Why frontier markets bring higher returns

Dateline: Bangkok, Thailand

“You can’t beat the market every year. Averaging 7% to 8% is the best you can do.”

If you’re an investor, you’ve probably heard this line before — and its mostly true in developed western countries. Short of being a top hedge fund or a financial genius, around 8% is about as good as it gets on average. You might do better one year, you might do worse. But it all balances out eventually.

However, most people don’t consider the fact that there isn’t just “the market”. From Japan, to India, to Kenya, there are many different markets. Each have their own opportunities, challenges, averages, and potential for profit.

To a typical stock or real estate investor, “the market” which they grew up in might be all they’ll ever know. But to global investors, beating the market is rather simple. It just involves going to a different, better one with higher growth and less attention from foreign investors.

Opportunities in Frontier Markets

On the other end of the spectrum from crowded markets such as the United States and Japan, frontier markets often have the highest potential for returns.

Part of this has to do with the lack of foreigners on the ground who are doing research and investing in less developed, but rapidly growing economies. For example, Vietnam has many stocks that receive no analyst coverage. In strong contrast to the New York Stock Exchange, where every single company has dozens of investment banks covering it, Vietnam provides the chance to find your own bargains and go where no one has before.

In some developing countries, the types of businesses that you might take for granted in your home country often don’t even exist yet. If there’s no pharmacy chain or high-end furniture store, it offers the perfect setting to create your own.

Frontier markets are almost always growing at a faster pace than their developed counterparts and will often entirely avoid the financial chaos in the rest of the world. Cambodia, for instance, hasn’t had a recession in more than 20 years. Skipping the Asian Financial Crisis of the 1990s, the tech bubble of the early 2000s and the Global Financial Crisis of 2008, Cambodia’s economy has shrugged off the rest of the world’s problems.

The reason for this is because frontier markets are less correlated with the global economy. The United States and Western Europe might be co-dependent on each other to the point where if one falls, the other goes along with it. This is not so much the case in smaller nations with less of an international presence.

Challenges in Frontier Markets

Of course, there are reasons why the entire world hasn’t flooded into frontier market investments yet. The main reason is simply because they can be very difficult to gain access to and often require being on the ground and doing the “dirty work” yourself in an unfamiliar environment.

If you want to trade stocks in Mongolia, you’ll need to personally visit the country and set up a brokerage account yourself. Once it gets to real estate, things get even harder. Doing market research in a foreign language, finding contractors in a place where services don’t usually meet international standards, or simply finding a grocer to buy the food you want while you’re there can all be challenging.

Still, for those who truly want to grow their wealth, frontier markets provide the ultimate reward for the adventurous investor.

The Easy Way Out?

Some investors wish to benefit from the growth of frontier markets but don’t want to do the hard work. In the case of stocks, investors will often buy shares in a mutual fund that invests in developing countries while thinking they get the full advantage of frontier market investment.

That isn’t quite the case. Mutual funds and ETF (exchange-traded fund) managers will pick only the largest, most established and well-known firms in each country to be part of their portfolio. A mutual fund manager’s goal is to simply track the market — not do anything special or find undervalued gems.

Oftentimes, a fund manager won’t even have people on their team who speak the language of the countries they’re investing in. They aren’t able to do research at the same level as a local who is on the ground, and therefore will never perform as well as someone who is physically present in and knowledgeable about the country they’re investing in.

Either way, going to a frontier market to invest only in the companies which are covered by analysts defeats the entire purpose of frontier market investing. There are so many unnoticed opportunities in the world, so why invest in the ones which everyone else already knows about?

Last updated: Dec 26, 2019 at 7:13PM

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