For many market participants, diversification was always one of the great attractions of emerging markets. In the past, since these markets did not track developed markets they provided a useful counterbalance for the global investor. That is no longer so much the case as emerging and developed markets have shown in recent years an inconvenient and increasing correlation.
Frontier markets, on the other hand, still offer a strong element of diversification.FTSE Frontier Index has a five-year correlation of only 0.5132 to the FTSE All Cap Emerging Index. Frontier markets are one step beyond other emerging markets in the sense that they are at an earlier stage of economic reform and financial market development. It does not, however, mean that they are necessarily any poorer or less economically developed than many emerging or even some developed market countries. After all, Qatar – with one of the highest levels of per capital wealth in the world – is classified by FTSE as “frontier”. So also is oil-rich Nigeria. Frontier markets still have a number of improvements to take before before their market structures qualify them for an upgrade to emerging status.
Accurately identifying which countries count as frontier, therefore, is crucial. For most market participants, that can be a tough job without expert help which is why FTSE has just launched a new FTSE Frontier Market Index Series to complement its existing developed and emerging market indices. Using its rules-based and transparent country classification system, FTSE has identified 26 frontier markets. The index series covers 368 companies within this universe. It is, in effect, a road map for index users to understand and access these often distant and lesser known markets.
One interesting characteristic of frontier markets that the new index series illustrates is that, counter-intuitively, these markets are less volatile than their emerging market cousins. In fact, as a group they have historically even exhibited less volatility than developed markets too. At the same time, they demonstrate lower valuations than emerging markets even though they have outperformed them for the last three years.
Source: FTSE, as at 31 December 2013
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