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Monday, 10 June 2019

The thin grey line between frontier markets and emerging markets

EXPLAINER FOR NON-FINANCE GEEKS- The thin grey line between frontier and emerging markets: In a recent explainer on frontier markets, Bloomberg makes a point of calling them the “smaller siblings” of emerging markets, a very popular — albeit simplistic — comparison. The reality is a little more nuanced considering the lines between the two are much more blurred as far as asset managers are concerned — particularly when you subtract the big economies from the list of emerging markets. We feel it is worth diving into these nuances at a time when frontier markets are increasingly being hailed as potential alternatives to emerging markets amid turbulence sparked by the ongoing US-China trade war — the theory being that frontier markets and smaller EM are less susceptible to being hit by fallout from the trade fight.

What’s the difference between FM and EM? Let’s start with the basic criteria. MSCI defines (pdf) frontier markets based on several criteria, including having “at least some” openness to foreign ownership, “at least partial” easing of capital flows, at least two companies worth USD 800 mn each, and a high degree of competition. On the flipside, an EM’s openness to foreign ownership needs to be “significant”, with a significant ease of capital flows and a high competitive landscape. An EM needs to have at least three companies with a market cap of around USD 1.6 bn.

Egypt is an emerging market on the “leading” benchmark: Some 29 countries are currently classified as frontier markets by the benchmark MSCI (pdf) with stocks with a combined market value of USD 715 bn, compared to the now 26 MSCI EM stocks (pdf) which are valued at around USD 20 tn.

But this isn’t an exact science: MSCI is just one arbiter of what constitutes a frontier or emerging markets. The IMF classifies 23 countries as emerging markets, Dow Jones classifies 22 countries, and FTSE Russell only classifies 19. Only Brazil, Chile, China, Colombia, Hungary, Indonesia, India, Malaysia, Mexico, Peru, Philippines, Russia, South Africa, Thailand and Turkey are classified by all three as emerging markets. Notice how Egypt is not on the list?

How does this grey area affect us? This variance in classification has allowed some asset managers to consider some EMs to be interchangeable with FMs, with Egypt being a prime example. This basically pits EMs that are not BRICs (Brazil, Russia, India,and China) against frontier markets in the fight for global capital.

According to the MSCI, FMs have been outperforming EMs this year, with the former seeing returns of 9.6% YtD (pdf), compared with returns of 4.1% YtD for EMs (pdf). Some investors are concluding that, given the impact of the EM Zombie Apocalypse last year and the effects of recent global market volatility, now is the time to cast the net further afield. This gets more bleak for EMs when we see returns beyond the BRICs, which were a measly 1.6% YtD (pdf).

What does the future hold for the EM vs FM rivalry? Several countries currently classified as EMs have been identified as likely to number the world’s strongest economies by 2030, including Egypt. Likewise, the frontier market class is shrinking, as an increasing number graduate to EM status. Argentina is due to be promoted to an EM this month, and Kuwait (which currently accounts for a quarter of the MSCI Frontier Markets Index) may be promoted in June. Saudi Arabia skipped the FM index altogether and was promoted directly to EM status in May. In the short-term, this is causing aggregate FM value to decrease. Furthermore, as the asset class shrinks, investments are likely to move towards EMs.

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