Choosing to invest money in some of the world’s smallest but fastest-growing economies, known as ‘frontier markets’, has always been a risky business.
But with that pool of countries becoming smaller and potentially more volatile, frontier-markets investing could become even more of a game of roulette.
The MSCI Frontier Markets Index, viewed by many as the benchmark for the sector, announced last month in its annual review that Argentina would be promoted to emerging market status.
Kuwait – now the largest frontier market – was singled out for a possible upgrade to the emerging market level in 2020, following upgrades for Pakistan last year and Qatar and the United Arab Emirates in 2014, while Bulgaria was booted out of the frontier markets division in 2016 and Ukraine in 2015.
Although promotion to emerging markets might be good news for the country’s economy, signalling confidence in its stability and attractiveness to investors, it is not so good for the 23-strong Frontier Markets Index itself.
Argentina and Kuwait account for almost 40 per cent of the index. If they were to move on, remaining countries such as Vietnam would be left accounting for a disproportionately large segment of the index.
Yet there are still compelling reasons to look at frontier markets. Charlie Sunnucks, of the asset manager Jupiter, said ‘there’s very little financial penetration’ in some of the frontier economies.
‘In Kenya, for instance, the number of mortgages is still below 30,000,’ he said.
These factors play into the hands of companies such as banks, which are beginning to offer products such as mortgages, or to companies creating products for a booming middle-class or youth sector.
But with fewer nations in the MSCI Frontier index, investing in a fund that simply tracks it may leave investors’ money vulnerable to a downturn in one particular country.
However, there are ways to invest in frontier markets and support small economies. Sunnucks, for example, is less constrained by the MSCI index in the Jupiter Emerging & Frontier Income Trust he manages along with Ross Teverson.
Kuwait – now the largest frontier market – was singled out for a possible upgrade to the emerging market level in 2020
It invests up to 25 per cent of its investors’ money in frontier markets, which it defines rather loosely as ‘not developed and not emerging’.
Sticking closely to one particular index ‘is a bit of a moving target, and as you have some countries elevated out of that, to some extent it’s a reducing universe of countries’, Sunnucks said.
However, he still finds jewels. One of the trust’s investments is Vietnam Dairy. Milk consumption per capita in Vietnam is very low compared to most emerging countries.
But Jupiter thinks Vietnam Dairy could be well placed to ride the wave as dairy produce finds favour with the growing population.
One problem is that many large frontier market stocks tend to be in the financial industry. The largest company on the MSCI index, for example, is the £5.8bn Bank of Kuwait. The index could take a hefty hit in a banking crisis.
Michel Perera, chief investment officer of Canaccord Genuity Wealth Management, stays well away.
He said: ‘They tend to be very complex markets and investors need an intricate understanding of the political backdrop and socio-economic factors.’