Investing in Frontier Markets

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.

US persons (both entities and individuals) are subject to US taxation on their worldwide income and may be subject to tax and other filing obligations with respect to their US and non-US accounts. The Foreign Account Tax Compliance Act (FATCA) is a US law designed to prevent the use of non-US accounts or non-US entities to avoid US taxation of income and assets. To meet this objective, FATCA imposes on US and non-US entities certain documentation, due diligence, withholding and reporting requirements with respect to accounts and certain payments. Investors should consult their independent tax advisors about tax implications prior to investing. Learn more about FATCA.

Risk Considerations:
There is no assurance that a portfolio will achieve its investment objective. In addition, there is no guarantee that any investment strategy will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly, an investor can lose money investing. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging-market countries are greater than the risks generally associated with foreign investments. Frontier market countries generally have smaller economies and even less developed capital markets or legal and political systems than traditional emerging market countries. As a result, the risks of investing in emerging market countries are magnified in frontier market countries. Fixed income securities are subject to credit and interest-rate risk. Investing in RMB-denominated debt instruments that may be issued by issuers located in Hong Kong and China or multi-national issuers with subsidiaries in Hong Kong or China, may involve special risks including but not limited to currency risk, political and economic risk. For complete risk considerations, which should be considered carefully along with the portfolio's investment objectives and fees before investing, please refer to the fund's prospectus.

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