Morgan Stanley emerging markets expert says frontier markets are much like emerging markets were 20 years ago, but that's where the similarities end.
[This article originally appeared in the August issue of ETF Report.]
Ruchir Sharma requires little introduction. As head of Emerging Markets at Morgan Stanley, Sharma has established himself as an expert, if not a pioneer. He was one of the first—and very few, at that—to suggest that thinking of emerging markets as a single asset class no longer worked as it did in the early 2000s. These evolving economies, he argues, are incredibly diverse, and are unlikely to move in unison going forward. That same concept applies to frontier markets. His book "Breakout Nations: In Pursuit Of The Next Economic Miracles," published in 2012, was an international best-seller that outlined the changing face of less-developed markets, and the opportunities that exist in them for discerning investors. Perhaps the secret to his largely unmatched expertise is his "foot on the ground" approach, where he's literally spending one week every month in a different country to incorporate his firsthand findings into his analysis. That's certainly a far cry from making assumptions about domestic themes and local realities from looking at GDP figures from a New York City office. Sharma spoke recently with ETF Report staff writer Cinthia Murphy.
In the last decade or so, investors have gotten comfortable with the idea of investing in emerging markets. Is that same type of thinking needed now when it comes to investing in frontier markets? How should investors look at frontier?
No two situations are the same, but frontier markets remind me very much of where emerging markets used to be, let's say in the early 1990s, when these markets were still being discovered. The capital markets in these countries are still in the process of being developed. Research in some of these markets is hard to come by. Traveling to these places makes even more sense because you need an on-the-ground feel and you need more local research to help you out with what's going on.
Some of these frontier markets are going to graduate and become emerging markets, as we saw with the case of Qatar and United Arab Emirates recently. "Frontier market" is really a term to describe these emerging markets in a way where the capital markets have not been fully developed or where the size of the capital markets is not big enough to classify them as mainstream emerging markets. So, it's really an extension of emerging markets, but a different category just because these markets have not been that well discovered and not that well established yet.
Investing in emerging markets has in a way evolved from an era of BRICs to now 45-plus individual markets with different dynamics. Are frontier markets still to be looked at as a block, or do you think differentiation is key?
The countries need to be considered more individually in frontier markets because the differences there are even greater than the differences between the mainstream emerging markets. Country selection remains a very important element in that space. Frontier markets have a couple of advantages over emerging markets: No. 1, they're not really so much burdened by this whole China debt boom, which I think is playing a big role or has played a big role in depressing some of the returns in emerging markets.
Secondly, in some of these frontier markets, the political leadership in place is, on a relative basis, a bit newer and fresher compared to what we have in emerging markets, so the reform momentum in some of these countries has been stronger. We're seeing that from Pakistan to Romania.
Those are a couple of advantages that frontier markets have over emerging markets. But otherwise, I feel that the habit of treating emerging markets as a block and treating frontier markets as a block will continue because people like to make quick decisions about asset classes. They'll continue to broad-brush these assets.