Emerging and frontier markets provide aggressive investors with opportunities to capitalize on smaller economies transitioning towards modern, industrial economies.
Over time, developing countries often adopt reforms similar to those seen in developed ones; however, their varying levels of efficiency may hinder performance.
Investing in Emerging Markets
Emerging Markets (EM) typically exhibit low per capita incomes and financial markets that are less liquid than in developed economies, making transitioning to modern industrial economies more challenging for residents of these emerging nations, which also tend to feature young, fast-growing populations and abundant natural resources. Emerging markets can pose increased risks than investing in developed nations like the US; commodity price fluctuations, political unrest and currency volatility pose potential issues when investing in emerging markets such as Russia or South Africa. To invest successfully in such ventures requires an investor with higher risk tolerance than investing in developed nations like America (i.e. USA).
Recently, Emerging Market (EM) stock market returns have been negatively impacted by factors including slowing global economic growth and subpar USD earnings growth. However, when considering China – which makes up roughly one third of most EM indexes – as part of the equation it paints a more positive picture.
Investing in Frontier Markets
Frontier markets tend to have lower market capitalization and liquidity than their emerging counterparts, and may face greater restrictions for foreign investments. Yet their lower correlation with global equity returns can provide valuable diversification benefits in a portfolio.
Frontier markets typically exhibit higher growth rates and less volatility than developed nations, giving investors an opportunity to capitalize on currency and credit risks with potential high returns in return.
There is no one-size-fits-all definition of what constitutes a frontier market, though various index providers classify countries based on their investment capabilities and level of development. Frontier market benchmarks from these providers typically encompass African, Middle Eastern, and CIS (Commonwealth of Independent States or former Soviet republic) countries despite any inherent differences among them; nonetheless they all share certain similarities such as lower valuation multiples and rapidly growing GDP per capita rates.
Investing in Developed Markets
Developed markets are distinguished by their robust economies and regulatory structures. These provide investors with stability and liquidity through companies focused on global industries like technology, healthcare, energy and consumer goods.
Investing in developed countries can be more risky than investing in emerging markets due to economic fluctuations that could impact exchange rate fluctuations, policy interest rates and stock market movements.
Research studies on determinants of stock market development have tended to focus on single markets rather than clusters of countries, yet this flaw can be addressed using panel data analysis methods.
The results of this study revealed that Foreign Direct Investment (FDI), banking sector development, infrastructure development, savings, inflation and trade openness all significantly influenced stock market development. These findings resonate with theoretical literature; specifically FDI had a positive effect while banking sector development and inflation negatively affected it; finally stock market liquidity also significantly contributed to its development.
Investing in Developing Countries
Market institutions in developing nations tend not to be as well established as in developed markets; yet, emerging markets often adopt reforms similar to modern developed nations over time which foster economic development, leading to economic expansion – this is a primary reason why investors seek out investments in them.
Emerging market economies are still projected to experience faster long-term growth rates than developed markets despite slowing rates of expansion in recent years, meaning their income levels should eventually converge with those seen in developed markets and increase their share in global market capitalization.
Dev & Shakeel (2013) conducted an error correction model with panel data analysis to examine how macroeconomic factors affected Pakistani stock market growth rate, specifically market liquidity, savings rate, and economic development as key determinants. Their results suggested these variables played significant roles in driving emerging markets’ stock markets forward.
