5 Misperceptions About Frontier Market Investing

When you’ve spent as long around Frontier Market investing as our team has, you’re regularly exposed to certain themes that repeatedly bubble up in investor conversations.

Such perspectives are largely tainted by misunderstandings and a broader lack of information about the asset class as well as a sense of “why bother?”

It all tends to add up to widespread aversion to equities from Frontier Market (FM) countries and those from less-prominent Emerging Market countries for U.S.-based investors, despite portfolios frequently positioned in a near-constant state of being under-diversified on a geographic and sector basis.

As part of helping set the record straight for investors, we frequently find ourselves dispelling the following misperceptions most often.

FM Investment Risks Overwhelming and Pervasive

The most persistent misperception about FM investments is that they’re excessively risky, due primarily to political and economic policy instability. This is fueled in part by a significant shortfall in reliable information on developing nations worldwide.

For example, when the New York Times, Washington Post, and even the Wall Street Journal produce a story about Vietnam, readers tend to get a view that is usually incomplete. And that usually tends to make the country sound and look much more dangerous than it actually is.

Generally, outside of big political changes that lead to economic policy disasters—which are not as common an occurrence as people think—the volatility isn’t that dramatically different from developed world indexes. Plus, in a multi-country opportunity portfolio, it can be managed through active asset management.

In fact, these political and economic cycles tend to create more investment opportunities and more ability to outperform in both an absolute and relative sense—it’s all about proactively taking advantage of the volatility, not the other way round.

FM Stocks are Deep Value Positions with Little Growth Potential

Asset managers in the developed world love assigning labels to products, placing strategy offerings into boxes that commonly have value or growth labels. Within that context, FM investments are frequently tagged as deep value holdings, which turns off many who seek at least some semblance of growth potential.

The reality is much more nuanced. We tell our investors that you can get value with growth, sometimes via value positions in some countries and growth holdings in others—again, an advantage of a multi-country portfolio.

To explain: FM countries move through political and economic cycles and when they’re first emerging from a difficult period, the stocks are usually in a deep value phase and may not seem to offer any semblance of growth. But as reforms cycle through and conditions gradually improve, there’s a transition from deep value to value. Then, stocks move into fair value territory and ideally, as momentum remains rolling in a positive direction, move into growth territory with multiple expansion as a final additional kicker.

This progress occurs at varying speeds from country to country and sector to sector. For example, a year ago, Argentina was in deep value territory, but due largely to the efforts of President Javier Milei, who took office in December 2023, it’s approaching a point where it may soon turn into a growth story. Meanwhile, Vietnam’s solid momentum places it strongly in a strategic growth phase, even though multiples still largely resemble value-like figures.

Is patience required? Usually. But it’s thoroughly incorrect to paint a world’s worth of investments with a brush that restricts investments based on value or growth labels, discounts the upside potential in a variety of positions, and unnecessarily pigeonholes an investment strategy. In addition, by adopting a value mindset in one country and a growth mindset in another, you’re further enhancing your portfolio’s diversification.

FM Consumers Contribute Little to Growth Outlooks

While allowing for the broader economic environment of the country concerned, this blanket statement is simply not true. Typically, fast-growing countries are bolstered by positive demographic trends: A young population moving through the teenage and young adult years into professional careers with growing discretionary income alongside healthy birth rates stimulating family formation and consumption.

Notably, while younger consumers typically have a propensity to consume more, especially as they enter the workforce, the robust population growth rates in FM countries outpace much of the developed world, where many nations are actually below the replacement threshold (see chart for Kazakhstan vs. U.S. fertility rate). Additionally, as countries grow and get richer, disposable income levels increase further.

Source, World Bank, https://data.worldbank.org/indicator/SP.DYN.TFRT.IN?end=2022&locations=KZ-US&start=2000

We view this trend as ideal, and these positive demographic trends exist in around 90% of the countries in which we either have investments or are considering investments. Plus, given that rising consumption trend, we focus on local businesses exposed to these trends, not those beholden to global business sector trends such as global tech companies.

It also generally buffers our strategies from U.S. decisions on trade. For example, in Vietnam, the bulk of our positions have zero direct developed world exposure and therefore limited ties to potential U.S. tariffs. What does bear watching, though, is whether the exporters in the country are significantly impacted by tariffs, as that could somewhat inhibit the prospects for Vietnam’s overall growth. Although, in that particular case, the level of foreign strategic direct investment in the country is so large it is likely to overwhelm short-term hiccups.

FM Countries Lack Sophistication

The developed world’s lens on FM nations can sometimes be harsh. At times, this translates into the thinking that if it’s not the U.S., Europe or Japan, the population—from people running businesses to the average consumer— is not as sophisticated.

This couldn’t be more wrong. We see a deep pool of smart, motivated, entrepreneurs in Vietnam and other FM countries and we believe the argument could be made that Vietnam is more capitalistic than most European countries. What can happen is that countries inhibit economic opportunity with their policies, but that’s why we focus on identifying countries that are fundamentally changing their approach to social and political reform that will, in turn, lead to economic policy reform.

Perhaps the only things that held Vietnam back in the past were self-dealing oligarchs and limited access to capital and technology, but those barriers are increasingly disappearing. Along with access to global capital and global technology for example, Vietnam’s Communist government has grown to become highly capitalistic over the last 20-30 years and the model has clearly delivered well for the country and its people.

FM Stock Losses Always Align with U.S. Market Losses

Many investors are obsessed with the correlation between FM stocks and U.S. equities, asking us how far FM stocks will fall if the U.S. market drops 25%. In the short term, there will likely be similar declines as correlated volatility in global markets pricing certainly exists. But the recovery from such downturns tends to be quicker, especially for active investors who strike that value/growth balance.

For example, if a stock is trading today with a dividend yield of 9% to 10% and a P/E ratio of 4 or 5 with double digit earnings growth, can it go down 25% to 30% in the short run? Yes. But history shows it will tend to bounce back more quickly because it’s gone from cheap to absurdly cheap and local investors will see this first, followed by international investors quickly thereafter.

A Constant Learning Process

Like any investment, the ebbs and flows of Frontier Market equities must be viewed in the context of each distinct country’s cycle, which may be normal and neutral, or it may be abnormal.

In the case of a political crisis like we saw in Argentina 3-4 years ago under a dysfunctional government, that was abnormal. But then, obviously, it’s the job of the investment manager to minimize exposure to such a country. Specifically in that instance, our portfolio was more exposed than we should have been when the opinion polls were very misleading ahead of mid-term elections, and our performance reflected that misstep. But we learned from the experience.

Ultimately, Frontier Market equities remain a dynamic, diverse, multi-country asset class that offers very attractive return potential with conditions that require steadfast monitoring and an active management mindset. To simply dismiss it from consideration when it represents such a significant part of the world’s GDP growth is a mistake.