A Beginner’s Guide to Investing in Frontier Markets

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For many years, investors were able to capitalize in the accelerated growth of emerging markets, such as Brazil and China. However, the economic problems in Greece and China have demonstrated that some emerging market economies are experiencing a slower rate of growth and, in some cases, facing substantial economic roadblocks.

Seeking alternatives for emerging markets, some investors are turning to so-called "frontier markets." While less developed than emerging nations, frontier market nations are experiencing such accelerated growth that they may provide aggressive returns to investors willing to take on the risk.

What Are Frontier Markets?

While there are many lists detailing what countries are considered frontier markets, the MSCI market classification is the most widely accepted. The MSCI Frontier Markets Index is made of 120 stocks from 23 frontier economies, including Argentina, Lithuania, Nigeria, and Sri Lanka. With 500 stocks from 34 frontier markets, the S&P Frontier BMI is another index that provides a comprehensive benchmark of the frontier market economy as a whole.

Frontier markets are characterized by their high volatility. For example, the MSCI Frontier Markets Index had a 72.74% annual gain in 2005 — and a 54.10% annual loss in 2008. Investors seeking potentially high returns in frontier markets need to understand that they will be facing higher risks, such as large currency fluctuations, political instability, and unfamiliar — or relaxed — regulatory systems.

Why Frontier Markets Matter

Despite the higher risks, many companies are investing in these markets for the long run. One example is the Coca-Cola Company.

Coca-Cola has substantial investments in heavy soda-drinking nations in developed markets, such as the United States and Belgium, and emerging ones, such as Mexico and Brazil. However, frontier nations are the ones promising the most growth for the beverage company.

In 2014, Argentinians consumed the most soft drinks per capita in the world, a whopping 154.6 liters. That's one liter per person more and 18 liters per capita more than U.S. drinkers (#2 on the list) and Mexican drinkers (#4 on the list) purchased in the same year. This explains why Coca-Cola's CEO pledged to invest $1 billion in Argentina over a four-year period starting in 2016.

Vietnam is another frontier market of interest to Coca-Cola. Over the 2013–2015 period, the southeast Asian nation was one of the world's fastest growing markets for the brand. It has been estimated that the consumption of soft drink liters per capita in Vietnam increased by over 105% over the 2009–2014 period.

Just like Coca-Cola, many other domestic and international companies are interested in frontier market nations. Even governments recognize the importance of increasing trade relations with up-and-raising developing nations. For example, the Trans-Pacific Partnership (TPP) trade agreement signed in February 2016 aims to lower trade barriers between 12 nations, including Vietnam.

How to Invest in Frontier Markets

For the average individual investor, buying stocks in individual companies trading in frontier market stock exchanges may prove impractical for several reasons.

• Trading volume for frontier market stocks is generally lower than that for U.S. stocks, which produces more volatility and prevents efficient market transactions.
   
• Finding "winners" is very challenging for individual investors without connections in those markets. Many investors can track the price of Bao Viet Holdings, the largest insurance company in Vietnam and the seventh largest listed company by market capitalization in that nation, but very few can name stocks in Estonia or Kenya.
   
• Less-developed nations are still working on implementing international financial accounting standards, putting investors in the dark about the latest developments.

Therefore, the average investor has three main ways to invest in frontier markets.

1. U.S Companies Focusing on Frontier Markets

First, an investor could invest in U.S.-traded companies that have strong interests in frontier markets. Besides Coca-Cola [NYSE:KO], Facebook, Inc. [NASDAQ:FB], and Apple, Inc. [NASDAQ:AAPL] are other companies eyeing those fast-growing nations.

• Facebook is working hard on increasing its presence in frontier nations. Through its 2G Tuesdays initiative, Facebook engineers are learning how to adapt the features of the social network app to work seamlessly even on a 2G Internet network. Also, Facebook is offering free Internet access to cellphone users in Kenya, Bangladesh, and Pakistan and working on reaching similar agreements with cellphone carriers in other frontier markets.
   
• Trying to diversify its Asian portfolio, Apple opened a subsidiary company in Vietnam back in 2015 with an investment of 15 billion Vietnamese dong (over $670,000). In 2014, sales of Apple's products in Vietnam grew five times faster than in India. Beyond Vietnam, Apple is looking to expand in other frontier markets.

2. Frontier Market Exchange-Traded Funds (ETFs)

Frontier market ETFs allow investors to include frontier stocks in their investment portfolios. For example, the iShares MSCI Frontier 100 [NYSE Arca:FM] tracks the MSCI Frontier Markets 100 Index and holds over $408.70 million in net assets as of March 2016. By meeting minimum liquidity standards, ETFs allow investors to liquidate their positions with more ease when necessary. (See also: 10 Questions to Ask Before You Sell a Stock or a Fund)

3. Mutual Funds Focusing on Frontier Markets

Structured and maintained to meet the demand of investors interested in frontier markets, mutual funds focusing on frontier markets seek to produce capital gains from stocks traded in less developed exchanges. Some examples are the Templeton Frontier Markets [MUTF:TFMAX] and the Wasatch Frontier Emerging Small Countries Fund [MUTF:WAFMX].

Investors who are particularly bullish in individual nations should consider ETFs and mutual funds focusing on specific frontier nations.

The Bottom Line

To compensate for slower growth in developed and emerging markets, investors can look into frontier markets. By investing in U.S. publicly traded companies, ETFs, and mutual funds focusing on frontier markets, individual investors can access these markets with better liquidity and more diversification. However, an individual investor should assess applicable fees for such investment vehicles, understand the higher risk involved in such investments, and limit the exposure to a number that is consistent with the investor's overall objective.

How are you investing in frontier markets?