The frontier markets sector—comprising countries with economies not yet developed enough to be considered emerging markets—may be in a position to reward investors after losing 15 percent over the past year, a report by Cerulli Associates said.
According to the report, the 29 nations that compose the MSCI Frontier Markets Index are poised to possibly benefit from several trends as the year progresses.
"The U.S. Federal Reserve appears less likely to tighten policy further, the threat of trade disputes appears to have diminished, and China has put in place measures to stimulate its economy," the report stated. "Together, these factors may be constructive for frontier markets in the near term."
Among the risks investors face in the frontier markets sector are high volatility and, sometimes, a lack of diversity and liquidity. For example, the most heavily weighted country in the MSCI frontier index is Kuwait, whose economy is heavily tied to the oil market. Other nations with high weightings in the index include Argentina, Vietnam, Morocco and Nigeria.
In its prospectus, the iShares MSCI Frontier 100 ETF points out that frontier markets "may be more likely to experience inflation, political turmoil and rapid changes in economic conditions than more developed and traditional emerging markets."
Over the past 10 years, the frontier markets index has brought an annualized return of 8.6 percent to investors, while emerging markets delivered 10.7 percent and the MSCI World Index showed a 13.7 percent annualized return, according to Cerulli.
Over the past year through February, the frontier sector was down 15 percent, while the MSCI World Index logged a 1 percent gain.
Yet the report noted that some regions within the sector give reason for optimism.
"At present, several regions appear favorable for investors," the report said. "In the Middle East and North Africa, fiscal reforms, rising corporate earnings, improving valuations and higher inflows of foreign capital should stand the region in good stead. Similarly, several catalysts such as population growth, rising incomes and urbanization are benefiting several Asian markets, including Vietnam."
Because of the sector's risks, the report’s authors advised investors to approach frontier markets through an active manager who can adapt to changing circumstances. The report noted, for example, that Argentina and Saudi Arabia are due to be removed from the frontier markets index in June because they will be added to the MSCI Emerging Markets Index. The change means that the frontier market index will have to absorb more holdings from weaker economies.