Frontier market

Frontier market is an equity market in a developing country that is more accessible to foreign investors than least-developed countries but too small, illiquid, or risky to qualify as an emerging market (Khambata F. 1992)^[1]. These are the markets before the markets everyone knows. Vietnam before Vietnam appeared in emerging market indexes. Nigeria before institutional investors paid attention. Kuwait before the oil money attracted global capital. The frontier label signals potential—and patience required.

Farida Khambata at the International Finance Corporation coined the term in 1992. She needed a category for investable markets that didn't fit the emerging market definition. Three decades later, frontier markets remain a distinct asset class—higher risk, higher potential return, and fundamentally different characteristics than their better-known emerging market cousins.

Classification framework

Index providers like MSCI and FTSE classify markets based on:

Market capitalization. Total value of listed companies. Frontier markets are typically smaller—under $100 billion total.

Liquidity. Trading volume relative to market size. Can you buy and sell positions without moving prices dramatically? Frontier markets offer less liquidity.

Accessibility. Can foreign investors actually participate? Restrictions on ownership, capital controls, settlement complexity. Frontier markets have more barriers than emerging markets—but fewer than closed markets^[2].

MSCI's frontier market classification includes countries like Vietnam, Bangladesh, Kenya, Morocco, and Romania. The list evolves—countries get promoted to emerging market status (Qatar and UAE in 2014) or demoted from emerging to frontier (Pakistan in 2021, later reinstated).

Investment characteristics

Frontier markets behave distinctly:

Low correlation. Frontier market returns show limited correlation with developed and emerging markets. When the S&P 500 drops, frontier markets don't necessarily follow. This diversification benefit attracts institutional investors.

Higher volatility. Smaller markets with fewer participants swing more wildly. Political events, commodity price changes, and currency moves create larger price impacts.

Illiquidity premium. Patient investors may earn excess returns for accepting illiquidity. Getting in is easier than getting out—but compensation exists for bearing that risk^[3].

Growth potential. Frontier economies often grow faster than developed ones. Young populations, urbanization, technology adoption. Of the twenty fastest-growing economies globally, nineteen are frontier markets.

Currency risk. Frontier market currencies can depreciate sharply. A 20% stock gain evaporates if the local currency falls 25%. Hedging options are limited or expensive.

Country groupings

Frontier markets fall into rough categories:

Small developed economies. Estonia, Slovenia, Croatia. High per-capita income but markets too small for emerging classification. Low risk relative to other frontiers.

Gulf Cooperation Council. Kuwait, Bahrain, Oman. Oil wealth with underdeveloped capital markets. Improving accessibility has moved some (UAE, Qatar) to emerging status.

Sub-Saharan Africa. Kenya, Nigeria, Ghana. High growth potential, significant risks. Commodity dependence and political uncertainty^[4].

Southeast Asia. Vietnam, Bangladesh, Sri Lanka. Manufacturing hubs with large populations. Vietnam particularly has attracted investor attention.

Other. Pakistan (recently relegated from emerging), Kazakhstan, Tunisia. Various circumstances creating frontier classification.

Promotion and demotion

Countries move between classifications:

Promotion to emerging. Improved market infrastructure, lifted investment restrictions, increased liquidity. UAE and Qatar graduated in 2014. Vietnam has been discussed repeatedly but hasn't moved.

Demotion to frontier. Deteriorating conditions can reverse progress. Greece fell from developed to emerging in 2013—the first such demotion. Pakistan dropped from emerging to frontier in 2021 due to liquidity concerns^[5].

Promotion effects. When MSCI announces promotion, passive funds tracking emerging market indexes must buy. Prices often rise in anticipation. The promotion itself creates returns.

Demotion effects. The reverse—forced selling as indexes drop the country. Prices typically fall before and during the transition.

Investment vehicles

Accessing frontier markets presents challenges:

Direct investment. Opening local brokerage accounts, navigating foreign ownership rules, handling settlement complexities. Practical only for large institutions.

ETFs. Exchange-traded funds provide retail access. iShares MSCI Frontier 100 ETF offers diversified exposure. Liquidity is limited compared to developed market ETFs.

Mutual funds. Actively managed frontier funds attempt to add value through country and stock selection. Higher fees than passive options.

American Depositary Receipts. Some frontier market companies list ADRs on U.S. exchanges. Limited selection but easier access^[6].

Risks specific to frontier markets

Beyond normal equity risk:

Political instability. Coups, civil unrest, sudden policy changes. Nigeria's oil politics, Bangladesh's garment sector labor issues, Kenya's election tensions all affect markets.

Regulatory uncertainty. Rules change unpredictably. Foreign ownership limits might tighten. Repatriation of profits might become difficult.

Operational risk. Settlement failures, custody problems, documentation issues. Things that work automatically in developed markets require active management in frontiers.

Information asymmetry. Less analyst coverage, fewer disclosed financials, limited transparency. Local investors may have significant information advantages^[7].

Market manipulation. Smaller markets with fewer participants are more susceptible to price manipulation.

Performance history

Frontier market returns have been mixed:

The MSCI Frontier Markets Index launched in 2007. Performance has varied dramatically by period and by country. The diversified index has generally underperformed emerging markets since inception—but with lower correlation and occasional outperformance periods.

Individual country selection matters enormously. Vietnam has dramatically outperformed; others have disappointed. Country-level analysis dominates stock-level analysis in frontier investing.

Role in portfolios

Institutional investors typically allocate small percentages—1-5%—to frontier markets:

Diversification. Low correlation adds portfolio efficiency even with higher individual asset volatility.

Return enhancement. Growth potential may boost long-term returns.

Frontier-to-emerging transition. Early positioning in countries likely to be promoted captures upgrade premiums^[8].

ESG considerations. Some frontier markets pose governance challenges that ESG-focused investors must navigate.

The allocation remains small because risks are substantial and liquidity constraints limit position sizes.

Frontier market — recommended articles

Investment — Emerging market economy — Risk management — Portfolio management

References

• Khambata F. (1992), Emerging and Frontier Markets, International Finance Corporation Working Paper.
• MSCI (2023), MSCI Market Classification Framework, MSCI Inc.
• Speidell L.S. (2011), Frontier Market Equity Investing, CFA Institute.
• Garg R., Dua P. (2014), Foreign Portfolio Investment Flows to India, Journal of Emerging Market Finance.

Footnotes

1. ↑ Khambata F. (1992), Emerging and Frontier Markets
2. ↑ MSCI (2023), Market Classification Framework
3. ↑ Speidell L.S. (2011), Frontier Market Equity Investing
4. ↑ MSCI (2023), Market Classification Framework
5. ↑ MSCI Index Review 2021
6. ↑ Speidell L.S. (2011), Frontier Market Equity Investing
7. ↑ Garg R., Dua P. (2014), Foreign Portfolio Investment Flows
8. ↑ MSCI (2023), Market Classification Framework

Author: Sławomir Wawak