Frontier Markets & Investing in Africa: What You Need To Know
If you are searching for some unique investment opportunities, diving into frontier markets can be an option to consider. These markets are far less competitive than those in developed nations, but there are some risks associated with frontier market investments.
What Are Frontier Markets?
Different index providers, such as S&P, MSCI and FTSE will classify countries as frontier markets based upon a number of factors. In general, when we talk about frontier markets, we are discussing countries that do not yet have developed markets. These nations often will have less liquidity, lower market capitalization and may still be developing a stable economy, but not always.
For instance, Iceland is considered to be a frontier market, and they have one of the highest standards of living in the world. Index providers don’t always agree as to which nations qualify as frontier markets. For instance, Kuwait is listed by MSCI as an emerging market while S&P rates it as a frontier market. Again, Kuwait also has a fairly high standard of living, so when we talk about frontier markets, we sometimes are simply talking about ease of access in terms of investing in that nation.
There are frontier markets throughout the world including Africa, South America, Asia and Europe. In Africa, where we maintain our focus, some frontier markets include Nigeria, Kenya, Tanzania, Morocco, Ghana and the Democratic Republic of the Congo (DRC). As nations develop and more investment opportunities become available, these countries may be moved from the frontier category up to the status of an emerging market.
How Do Frontier Markets Differ From Emerging Markets?
There are three basic market levels – Developed, Emerging and Frontier. Developed markets include nations such as the United States, Canada, the United Kingdom, France, Italy, Spain, Sweden, Australia, Japan, Singapore and others that have highly developed economies, thriving markets and easy access for investors.
Emerging markets include countries with developed economies, but they aren’t quite as accessible or stable as the developed markets. For instance, while Hong Kong is considered developed, China is listed as an emerging market. Brazil, Russia and India are three other emerging markets that are popular with investors, but there are many more, such as Argentina, Mexico, Egypt, Greece, Hungary, the UAE, Korea, Pakistan and Thailand.
Why Should An Investor Consider Frontier Markets?
In general, investments in developed countries pose the least amount of risk to investors, followed by emerging markets and then frontier markets. While frontier markets can be somewhat riskier, this doesn’t mean you should not consider investing in these markets or emerging markets.
In some cases, higher risk leads to higher rewards. For instance, let’s say you invest your money in a tech startup. This new business is relatively untested and there’s always the possibility that the company could go under. However, if the company has some interesting products or services, the business could become a major player in the tech industry, and you can reap the rewards. It’s a higher risk, but also carries the potential of high yields that you might not see from an established player in the tech industry.
Frontier markets provide investors to essentially dive into a nation’s economy on the ground floor. There’s little competition so you end up being one of the premier players in the region. Not only that, but you have the opportunity to invest in a nation’s future, which can be a once-in-a-lifetime opportunity to help a country realize its economic potential.
While you should never put all your eggs into one basket, so to speak, investing in frontier markets offers you the potential of higher yields than you might earn with investments in developed markets. The key to any investment opportunity is to research the investment and learn as much as you can about the company and its potential.
In general, it’s best to create a balanced portfolio that minimizes risk. However, if your portfolio includes an abundance of lower-risk investments, it can be a smart idea to consider one or two investments that might provide you with a higher yield. Talk to your investment advisor about which frontier markets might be a good fit for your portfolio.
Types Of Investments To Consider
In general, you will find that there are three types of frontier market investments to consider – stocks, mutual funds and ETFs. With stocks, you will be purchasing a stake in a company and essentially owning a small portion of that company. If the business becomes more profitable, your stocks will be worth more per share and vice-versa.
With bonds, you are lending money to a company which they will pay back with interest by a set date. When a company issues a bond, this is known as a corporate bond. State and local governments also issue bonds, and these are known as municipal bonds or muni bonds. When a federal government issues a bond, it is known as a treasury bond.
Mutual funds are bond funds that include multiple holdings to minimize risk. Instead of simply lending to one company, you lend to many, diversifying the investment. ETFs are a type of mutual fund that is traded (bought and sold) on actual stock markets, such as the NASDAQ or NYSE or a non-U.S.-based stock market.
Investing In Africa: Is This Right For You?
At Money Watch Africa, we focus on frontier markets throughout Africa. There are many reasons why investing in Africa can be an excellent opportunity for a long-term investor, including:
1. Africa is rich in natural resources.
The African continent contains 13% of the global reserves for oil, 50% of proven gold reserves, 50% of proven iron ore reserves, 60% of cobalt just to name a few. African will continue to supply the world with these high-demand materials.
2. Valuations are attractive
Compared to developed markets and emerging markets, Africa markets and stocks trade at lower multiples, are less liquid, have lower coverage by Wall Street analysts and are not followed by large money managers. Additionally, companies and households have low levels of debts, and countries generally have better fiscal balances, and the economies have low leverage.
3. Africa’s growth is driven by its demographics.
Currently, Africa’s population is estimated at more than 1.2 billion and is expected to double by 2040. The continent’s young population, with an average age of 21 (compared to 45 in developed countries) will fuel more demand for goods and services, relative to the developed countries that spend more on social security, health care and entitlements.
4. High risk-adjusted returns
There is a large information deficit about the performance and opportunity in Africa markets. Although there has been robust evidence of high returns in Africa, there has thus far been relatively little investment, even after adjusting for risk premiums.
5. Steadily increasing capital flows.
BRIC investments are highly popular, and these are investments in four key emerging markets – Brazil, Russia, India and China. Fund flows to Africa now exceed those of India, Brazil and Russia.
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