What is a frontier market?
The lack of information available to investors in frontier markets can mean a wide disparity between a company's true value and its current share price.
Frontier markets are countries that because of demographics, development, politics and liquidity are considered less mature than emerging markets.
There are 29 countries currently considered frontier markets by indexer MSCI. These are Argentina, Bahrain, Bangladesh, Burkina Faso, Benin, Croatia, Estonia, Guinea-Bissau, Ivory Coast, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Mali, Morocco, Niger, Nigeria, Oman, Romania, Serbia, Senegal, Slovenia, Sri Lanka, Togo, Tunisia and Vietnam.
Unfortunately for those trying to get their head around frontier markets, there's no universally embraced definition of what constitutes a developed, emerging, or frontier market. Classification systems vary widely between indexers and benchmarks.
MSCI examines each country's economic development, size, liquidity and market accessibility in order to be classified in a given investment universe. The World Bank focuses on a country's economy and, in particular, its relative level of wealth per capita. Countries with high levels of per capita income are classified as developed. Meanwhile, those countries with low, middle, and upper-middle incomes per capita, relative to incomes in other countries around the globe, are classed as developing, or emerging.
Countries with even lower levels of income per capita are deemed frontier markets. These tend to have more volatile, less diverse stock markets and the companies have poorer levels of shareholder and corporate governance.
Many of the Middle Eastern stock markets for example are dominated by oil-related stocks, while the Argentinian equity market is equally commodity heavy.
The lack of transparency and information available to investors in frontier markets can mean a wide disparity between a company's value and potential for growth and its current share price. This can result in considerable returns for investors. Similarly, because it can be difficult for foreign investors to access these regions, you can make significant losses.
The macro backdrop to frontier markets can be more uncertain, with many regions suffering from civil unrest or engaged in war. These factors are unpredictable and can cause even high-quality stocks to underperform. While the potential rewards for investing in frontier markets are much higher than those in developed markets, so too are the risks.
For this reason, frontier markets should only make up a small part of a well-diversified investment portfolio. However, because of the disparate and heterogenous nature of individual frontier markets, experts argue you can experience less volatility in a fund which invests across the sector.
More from Morningstar
• Make better investment decisions with Morningstar Premium | Free 4-week trial
Emma Wall is senior international editor for Morningstar.
© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.
