frontier markets: safer than emerging markets?–I don’t think so

On Sunday the Wall Street Journal published an article whose apparent conclusion is that frontier stock markets have not only better performance than emerging or developed markets, but they’re safer as well.

I don’t think this is right.

developed, emerging, frontier

The dividing lines between developed, emerging or frontier markets are a little vague, but basically they are as follows:

–Developed markets are in politically stable, high GDP mature countries that have large liquid stock markets and where there’s a long history of trading in different economic climates.  Think:  US, UK, Japan…

Emerging markets are the next step down.  They’re in relatively politically stable countries whose stock markets offer a variety of sectors and names.  Under normal conditions, liquidity of large-cap names is good, although there may be restrictions on taking profits out of the country.   Think:  Taiwan, China, Brazil…

Frontier markets are the countries with stock markets that don’t make the emerging markets cut.  They may be too small, not liquid enough, politically unstable…or just new.  Think:  Nigeria, Bulgaria…


Over the past ten years,

the MSCI developed markets index has returned 5.16% annually.

the MSCI emerging markets index has returned 9.44% annually.

the MSCI frontier markets index has returned 5.35% annually.

Yes, frontier markets have had a fine past 18 months, but a lot of that is catch-up with other markets.


Here’s where I really question the WSJ article.

It refers to a study distributed by LR Global, a tiny frontier markets specialist($200 million under management), to its clients.  The report measures weekly stock market volatility–the ups and downs of stock prices.  Such volatility is the standard academic measure of risk.  Its main virtues are that it’s simple, clearly defined and easy to calculate.  In my view, however, weekly price volatility has virtually nothing to do with what investors mean when they talk about the risks they are taking in investing…but that’s another issue.

LR points out that over the past ten years frontier markets have routinely been less volatile than emerging markets.  In addition, they have been less volatile than developed markets over the past three years.  LR’s conclusion:  frontier markets are safer than popular opinion would make them.

my take

I have two observations about this, both of which relate to liquidity:

–smaller markets, in my experience, have the appearance of stability because it can be difficult to trade in them.  In bad times in particular, bids for a stock may completely disappear–or come in for only a small number of shares and at a 20% discount to the previous trade.  Holders a choice between taking taking this price to sell , say, 10% of the holding (thereby devaluing the entire holding), or do nothing.  The easier choice is the latter.  So no trade happens, and the official stock quote remains unchanged.

–liquidity in small markets is very often mostly provided by foreigners trading with one another.  If they leave–and they may be gone for several years, liquidity dries up.  Volatility may be low, but that’s a bad thing, not a good one.

For individual investors in frontier market mutual funds that are part of a large, well-capitalized mutual fund complex, the liquidity issue is probably not crucial.  For anyone else, it deserves a lot of thought.

Personally, I have no burning desire to invest in frontier markets.  I don’t see what advantage I would have there.  But I don;t think that safety is one of the virtues of these markets.


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