Emerging markets are a rich source of potential investment opportunities, but investors may be neglecting some of their most attractive sources of growth. Funds often focus principally on the largest markets – China, India or Taiwan. Looking into the world’s smallest markets – the frontier economies - brings something new and truly different to a portfolio, we believe.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Between them, Asian giants China, India, South Korea and Taiwan make up around three-quarters of the index1, leaving regions such as Latin America, Eastern Europe, Africa and the Middle East relatively unrepresented. While this approach is not without its merits, exploring the world’s smaller markets for unique and untapped growth opportunities may be rewarding.
Although larger emerging markets present considerable growth prospects, the range of opportunities found in the smaller emerging markets may be less correlated to the global cycle. In the MSCI Emerging Markets index, for example, the largest weightings are Taiwan Semiconductor, Samsung Electronics and Tencent1. These are large global businesses, dependent on global demand patterns. They may be great companies, with strong growth prospects, but their fortunes are determined as much by the outlook for the US economy as Taiwan or South Korea.
Idiosyncratic risks
The fortunes of companies in smaller emerging markets tend to have a more direct relationship with domestic economic growth. For instance, a bank in Indonesia or Georgia would primarily be an investment in the potential for economic expansion and increasing financial inclusivity within its own country, rather than being influenced by global factors. This is part of the appeal of investing in frontier markets.
These frontier market countries are, we believe, often only lightly correlated to each other2 - Saudi Arabia may not be impacted by what's happening in Indonesia or Chile - which also helps risk management in a portfolio. The risks for each company and country may be idiosyncratic. This means an allocation to these smaller markets may add true diversification to a portfolio.
Because investor attention is elsewhere, there are a lot of under-researched opportunities in the rest of the world3. We believe these smaller countries provide a differentiated range of investment options and will often trade at lower valuations4.
Also, these companies need to work harder to attract attention, so will often return capital to shareholders via dividends4. This may give investors a diversified source of income in their portfolios. While we don’t have an income target, the current yield of the portfolio is a result of the companies we invest in, which generate considerable amounts of cash.
How BlackRock manages risk in Frontier market investing
Investing in frontier markets may give investors exposure to attractive growth stories, but these are markets that need to be approached with care. Small capital flows can make a significant difference, and they are often illiquid. There may be political and economic volatility. We manage these risks through careful due diligence and holding a spread of assets. We travel frequently to the countries within our universe, to make sure we understand both the company and the environment in which it operates.
These smaller companies often sit outside the mainstream – apart from the broad sweep of global politics and economies. They may be able to side-step geopolitical tensions, trading with both China and the US, and can forge their own paths. Against this backdrop, they have the potential to be a source of diversification and growth for investors.
