David Feather - Investing in Frontier Markets: Opportunity, Risk and Role in an Investment Portfolio

T hroughout history, frontiers have represented unexplored opportunities, untapped potential, the promise of riches and the lure of discovery.

For today's investors, frontier markets can offer all that and more. They can offer the chance to invest in some of the fastest-growing economies in the world, most with young, vibrant populations and substantial natural resources. They can open a window to new cultures and new industries. And they can help diversify a portfolio and offer the opportunity for enhanced returns.

In this book, authors Gavin Graham and Al Emid outline the potential that investing in frontier markets can hold for investors. Graham, a noted expert on emerging markets, and Emid, one of Canada's foremost writers on investing, have created a comprehensive study on how investors can benefit from gaining exposure to this new market segment.

They conclude, and Russell Investments agrees, that frontier markets are a logical next step for investors who have already discovered how investments in emerging markets can enhance returns and potentially lower a portfolio's overall risk. They believe that since globalization has had numerous economic benefits for emerging markets, it will likely have the same impact on frontier markets over time.

True, investing in frontier markets also holds risksmany of the countries considered frontier markets are politically unstable, can be influenced by strong governmental control over natural resources and industries, and have economies that are vulnerable to sudden shifts in global trends. Moreover, these markets are often less transparent, less liquid and more volatile even than emerging markets.

But many of the more established emerging marketsBrazil, Russia, India and Chinawere considered frontier markets not so long ago. They now contain some of the largest companies in the world, have been integrated into the world economy andimportantlyhave provided investors with returns that have frequently outpaced those from the developed market economies. Indeed, these countries, known collectively as the BRIC nations, have generally better fiscal accounts, balances of trade and growth prospects than their developed market counterparts.

As Graham and Emid show in this book, the MSCI Emerging Markets (Free) Index delivered a return of 13.4 percent p.a. in the decade ending October 2012, compared with the MSCI World Index of developed markets, which gained 5.61 percent p.a. in the same period. Russell research found similar results over the longer term: despite greater volatility, since the late 1980s emerging markets produced the best returns among the asset classes analyzed, and since 1988, emerging markets have outperformed Canadian and U.S. equities by a wide margin. Given demographic trends, growing urbanization, rapid industrialization, increased trade flows and other factors, there is potential for continued outperformance from emerging markets.

Russell Investments believes that frontier markets are now essentially where emerging markets were back in the 1980srelatively unexplored opportunities with great potential. The success that emerging markets have had over the past 30 years is the promise that today's frontier markets now hold.

Moreover, frontier markets show a similarly low correlation with Canadian and U.S. equities as emerging markets did in their infancy. According to Russell research, prior to the global financial crisis in 2008, the rolling correlation was generally below 0.30, and similar to emerging markets, even negative at times. While the crisis caused correlation to briefly spike to over 0.60, it has since trended toward its historical range of 0.20 and lower. However, it would not be surprising for correlations to have episodic spikes due to ongoing macroeconomic uncertainty.