Last updated September 20th, 2021.
You probably have seen the terms “frontier markets” and “emerging markets” elsewhere before. At a first glance, it might seem fairly self-explanatory what these terms mean.
Emerging and frontier market economies are very different in nature though, and the implications of investing in either of them are complicated.
Sure, it’s common knowledge among investors that frontier/emerging markets are generally faster-growing and less developed than Japan or Western Europe, for example.
But more importantly, how can they help your portfolio? Which specific countries are the best emerging markets? And what are the differences between emerging and frontier markets?
I should start off by saying the definition of “emerging markets” and “frontier markets” can change depending on who you ask.
For example, MSCI includes places like South Korea, Qatar, United Arab Emirates, and Taiwan as “emerging markets”. These are all among the most developed economies on the planet though.
Here are the five holdings of the iShares MSCI Emerging Markets fund by country. Yet two of them are developed economies. Just three nations (China, Korea, and Taiwan) make up 70% of total holdings!
In my opinion, that’s a great reason why you shouldn’t rely on emerging or frontier market ETFs.
Such ETFs often don’t even invest in the types of economies they’re named after, and certainly aren’t ideal for diversification.
However, that’s a topic for another post. We’re here to pit emerging markets vs. frontier markets and figure out which is better for your portfolio.
Keep reading to find out why these rapidly growing nations can help your portfolio… and whether they’re right for you at all.
Here’s What Emerging Markets Are *Not*
Frontier markets and emerging markets are widely misunderstood among investors. In fact, people often confuse the benefits they offer.
The kind of perks which many people would attribute to investing in emerging markets (recession avoidance, etc.) are often only true with frontier markets, and vice versa.
One of those misconceptions is that emerging markets are somehow less correlated with your home nation’s economy.
Quite frankly, emerging markets won’t protect you from a recession. They might even have worse performance than other investments during a global crisis.
You can find McDonalds, Starbucks and Ikea on practically all corners of the earth nowadays. That includes almost every emerging market too. China, Turkey, and Brazil have the same modern brands you’re familiar with at home.
Because of this, a recession which starts in the United States, Europe, or any other major economy will heavily impact emerging markets as well.
A financial crisis means declining business activity and falling exports around the globe. That’s especially bad for emerging, newly-industrialized nations which depend on foreign direct investment (FDI) and exports.
The auto manufacturing sector is one of Indonesia’s largest. What happens if American or Japanese consumers stop buying Indonesian car exports though?
It gets more confusing once you realize the terms “emerging” and “frontier markets” include a wide variety of different countries. You can’t paint dozens of economies using a wide brush.
For example, the Turkish Lira and Argentine Peso are getting crushed. Yet Thailand’s Baht has better recent performance than the Euro and Yen.
How Are Frontier Markets Different?
Frontier markets are a step below emerging on the economic development ladder. Yet they often boast rapidly growing economies which rely on internal factors, like their strong demographics, far more than FDI.
Usually, frontier markets benefit from a low average age, rising urbanization rate, and growing middle class. They’ll almost inevitably see greater demand for real estate, and thus rising asset prices, by the mere reality of their demographics.
What’s the effect from all this? Frontier economies aren’t nearly as dependent on global markets. They’re less correlated with the NASDAQ and its daily whims.
These high-growth nations commonly skip global recessions altogether. Cambodia and Vietnam are just a few frontier markets which haven’t entered recession for over two decades… all while increasing their economy’s size by 6% each year.
You shouldn’t paint all frontier markets with a broad brush either though.
Several frontier markets have a wonderful track record, business-friendly policies, and laws that are pro-foreign investment. The Philippines and Cambodia are two examples.
However, countries like Myanmar and Laos are difficult and problematic – especially the former considering its recent coup. Doing your research and knowing the best frontier markets to invest is crucial.
During a typical year, 2 million tourists visit Angkor Wat. Ticket income almost doubled every year in the later part of the 2010s.
Frontier vs. Emerging Market Investments
Which of these economies make a better investment? It completely depends on who you are, your investment goals, and your risk tolerance.
I don’t want to finish this article with a non-answer. It’s true though, and is the only correct piece of advice.
Both can provide higher returns, along with greater volatility, than in developed economies. Generally speaking, international exposure of any kind will diversify most people’s portfolios and offer higher returns.
Emerging markets are better if you value convenience. Buying stocks in China or a condo in Malaysia is much easier than figuring out places like Myanmar.
In contrast, frontier markets are best if you want low correlation with other investments, possibility for outsized returns, and don’t mind some additional work.
A major reason why frontier markets have strong growth potential is because few people put forth the effort needed to discover them.
That’s a positive thing if you’re among the willing. While entry barriers are inconvenient, they also help keep asset valuations fair.
Large money managers spend billions on trading algorithms and well-paid staff. They’ll find any truly undervalued stock before you’re even aware it exists. As such, there aren’t many deals left on major equity exchanges.
Goldman Sachs isn’t looking at stocks in Vietnam or land in Manila though, which leaves a chance for smaller investors.
The point is: frontier market investments are a great way to make your portfolio less correlated with the global economy.
By comparison, emerging markets offer portfolio diversification but generally not lack of correlation, and thus aren’t as ideal in a recession.
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