combines Belgium and Luxembourg. Romania ✓ ✓ ✓ c. Cote d’Ivoire is home of the regional exchange Bourse Régionale des Valeurs Mobilières (BRVM) that includes stocks from c ✓ ✓ Burkina Faso, Benin, Guinea-Bissau, Mali, Niger, Senegal, and Togo. Both MSCI and FTSE include a company domiciled in Senegal Senegal as an index constituent, FTSE includes another from Burkina Faso. Both list them under Cote d’Ivoire/Ivory Coast. Serbia ✓ ✓ d. Poland was upgraded to Developed status by FTSE in September 2018 but remains defined as an Emerging market by both Slovakia ✓ ✓ MSCI and S&P Dow. Slovenia ✓ ✓ ✓ e. Saudi Arabia, designated a “stand-alone” market by MSCI, S&P Dow Jones, and FTSE, is included as Emerging because all Sri Lanka ✓ ✓ ✓ three index providers have announced its upgrade to Emerging effective in 2019. Trinidadf ✓ ✓ f. MSCI covers these markets in their “stand-alone” indexes. Tunisia ✓ ✓ ✓ Source: S&P DJI denotes S&P Dow Jones Indexes’ S&P Frontier BMI, S&P Emerging BMI, and S&P Developed BMI indexes. FTSE denotes FTSE Russell’s FTSE Frontier Index, FTSE Emerging Index, and FTSE Developed Index. MSCI denotes the MSCI Vietnam ✓ ✓ ✓ Frontier Market Index, MSCI Emerging Markets Index, and MSCI World Index. Zambia ✓ consumer-facing companies operating in improve GDP per capita and increase the This makes sense because many of the countries where economic growth can spending power of the consumers in that frontier countries are starting from a mean increasingly wealthier consumers, country. When comparing the average much lower base of development. The a burgeoning middle class, and higher frontier economy to the average path of development, and its potential earnings growth for these companies. emerging-market economy over time, translation into investment opportunity, Faster economic growth, shared broadly frontiers are outpacing their larger coun- is in essence what investors in frontier by a country’s population, should terparts on this measure (see figure 2). and emerging markets are attempting to 21 © 2018 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE | Frontier MARkets: A COMPARATIVE Analysis 2018 Figure FIVE-YEAR FORECASTED ANNUAL REAL GDP GROWTH, capture from these developing economies. 1 2019–2023 One measure of development is a coun- try’s urbanization, or percentage of the population that lives within an urban 3.8% 3.7% area. As the urban population grows, there are benefits that can support growth of GDP per capita. For example, as a population shifts from the informal 2.0% sectors of the economy to the formal, such as from small-scale farming toward manufacturing jobs in the cities, higher and more stable household incomes are likely to result. This, in turn, can Frontier Emerging Developed increase demand for housing, services, and consumer goods that create further Source: World Economic Outlook Database April 2018, http://www.imf.org/external/pubs/ft/weo/2018/01/weodata/index.aspx. economic value. Indeed, frontier coun- Average country compounded annualized growth rates within respective Frontier, Emerging, and Developed groups. tries
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