The investment universe
At HSBC, our frontier markets investment universe includes countries that are in the MSCI Frontier Markets index, as well as emerging markets which are considered ‘cross-over’ markets, and a number of companies that are listed outside frontier markets but are heavily exposed to them. ‘Cross-over’ markets are those that are formally included in main emerging markets indices but exhibit some “frontier markets” characteristics, such as foreign investment restrictions, lower correlation with global markets and/or other economic and political factors.
While the majority of index providers produce frontier market indices, there are significant differences between them with respect to country and regional representation, and we believe that none of them really give a true representation of the frontier markets universe. The MSCI Frontier Markets index, for example, is very heavily weighted in Middle Eastern countries, while other regions are under-represented. At HSBC we have carried out extensive studies of the underlying markets, and have worked with MSCI to design an MSCI Capped index which we believe more accurately reflects the frontier markets opportunity and provides sufficient diversification to have a well-balanced universe. This index is based on the MSCI Frontier Emerging Markets index but caps the weight of the combined ‘cross-over’ markets and also caps any individual country weight at 10%, solving the issue of too much concentration in any one region or country. A comparison of the makeup of existing indices and our capped index is shown below:
How to acces this strategic opportunity
Frontier markets present an interesting long-term investment opportunity, as they offer above average growth potential through economic cycles, together with potentially lower than average volatility.
We believe the best way to access this opportunity is through a strategic allocation to frontier market equities. Although some general emerging market managers have the discretion to invest in frontier market equities as part of an emerging market mandate, this may not harness their full potential e.g. if investment is limited only to the most liquid frontier market stocks or if the smaller frontier countries are overlooked. These markets are typically less researched and less liquid than most equity markets, and so tend to be less efficient.
The resulting pricing anomalies can create exciting 'alpha' opportunities, which typically can be systematically captured by active managers who have the commitment, skill and global resources available to do the necessary research and take advantage of such market inefficiencies.
Investors seeking sources of long-term growth with low volatility can consider a potential allocation to frontier markets as a complement to their existing global emerging markets exposure.