Four graphs explaining… frontier markets

In this month’s ‘Four graphs explaining’ our experts consider frontier markets.

A fund manager, multi-asset manager, fund picker and economist each picked a graph to show the difficulties and benefits of investing in this asset class amid a new market cycle and shifting trends within this part of the market.

MXFM forward P/E

Four graphs explaining... frontier markets

Daniel Egger, CIO at St Gotthard Wealth

Due to the strong USD, emerging markets and in particular frontier markets have suffered in the past years, underperforming global equities by more than 50% in the past eight years. This period of underperformance may well have come to an end, as the valuations of frontier market equities have dropped by 50% and more to single-digit forward P/Es. While the environment will remain difficult for the foreseeable future, building up positions in frontier market equities at the current valuations makes sense to us, especially considering the prospects of continued strong economic growth in countries such as Vietnam, Romania, and Kazakhstan.

Inflation (consumer price index)

Four graphs explaining... frontier markets

Emily Fletcher, emerging market fund manager at BlackRock

Inflation has dominated market sentiment (and conversations) through 2022. We are starting to see early signs of global inflation peaking- whether in commodity markets or in shipping freight rates. In several parts of the frontier market universe – inflation remained remarkably muted even through 2022. Looking ahead to 2023, an imminent peaking of real rate expectations and the USD would set up a favourable backdrop for frontier and smaller emerging markets. 

MSCI EM Asia vs MSCI EM Latin America

Four graphs explaining... frontier markets

Hartwig Kos, head of investment strategy multi-asset & solutions at DWS

For the past decade, many investment gurus have made the compelling case that one size does not fit all in the developing world, and investors must look at different countries and regions individually. And indeed, the Covid-19 crisis has heralded a shift from globalisation towards regionalisation, making it even more important to look at each individual “business model” in order to assess the investment merit of each country. Yet a rising US dollar, rising interest rates and a geopolitical tensions almost everywhere have left the entire bloc in disarray; the only driver of performance seems to have been whether the country in question was a commodity exporter or not. And while some of these dynamics have started to level off, the prospect of China reopening with its insatiable hunger for commodities could easily reinforce this divergence in performance once more.

EM Local Currency has delivered significantly lower volatility

Four graphs explaining... frontier markets

Jonathan Francis, head of investment research at Harrington Cooper

The EM Local Currency frontier market has delivered significantly lower volatility versus both local and hard currency EMD markets, while outperforming over the long term. The total returns from local currency frontier bond investments tend to be driven by the carry component and less so price return, often resulting in lower beta, and better downside protection, as can be seen in the chart. The dynamic of the asset class is driven more by local economic factors, such as inflation and central bank policy than global risk sentiment. Foreign investor involvement in the local bond markets is still low, helping to decrease the correlation to global assets. The combination of lower sensitivity to global portfolio flows, the low duration of the fixed income market and occasionally active central bank currency management has historically resulted in lower volatility figures compared to emerging market local currency investments and certainly compared to investments in dollar-denominated frontier bonds.

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