By: Mat Lystra, Sr. Research Analyst
When we think about frontier markets as investment options, concerns like corruption, rule of law (or lack thereof) and inaccessible government services might come to mind. These are the types of risks that make for catchy news headlines but they shouldn’t necessarily be showstoppers when considering this segment of the market. To get the whole picture, one needs to consider the factors outside of the headlines that drive performance.
As an example, I recently took notice of a story by The Global Post, which reported that a person living in a Kenyan city pays an average of 16 bribes per month in order to get on with daily life. Such costs are largely unthinkable for those of us living in well-established developed markets. This prompted me to look at some of the countries commonly classified as “frontier markets” to determine if this headline risk was aligned with the historical returns in these markets. Kenya is currently classified by FTSE Russell as a frontier market.
As you can see in the chart below, despite having one of the lowest ratings among frontier markets as measured by Transparency International’s Corruption Index, Kenyan stocks—as measured by the FTSE Russell Frontier index—have been some of the highest performing over the last five years. Kenya’s five-year annualized return of 14.87% is second only to Malta among this grouping of countries.
Transparency International’s Corruption Index Score and Performance
Sources: Transparency International and FTSE Russell data as of March 31, 2016. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Based on the data in the chart above, it seems that levels of corruption are not necessarily inversely related to poor returns for frontier markets. A large part of a frontier market’s potential, particularly for a country such as Kenya, lies in how much room there is for improvement: imagine the additional buying power of the Kenyan consumer if paying bribes were to become a thing of the past. The headlines don’t tell the whole story.
Let’s take a broader look at how frontier markets fare versus developed and emerging markets as tracked by the Russell Frontier Index. We can see below that the Frontier Index performance falls squarely in the middle of the Russell Developed (ex US) and the Russell Emerging Markets Indexes for both the three and five year periods on an annualized basis. Most strikingly, it has done so with the least volatility of the three since the financial crisis in 2009.
Comparative Annualized Performance and Volatility of Russell Indexes
Source: FTSE Russell data as of March 31, 2016. Past performance is no guarantee of future results. Please see the disclaimer for important legal disclosures.
As we can see above, frontier markets offer a different risk/return profile than their developed and emerging market counterparts. This makes sense because as a group frontier markets combine characteristics of the other two categories in that they can be as diverse as emerging markets, with some as economically and politically free as many developed markets. So, if we can look past the headlines we can identify other factors that drive performance in these regions or countries, which can inform investment analysis, diversification and decisions.
Please see the FTSE Russell website to learn more about the Frontier Index series.
 Fannin, Z. & Schifrin, N. (2016). The average city dweller in Kenya pays 16 bribes a month. Global Post, accessed on May 27, 2016 at: http://www.globalpost.com/article/6771363/2016/05/23/average-city-dweller-kenya-pays-16-bribes-month-officials
 For more information about FTSE’s country classifications please visit: http://www.ftse.com/products/indices/country-classification
 For more information about Transparency International’s Corruption Index please visit: http://www.transparency.org/cpi2015
 Country returns from the Russell Frontier Index.
© 2016 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE TMX Global Debt Capital Markets Inc. and FTSE TMX Global Debt Capital Markets Limited (together, “FTSE TMX”) and (4) MTSNext Limited (“MTSNext”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE TMX and MTS Next Limited. “FTSE®”, “Russell®”, “FTSE Russell®” “MTS®”, “FTSE TMX®”, “FTSE4Good®” and “ICB®” and all other trademarks and service marks used herein (whether registered or unregistered) are trade marks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, or FTSE TMX.
All information is provided for information purposes only. Every effort is made to ensure that all information given in this publication is accurate, but no responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for any errors or for any loss from use of this publication or any of the information or data contained herein.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the results to be obtained from the use of the FTSE Russell indexes or the fitness or suitability of the indexes for any particular purpose to which they might be put.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing in this communication should be taken as constituting financial or investment advice. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any representation regarding the advisability of investing in any asset. A decision to invest in any such asset should not be made in reliance on any information herein. Indexes cannot be invested in directly. Inclusion of an asset in an index is not a recommendation to buy, sell or hold that asset. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group index data and the use of their data to create financial products require a license from FTSE, Russell, FTSE TMX, MTSNext and/or their respective licensors.