For a long time it was considered that the sources of uncertainty in the global economy were the least developed countries. However, according to Meredith Sumpter of Eurasia Group, today it is the developed countries that represent the greatest risks to the international economy. Thus, the so-called “emerging economies” -some of which were zones of conflict during the last century- now present great economic opportunities. In addition to these economies, there are “frontier markets” that, despite presenting higher political risks, have high investment returns.
In 1992, the World Bank formulated the concept of frontier markets to describe countries whose economies are neither large enough nor developed enough to be considered emerging, but which show signs of sustained evolution. That is, a country can be found under the heading of “developing” but show adequate structural conditions for economic development and the generation of future returns.
Obviously, frontier markets present risks such as political instability, high inflation rates and regulatory deficiencies. However, its economic activity is dynamic enough to be in more favorable conditions than those on the list of “least developed countries” of the UN (LDC’s). Currently, economies are within a spectrum of different sizes, infrastructure needs, liquidity levels and development speeds. The diversity of economic structures expands the range of investment opportunities and, of course, the underlying political risks.
This diversity presents a great opportunity for investors since it allows us to have a strategy to invest in new economies with the possibility of balancing risk across different markets. Emerging economies present high levels of political risk and, since there is a multiplicity of frontier markets, placing investments only in emerging markets would imply unnecessarily riskier capital management.
However, participation in frontiermarkets depends on the risk appetite of each investor and each company. In this sense, the frontier markets are also characterized by little connectivity with the global economy, so that investors participating in them will enjoy – to a greater or lesser degree – the advantages of being an early participant in new markets. The border markets are going through important changes, for example, demographic. According to UN data, the proportion of young people in the population (under 14 years old) is higher than 20% in frontier markets, unlike approximately 18% in developed countries. Likewise, the growth rate of the urban population in frontier markets is over 60%, unlike 14% in developed countries and 40% in emerging economies.
Given that frontier markets are less integrated into the global economy, paradoxically, they offer greater opportunities to investors. Frontier market government bonds show low correlation with US treasury bonds and -according to Aberdeen Standard Investments- have an average yield higher than 6%, higher than that of emerging economies. As the frontier markets become integrated into the global economy – and as emerging economies rise to “developed” status or down to “frontier” – global financial risks will change.
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