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The thought experiment of America as a frontier market may amuse, but one factoid surely is closer to the realm of reality: In recent years, emerging markets have outperformed developed markets—and, even further, smaller emerging economies are outperforming larger ones.
The so-called BRIC economies of Brazil, Russia, India, and China are has-beens, data show. As a result, industry observers note that smart investors would position themselves well by achieving further emerging diversification through a frontier market allocation—all the better to capture the nascent inefficiencies that inherently occupy such markets. A March report by State Street Global Advisors (SSGA) provides evidence to support this. According to research carried out by SSGA’s Active Emerging Markets investment team since 1997, BRIC countries have underperformed a group of smaller countries within the emerging market subsector. As of March 2011, non-BRIC emerging market countries outperformed BRICs by 39% over the entire time frame of the study. “Many of the smaller emerging and frontier economies have quietly been making investor-friendly reforms and deserve the attention of international investors,” Chris Laine, portfolio manager for active emerging market equities at SSgA, said in the report, referring to the smaller markets of Columbia, Turkey, Chile, the Czech Republic, Egypt, Hungary, Israel, Peru, Poland, Thailand, and the Philippines. “Many of these economies offer value, growth, and solid profitability,” he added.
Greg Behar, Northern Trust’s senior investment strategist, urges investors to open their eyes to other growth areas in the emerging world. “When you invest solely in the BRICs, you are missing out on a large portion of the overall opportunity set, concentrating your emerging markets portfolio in four countries dominated by financials and energy companies,” he says, challenging investors to also pursue less developed frontier markets. “A BRICs-only strategy significantly increases your volatility versus a diversified basket of developing market countries, and foregoes the potential growth prospects in smaller emerging and frontier market countries.” Behar adds that, until recently, emerging benchmarks have been slow to evolve to completely cover the full emerging and frontier market opportunity set. “Investors should consider shifting to more complete developing market benchmarks that include large, mid, and small capitalization emerging and frontier market securities.”
Multiple industry sources also have pointed to Africa for explosive frontier market growth. In fact, Goldman Sachs Asset Management Chairman Jim O’Neil, who is credited with coining the term “BRIC,” has claimed that African nations could soon become the next popular emerging market destination, surpassing Brazil and Russia. Additionally, last year, Adam Tosh, Managing Director of Investment Solutions at Rogerscasey and the former Chief Investment Officer of the Kentucky Retirement System, dubbed Africa “the next frontier,” noting that, over the next five years, exposure to Africa should make up 1% to 2% of a total institutional portfolio. Despite instability, hunger, and widespread disease, the growing middle class in Africa—which includes 53 countries of both emerging and frontier markets, with no one country yet considered developed—has contributed to emerging institutional investment opportunities within the region, according to Tosh. He noted that his firm, which advises on more than $315 billion in assets, is recommending that emerging markets be at least 20% of any pension fund or total portfolio. “Africa is not the place that you see just on the headlines on the evening news,” he said at the time. “There’s a lot more to Africa, and investors need to understand the regions within Africa, how the dynamics of those regions play out, and how those different economies offer investors diversification.”
At least one other prominent consultant agrees. Cynthia Steer, previously at Rogerscasey and now the Managing Director of Investment Strategy and Consulting at Russell Investments, has made much headway in advocating for harnessing opportunities in the region. In an earlier study on the topic, she noted that improving economic and political conditions in Africa have made investments more accommodating. “Promising political revolution is essential in improving the lives of the people who live there, as well as creating a stable environment for investors,” Steer commented in a statement. “Africa’s GDP growth has outpaced world aggregate GDP growth since 2001.” According to Steer, investors can find diversification while facilitating economic progress in what is often labeled a troubled continent.
It may be intellectually amusing to compare America—arguably the world’s most developed market—to the opposite end of the geographical investing spectrum, but, when allocating capital, it is far more practical to consider the nuances of emerging and frontier markets themselves. While the BRICs may be receiving the most attention as of late, it’s the non-BRIC emerging economies—often thought of as the modern Wild West—that data suggest offer some of the most rewarding opportunities for an institutional portfolio. —Paula Vasan
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