Capital Ideas^TM

After facing a number of shocks, select frontier local markets are looking more attractive thanks to a combination of large exchange rate devaluations, tighter monetary policies and increased external financing.

Frontier markets typically represent emerging market (EM) economies that are less developed, often with sub-investment-grade credit ratings. These markets usually have underdeveloped infrastructure and perform poorly on a range of social indicators; their bond markets are often smaller with numerous limitations for foreign investors (including a greater risk of capital controls), and they usually lack the liquidity found in more established EMs. Examples include Kenya, Pakistan and Ghana.

There are also several ‘fallen angels’ in this space – markets that were once part of the primary EM landscape but have lost their core EM status due to economic crises or issues related to trading their local currency bonds, including problems with fund repatriation, index replication, or liquidity. Countries such as Egypt and Nigeria, which were once part of JPMorgan’s GBI-EM indices, have fallen out of the benchmarks for various reasons, with Egypt’s removal occurring earlier this year.

As interest rates start to come down in developed and more mature emerging markets, prospects for frontier local markets look positive, based on low correlation with global markets, stronger external positions and improving valuations.

We see opportunities within a few select local markets, in which recent policy changes have led to an improvement in the fundamental macroeconomic environment. The outlook for the asset class overall is looking positive, with diversification/uncorrelated returns, better external buffers and improving valuations, but investors need to conduct careful and detailed analysis of each country as there is still a great deal of variation.