Frontier markets refer to the small and illiquid emerging market countries that are in the early stages of development. Investing in frontier markets can provide great opportunities but also comes with significant risks. This article analyzes the pros and cons of frontier markets investing strategies from aspects of market potential, volatility, liquidity, diversification and more. It also introduces the investment vehicles available for accessing frontier markets.
High growth potential but with volatility
As the poorest and least developed countries in the world, frontier markets have tremendous room for economic growth in the long run. However, they tend to be more volatile than developed and emerging markets due to political instability, reliance on commodities, lower liquidity and weaker regulations. Investors need to be cautious of the large price swings.
Illiquidity requires patience
Trading volumes and market caps in frontier stock markets are very small. It can take days or weeks to enter or exit positions of any meaningful size. Investors need to have a long-term investment horizon and not be disturbed by the lack of liquidity.
Diversification benefits
Frontier markets have low correlations with both developed and emerging markets. Adding a small frontier markets allocation can improve portfolio diversification and risk-adjusted returns. But due to higher volatility, position sizing needs to be moderate.
Accessing through funds and ETFs
Given the complexities of directly investing in frontier countries, using mutual funds and ETFs is the easiest access route for most investors. Some offerings provide exposure to frontier market equities as well as debt and currencies.
In summary, frontier markets investing comes with high risks but also high reward potential. Investors should use appropriate vehicles, control position sizes and be prepared to endure volatility.