Frontier Equity Markets: Finally, a new dawn after a 12-year long night?

The risk of global investor flight in and out of frontier- and early emerging markets used to one of the biggest worries for developed market investors considering adding these markets to improve diversification and gain a better expected risk-return combination.

However, as seasoned frontier markets investors like Mattias Martinsson from Tundra Fonder has been saying for the past couple of years: No reason to fear investor flight, they have already left!

Investors often they move in herds. There have been some good reasons to give up on this sub asset class, but it leaves opportunities for others now. The smart money could move in.

Read on and you will find a genuine surprise:

The legacy of global investors in frontier markets:

In 2011, an 84-page report authored by Lawrence Speidell and published by the CFA Institute declared, "Today, many of these countries are considered 'frontier markets' because they are small, unpopular, and illiquid. (..) With patience, care, and good diversification, frontier markets can prove very rewarding and can make a significant contribution to global portfolios.”

An internet search reveals that in 2012, the largest, passive global asset managers like Vanguard and Blackrock, had a significant presence, while the active crowd of, for instance, T. Rowe Price, Aberdeen, and Morgan Stanley were also there.

But it didn’t live up to expectations. Now, in the summer of 2024, Blackrock has had enough! How often has that happened in recent times? An analyst in the Financial Times concludes: “iShares move to close the last physical frontier ETF marks end of era. ‘Persistent liquidity challenges’ and denuding of the index have ended a 12-year experiment. The imminent closure of the world’s only exchange traded fund investing directly in frontier markets draws a line under an attempt to extend the ETF format into a notoriously illiquid field.“

Markets without the ETFs

For some, it is good news that these markets couldn’t accommodate big ETF-flows. Active managers finally have markets of their own, and true stock pickers are teaming up again with ambitious investor presentations, including some very large global asset managers focusing on active management.

The contrarian investors often say: "It is always darkest just before the dawn." This proverb suggests that the most challenging times often precede improvement. A seasoned team recently called frontier markets the “world's cheapest equities” in AMWatch.

So, what will contrarian equity portfolio managers find now?

• Growing countries with equity markets trading at all-time large discounts.
• Fine companies trading at all-time large discounts to their sector peers in developed markets.
• Many opportunities to find well-managed companies in modern, asset-light sectors and finance, staying clear of heavy industry and former state monopolies.

And the asset allocation teams will find

• Pro: True portfolio diversification with less correlated and less volatile markets.
• Con: Are these markets large enough for the institutional portfolio composition?

Investors must weigh against good reasons for a discount:

Where will the discount come from?

The major risk factors warranting a discount are:

• Higher inflation rates mean expected currency depreciations.
• Corporate and country governance risk
• Corrections for liquidity and information deficiencies.

On balance, it could be the darkest just before dawn, a suitable time to move in.

As the above text should reveal, we have a fair amount of experience with bringing frontier equity markets to institutional investors with the Swedish-based Tundra Fonder, now a USD 1bn entity on frontier and emerging. If you want to learn more as in investment professional, please reach out with a LinkedIn message.