Johannes Loefstrand, portfolio manager at T. Rowe Price, defines frontier markets as countries that are neither developed nor emerging, such as Vietnam, Morocco, and Romania. Despite often having smaller sizes and less liquid markets, they are the fastest-growing cluster of countries globally, offering fertile ground for active stock picking due to market inefficiencies and dynamic companies with high corporate governance standards.
Loefstrand emphasizes that frontier markets are surprisingly less volatile than other equity indexes. This is because these markets are not significantly connected to global liquidity flows, meaning that economic events in one frontier market (e.g., Vietnam) do not necessarily impact others (e.g., Morocco or Romania). This low correlation with developed and emerging markets helps reduce overall portfolio volatility for global investors.
Frontier markets represent a significant portion of the global economy, accounting for 36% of the world's population and 15% to 16% of global GDP, making them the fastest-growing part of global GDP. Despite this, they only comprise about 0.3% of total global market capitalization. Loefstrand notes that the financial sector is a significant part of the frontier market index, accounting for nearly 40% of the opportunities, but there are also dynamic sectors like technology, with Vietnam alone having 1,700 listed stocks.
From a valuation perspective, frontier markets are currently the cheapest region globally, with a price-to-earnings (P/E) multiple of around 9.5 times, which is below its historical average of over 10 times and lower than any other major equity index. This attractive valuation, coupled with accelerating earnings growth and high dividend yields, suggests potential for significant returns. Geopolitical shifts are also directing more money towards these regions. Loefstrand strongly advises active management over passive investing in frontier markets due to their inefficiencies and the need to navigate risks like capital controls.
Historically, frontier markets have provided solid long-term performance, comparable to more mature equity markets, with the MSCI Frontier Markets Index returning 20% in 2021 compared to a -2% return for the MSCI Emerging Markets Index. The T. Rowe Price strategy for frontier markets has seen nearly a 90% return in pound terms over the last five years, despite multiple re-ratings, driven by strong earnings growth and dividends. Investing in these markets offers portfolio diversification and long-term growth opportunities.
