While emerging market equities have under-performed developed world stocks recently, equities in “pre-emerging”, or frontier, markets have actually outperformed both their developed and emerging world counterparts.
But it’s not too late to explore the frontier. Here are three reasons why investors should consider having a small strategic allocation to equities in the pre-emerging world.
Valuations: Despite their outperformance, frontier markets still appear to be good bargains. According to my team’s research, frontier markets, as represented by the MSCI Frontier Markets 100 Index, were recently trading at a price-to-book ratio of around 1.2, below the 1.6 ratio of the MSCI Emerging Markets Index. And while firms in frontier markets are less profitable than emerging market companies, frontier stocks look inexpensive even when this difference in profitability is accounted for.
Growth: Frontier valuations also look attractive considering that I expect these markets to experience faster growth in coming years than many emerging and developed world countries.
Diversification: Finally, companies in frontier markets tend to just focus on demand in their local countries and thus are less tied to the global economy than emerging markets like China and Brazil. As my colleagues Del Stafford and Daniel Morillo pointed out last fall in blog posts, this means frontier markets have exhibited a low correlation to emerging and developed markets and can add some diversification to a portfolio.
Though a growing number of funds are providing access to frontier markets, it’s important to remember that frontier countries generally have less established equity markets, and more regulatory and political unknowns than markets elsewhere in the world. In other words — investing in them can be risky.
That said, frontier markets are a strategic asset class, along with US equities, bonds and gold, that investors want to consider always having a little of in a portfolio. Assuming that frontier markets will likely decrease in risk as they develop over the long term current valuations present a potential buying opportunity. Frontier markets are accessible through the iShares MSCI Frontier 100 ETF (NYSEARCA:FM).
The author is long FM