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Frontier markets – the richly diverse path to yield
A new study published today by the Credit Suisse Research Institute explores the diverse investment region of frontier markets and introduces the Credit Suisse Frontier Markets group of 30 countries, representing 16% of the global population, occupying 12% of the planet's landmass and generating 5% of world economic activity. These 30 countries collectively account for USD 3.7 trillion of economic output equivalent to 15% of the USD 24.4 trillion GDP generated by emerging markets. By assessing factors such as the macroeconomic environment, demographic trends and the quality of institutions in these developing nations, the report shows that frontier markets offer investors the potential to increase risk-adjusted returns through diversification benefits.
As conventional emerging world economies mature, investors in search of superior growth, higher yield and discounted valuations are increasingly drawn toward the next frontier of investment opportunities in less developed markets. In its report on “The Next Frontier”, the Credit Suisse Research Institute (CSRI) examines the potential for this frontier universe of countries to deliver consistent risk-adjusted returns, identifies the myths and hazards involved, and cautions against drawing sweeping parallels with the emerging markets of yesteryear.
Alexander Redman, co-author of the publication: “While frontier markets are still the most under-represented asset-class in both global bonds and equities, they offer investors the potential to increase risk-adjusted returns through diversification benefits and the scope to differentiate their performance from the benchmark. Given the heterogeneity of this investment region, key factors for investors to watch include the ability of frontier markets to absorb a fast growing population into the workforce, urbanization dynamics, technology utilization as well as the quality of administrative and corporate governance.”
With regard to the newly introduced Credit Suisse Frontier Markets group of 30 countries across Asia, EMEA, Sub-Saharan Africa and Latin America, the study includes the following key findings:
- Frontier markets remain a diverse investment region: The breadth in per capita economic activity as well as in equity and bond market depth and liquidity underscore the diversity of this heterogeneous group of 30 developing nations. Based on IMF projections up to 2021, some of these countries – notably Côte d'Ivoire, Bangladesh, Kenya and Vietnam – are on course for impressive growth, outpacing India or China. However, several of the frontier markets – typically in Latin America and EMEA – will likely underperform in growth terms, compared to developed economies.
- Frontier markets have strong demographics: Relative to developed and emerging markets, frontier nations show high (yet moderating) fertility rates, elevated population growth of up to 3% per annum, a rising share of working age population, improving life expectancies, low urbanization rates of 48% on average and a higher degree of ethnic and linguistic fractionalization. The potential to exploit this “demographic gift” is reliant on the ability of frontier market economies to integrate the fast-growing population into the workforce.
- Frontier markets have potential for significant productivity gains: Frontier market grading on competitiveness, human development and labor flexibility has great development potential. The prevailing incentive to invest in frontier markets is to participate in the region with the greatest scope for advances in governance, productivity, urbanization, technology utilization, penetration in financial services, education and healthcare, while benefitting from the financial asset rerating as a consequence of the convergence towards developed and emerging market norms.
- Frontier markets show selective improvements in governance: Supportive demographics, potential benefits of urbanization and convergence in productivity with the developed world notwithstanding, the quality of public institutions in the respective markets will remain crucial. Frontier markets have been characterized by dual speed progression in the quality of administrative and corporate governance led by smaller nations, while those with larger, more heterogeneous populations struggle to keep pace.
- Frontier markets will benefit from open trade: While more open to trade than some of emerging economies, frontier markets are well positioned to expand their market share of global exports. Frontier markets benefit from an abundant supply of comparatively cheap labor and from emerging markets progressing up the value-chain from labor intensive manufacturing. This will allow frontier economies to reduce their dependence on commodity exports and to focus on more value adding products and services.
- Frontier markets have potential in capital markets: Frontier markets are the most under-represented asset-class in both global bonds and equities. While representing 16% of the world-wide population and generating 5% of global economic activity, they account for merely 0.5% of global equities.
- Frontier markets offer attractive valuations: Frontier markets offer large pockets of highly profitable corporations with a track record of creating value for shareholders. With a higher cost of equity, frontier assets currently trade on a considerable discount to developed equities and have consistently offered superior yield.
The Credit Suisse Frontier Markets group of countries
In its report, the CSRI introduces a proprietary framework of 30 countries (Credit Suisse Frontier Markets, CS FM) across four continents, which it sees as best representing the core characteristics of superior growth and demographics, improving governance, convergence in productivity and discounted valuations typically associated with the frontier market universe. The CS FM collectively account for USD 3.7 trillion of economic output equivalent to 15% of the USD 24.4 trillion GDP generated by emerging markets.
Furthermore, the report assesses a focus group of frontier nations, the CS FM10, made up of the ten largest constituents selected by their respective simple ranking of current nominal GDP, population and equity market capitalization. This group of developing nations includes Argentina, Bangladesh, Egypt, Iran, Kenya, Morocco, Nigeria, Pakistan, Romania and Vietnam, which are highly representative of the larger group as a whole in terms of average GDP and population growth, per capita economic output, fertility rates and urbanization dynamics and growth.
“The Next Frontier” report published by the Credit Suisse Research Institute is available for download at www.credit-suisse.com/researchinstitute.
About the Credit Suisse Research Institute
The Credit Suisse Research Institute is Credit Suisse's in-house think tank. The Institute was established in the aftermath of the 2008 financial crisis with the objective to study long-term economic developments, which have – or promise to have – a global impact within and beyond the financial services.
For more information, visit: www.credit-suisse.com/researchinstitute.
About the authors of the report
Alexander Redman is Head of Global Emerging Market Equity Strategy and Emerging EMEA Equity Strategy in the Credit Suisse European Research team. Alex joined Credit Suisse in September 2000 from Donaldson, Lufkin & Jenrette, where he co-authored the International Equity Strategy product. Prior to that, he worked at Robert Fleming Securities in London and Jardine Fleming Securities in Hong Kong as a Global Emerging Markets Quantitative Analyst in the equity strategy team.
Arun Sai is a Vice President in the Global Emerging Market Equity Strategy team. Arun joined Credit Suisse in January 2011 from CRISIL India, where he led a team of strategy and quantitative research analysts. He holds an MBA specialising in finance and a degree in Computer Science and Engineering.