When one considers emerging and frontier markets, what frequently comes to mind are images of remote, poverty-plagued places, with volatile social fabrics and corrupt institutions. This is an overly simplistic and largely misleading narrative, however, and overlooks some crucial realities. The emerging markets (EMs) offer many more economic growth opportunities than do most developed countries such as the US, Germany or Japan. The IMF has forecast that over the next 10 years, 70 per cent of the world’s economic growth will come from the EMs and 40 per cent of that from China and India alone.
Yet with estimates showing as little as five per cent of the average portfolio invested in the EMs, in spite of the MSCI Emerging Markets Index’s stellar 10-year annualised 16 per cent returns – many investors are neglecting an area of the world which constitutes 51 per cent of global GDP.
There is no universally accepted definition of what constitutes EMs but they are generally considered to be places progressing towards becoming advanced economies, usually transitioning from agriculturally-based economies to manufacturing and service-related ones. Frontier markets (FMs), on the other hand, are a sub-set of emerging markets; they are less developed and often have greater opportunities than do EMs. What constitutes an emerging market isn’t always straightforward. Qatar has the world’s highest GDP per capita ratio, but only this year was elevated from frontier to emerging market status by index provider MSCI.
What makes emerging and frontier markets so compelling are their many positive economic and demographic drivers: young populations; low debt; a growing middle class; increasing consumption; and for the most part governments embracing free market principles.
Whereas many developed markets have aging populations, emerging and frontier countries have young ones. In Japan and Germany the median age is 45, comparatively old when likened to Iraq with half of their population under the age of 25.
Africa and Asia have median ages of 20 and 30 respectively compared to developed markets in general with median ages of 41. Demographics drive economies, since young populations tend to produce and consume more, whereas older populations consume less and are often a strain on national pension and health care budgets.
No other EMs are as powerful as China and Russia. While developed economies barely grew this last decade, China’s economy soared at an annualised 10 per cent a year, and is forecast by the OECD to overtake the US as the world’s largest economy by as early as 2016. Like many other EMs, China’s finances are also significantly healthier than many developed countries. For example, the US, considered the bellwether for developed countries, holds $580 billion in saving deposits, low when compared to China’s $7.3 trillion stockpile of personal savings. Likewise, your typical emerging market economy has an average debt to GDP ratio of 35 per cent, half that of developed markets at 70 per cent.
Russia, which only in 1998 defaulted on its sovereign debt, today has over $522 billion in international reserves, little debt, and is the world’s second and leading crude oil and natural gas exporter respectively. Russia, the globe’s largest country geographically, is forecast to overtake Germany as Europe’s largest consumer market by 2014.
Consumerism is alive and well in the emerging markets, with roughly 60 million people a year entering the Chinese and Indian middle class – that’s about the population of Italy. Coca-Cola Co., the US beverage giant, relies on more than 60 per cent of its business coming from the EMs. KFC, with almost 4,300 outlets in China alone, will soon have more restaurants there than in the US. Even more impressive are just how cheap emerging market stocks currently are, with the MSCI Emerging market index having a price/earnings ratio of 12 – almost a third as cheap as is the S&P500. Although the EMs offer compelling prospects, FMs in particular offer some of the greatest opportunities.
With combined populations of two billion people, FMs account for roughly 30 per cent of the world’s population, yet constitute only six per cent of the world’s nominal GDP and less than 1 per cent of global equity market capitalisation.
Also the MSCI Frontier Market Index has a low .35 correlation to the S&P500, making it an excellent portfolio diversifier.
To be sure, investing in frontier and emerging markets has its risks considering they are highly volatile and prone to periodic outsized selloffs. A diversified portfolio of EM assets coupled with a long term outlook should benefit your portfolio, considering the future looks bright for emerging and frontier markets.
Joseph Portelli is the managing director and chief investment officer at FMG Funds (Malta). He also is a lecturer at the University of Malta and Institute of Investment Analysis.