Frontier markets are back in vogue for money managers around the globe, but now the subsector of the emerging markets asset class is earning its right to stand alone in institutional investor portfolios.
After a seven-year cycle of difficulties, developing countries in early 2016 moved back onto investors' agendas against a backdrop of improved fundamentals, outlook and performance by emerging markets companies as well as better structural growth potential vs. that of developed markets.
The excitement of emerging markets' potential rippled throughout the investment industry, with inflows over the year. But whereas the emerging markets boom from 2002-2009 saw investors lumping together countries into developed vs. emerging, money manager sources said they more recently are having developed, emerging and frontier market discussions as separate conversations with their institutional investor clients.
“We think that investors are increasingly more aware of what it means to invest in frontier markets as a separate asset class,” said Emre Akcakmak, portfolio adviser at East Capital International AB, based in Dubai, United Arab Emirates. “Most of our clients are happy to see that our emerging market funds can invest partly in frontier markets. However, the real story is that there is a growing interest to make portfolio allocations specifically to frontier funds in order to capture the attractive growth and diversification opportunity that they offer.” The firm manages €2.7 billion ($3 billion) in assets and has started to see “improvement in flows to frontier markets,” but Mr. Akcakmak said “we need to wait a bit longer to see if the recent interest will continue. Seeing the glass as half full, we think that frontier markets may be at the crossroads after having seen continuous outflows for the past years.”
Andrew Brudenell, head of frontier markets at Ashmore Group in London, also has seen the trend. He said clients are “looking at emerging markets and want to look at emerging markets vs. frontier markets, think about what sort of exposure (to have) … (and) asking us questions like 'how do we split our exposure?' These are fantastic questions we never used to get before.”
The opportunity is getting too big to ignore. Bryan Carter, head of emerging markets fixed income at BNP Paribas Investment Partners in London, cited International Monetary Fund data showing “32 frontier economies are growing at more than 4% a year, compared to 21 countries in the broader emerging market universe. Furthermore, for those investors looking to achieve a fully global portfolio, frontier markets are too significant a proportion of the global universe to ignore.”
Mr. Carter said 94 of the 190 IMF member states are classified as frontier.
“Although currently mostly represented as an interesting diversification opportunity in broader fixed-income portfolios, this next generation market is looking increasingly likely to become an autonomous asset class in its own right,” he added.
Allocations are low, but growing. Dominic Bokor-Ingram, portfolio manager at Charlemagne Capital U.K. Ltd. in London, said the firm estimates between 10% and 25% of investors' emerging market exposure is allocated to frontier markets. Data provided by EPFR Global showed assets in frontier market equity strategies were $17.9 billion as of April 30, up 7.8% compared with Dec. 31. Net flows have been mixed, show data.
And investors might have more exposure than they think. When it comes to the J.P. Morgan Emerging Market Bond index, probably the dominant benchmark for hard currency sovereign debt, “two-thirds of the names in the index are arguably frontier … although a lot of them only have one small bond. So … when you're buying the index you actually have exposure to a lot of frontier countries,” said Stephen Bailey-Smith, an investment strategist and senior economist at Global Evolution in London.