Article / 15 August 2017 at 13:26 GMT

Emerging market investors moving to the frontiers

Managing Partner / Spotlight Group
United Kingdom
  • Skinny yields driving investors deeper down the credit curve 
  • EM equity and bond funds enjoying major inflows 
  • Even higher returns are available from frontier markets 
  • With improved alpha comes increased angst 
Frontier markets
Investors are taking high risks for high rewards in frontier markets. Photo: Shutterstock

By Stephen Pope

It seems that week after week, investors are allocating increasing amounts of investment capital into emerging market funds in both equities and bonds. 

EPFR Global, a leading provider of fund flows and asset allocation data to financial institutions around the world, reported that emerging market equity funds had received an inflow of $2.2 billion for the week to August 2. In the same period, emerging market bond funds received $1.9 trillion.

The flow analyst firm stated that for 2017, on a year-to-date basis, the two asset classes for emerging markets had received inflows of some $90bn as 20 consecutive weeks of gains have been recorded.
Source: EFPR

This enthusiasm for emerging markets can in large part be traced back to low interest rates across the developed world and the ongoing weakness that has gripped the US dollar. 

The dollar index has fallen by 8.84% since the start of this year.

The final frontier

Another sometimes overlooked reason for the increases in inflow is that while many fund managers have taken the decision to wade deeper into “exotic” markets territory, they have always drawn a line between “emerging” and “frontier” markets.

This year has seen Pakistan gain promotion from frontier to emerging-market status and as a result its global emerging market equity fund weighting has risen. This pattern looks set to continue, for while Argentina has not yet been promoted it will not be long before the second-largest economy in South America is elevated to emerging market status. 

The same will be true for Saudi Arabia, although the prospect for oil-rich but strife-ridden Nigeria is not so certain.

MSCI has also boosted the potential for emerging market funds inflow as it agreed in June to add stocks listed in mainland China as well as Hong Kong-listed Chinese stocks. It added 222 China A-shares to its MSCI Emerging Markets index as part of the annual reclassification process. 

The 222 large-cap stocks added will account for 0.7% of the weight of the MSCI emerging markets index; inclusion will occur in stages in May and August of 2018.

Similarly, as oil prices appear to have stabilised Russian equity funds finally ended an eight-week decline despite the latest push for sanctions from the US.

As a result, the MSCI emerging market stock index has climbed over 23% this year. This performance can be corroborated as at Spotlight Indices our measure of developed market equities less emerging markets has fallen by a staggering 32.96%. 

The chart below shows that the differential has been locked in a downturn since mid-2015:
Source: Spotlight Indices

Fixed income, not so fussy 

Success in frontier markets could mean high returns for investors. Equity investors may not feel informed enough to make educated decisions because there are not enough data to populate sophisticated financial models, but the story is different in fixed income bonds. 

It is now common knowledge that emerging markets have provided favourable return benefits for many investors. If emerging markets offer enhanced returns, then frontier markets are supercharged in this regard. The attraction can be found in the fact that frontier markets with their potentially high returns tend to be uncorrelated to the predominant trends of the more developed asset space.

Frontier markets are investable, but they are less developed, liquid, efficient, and accessible than emerging markets. Therefore, and in the wake of such returns, frontier markets are now viewed by bond investors as a viable option to build diversity and add alpha.

Iraq is one such option and the sale of a five-year, dollar-denominated bond at a yield of 6.75% attracted $6.6bn worth of orders. Equity investors may raise an eyebrow as the country is in the grip of a civil war, but the message appears to be that oversubscribed risky sovereign bonds have become almost normal.

FI: fixed income or foolish investment?

In June, Argentina was oversubscribed for its 100-year eurodollar bond even though it is well known that Argentina defaulted on its debts six times in the previous century, the last time being in 2014. Other issuers this year have been Egypt, Ivory Coast, Nigeria, and Senegal – none of whom are remotely close to investment grade.

I have long advised investors to be wary of debt issuance from the comparatively safe Greece and so my stance on these insurers is even more clear... however, one cannot ignore the trend. What I would point out is the fact that Ivory Coast issued a bond in 2010 in lieu of unpaid debts. It then proceeded to miss an interest payment the following year and yet the investors keep coming back for more heartache.

Still... we are all adults and surely have our eyes wide open.

Fixed income opportunities await. Photo: Shutterstock
— Edited by Michael McKenna
Stephen Pope is managing partner at Spotlight Ideas


The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail