Frontier Market

A frontier market is a country that is still developing but has not met the criteria of being called an emerging market. Therefore, its capital market is less efficient in riskiness, liquidity, security markets rules, and regulations.

Thus, these economies are better than the very underdeveloped ones but cannot fall under the category of emerging markets. Investors prefer them for long-term investments due to their positive future potential. However, the companies existing in such markets are new with very less track record.

• A frontier market is a developing country that does not fulfill the criteria of being called an emerging market. Hence, its capital market could be more effective in riskiness, security market rule, liquidity, and regulations.
• The size of the country, restricted markets, development, liquidity, and risk are the characteristics of the frontier market.
• One must invest in the frontier market as it offers very high returns, growth in the initial period, and diversification benefits.
• The term frontier market is given to the developing market.

The frontier market is a term given to a developing market. Still, it has not reached the level of development required to be categorized as an emerging market due to a lack of free flow of capital, liquidity in the market, and another measure of economic and political stability.

Such categorization signals to the investor community whether they can think in the direction of investing in a natural frontier market based on the goals and objectives of their investment. Therefore, it helps in making an informed investment decision.

In 1992, Farida Khambata of the IFC Emerging Markets Database published underdeveloped and developing markets. That was when this categorization first emerged. In 1999, S&P purchased the rights to the same publication. Later in 2007, it launched two indices focused on frontier market countries: Select Frontier Index and Extended Frontier Index. Eventually, the competitor index publishing companies, such as the MSCI, found their versions. 

1. Size of the Country: If a country has a higher development quotient but is still very small to be categorized as an emerging market country, it is put in the natural frontier market bracket.
2. Restricted Markets: Those financial markets which previously had restrictions on the free flow of capital. Still, in the past few years, such limits have been on a reducing trajectory that falls under this category of markets. These restrictions can be in the form of foreign investment limits, rights of foreign investors, information flow, and so on. These determine the level of market accessibility.
3. Development: The countries with lower growth than those presently categorized as emerging markets form part of this market.
4. Liquidity: As there are fewer market participants go for frontier market investing, the liquidity for the assets of this market is low.
5. Risk: As such markets comprise very young companies with a lesser track record, the investment risk is very high. Most investments are in the form of joint ventures in which the investor plays a large part in the companies' day-to-day activities. Therefore, the risk and reward are very high for investments in such markets.

Based on these criteria, MSCI and S&P classify countries and their financial markets.

According to the MSCI June 2014 Market classification framework, based on the above characteristics, the following is how a country is categorized into the frontier market category: -

• Regarding frontier market countries and emerging markets, there is no requirement for sustainable economic development. This point is to restrict the developing markets from the developed market. The World-bank categorization of the high-income threshold is based on the per capita gross national income, which should be $12,615 per the limits published in 2012 using the Atlas method. If a country has a per capita GNI greater than the threshold by 25% for three consecutive years, it falls under the developed category; otherwise, it is a developing country.
• The size and liquidity categorization is as follows:

• Based on the restriction posed by the market and the accessibility level, the following is the categorization: -

Other players, such as the S&P, have a similar framework for categorizing countries into different markets.

All index publishers periodically review and reclassify various economies for upgrades or downgrades from one market to another. For instance, as per the results published by the MSCI in June 2019, the MSCI Kuwait index was reclassified from frontier market to emerging market index if it meets the required criteria by November 2019. In addition, it posted the launch of the market development program in Kuwait, which would lead to the necessary regulatory upgrades and reduction in market restrictions.

As per the Reuters update, FTSE Russel concluded on September 26, 2019, that Argentina would continue to be categorized under the frontier market only because of the imposition of capital controls. In addition, it was due to the political and economic instability following the elections in the country which led to the fall in its currency and bond value. MSCI, on the other hand, has upgraded its classification to an emerging market but is reviewing and monitoring the economy in real-time to publish a review.

Several countries, such as Mauritius, Nigeria, Tunisia, Sri Lanka, and Vietnam, fall in this market bracket.

• Very high return:  As a venture capital investment, the expected reward is very high if the project or the company is successful. When it comes to an investment in frontier market stocks, as the fund requirement is very high and investor competition is low, the chances of capturing a greater market share are high. Such an investment is like a double-edged sword. Risk and reward are both very high.
• Growth prospects: As these markets are at the initial stage, investors can benefit from an initial period of very high growth from frontier market stocks.
• Diversification: As developed markets get saturated, frontier market investing provide diversification benefits because it provides exposure to a new economy with a hopeful and growing trajectory compared to the cash-cow nature of mature markets.

1. Economic and Political Stability: Emerging markets have greater stability than the frontier market.
2. Movement of Capital: Emerging markets are more accessible to foreign investment. Therefore, the movement in and out of the economy is greater.
3. Risk and Liquidity: Emerging markets are more liquid and less risky.
4. The Breadth of Financial Instruments: Many financial instruments are available in emerging markets, such as derivatives. In contrast, the availability of such instruments and an active market for the same is less likely in the case of frontier markets.

This article has been a guide to what is Frontier Market. We explain its differences with emerging markets, investing, with example, characteristics & how it works. You can learn more about financing from the following articles: -

• Commodity Market
• Efficient Frontier Definition
• Financial Markets Classification
• Dealer Market