Investors are always hunting for profits, and right now so-called frontier markets, or markets in developing countries, are among the hottest markets around. Many so-called frontier markets, which include non-traditional investment markets, such as Myanmar, Argentina, and Vietnam, have been enjoying considerable attention from investors over the last few years.
Risk in frontier markets
Frontier markets are among the highest risk, as frontier economies are usually smaller and more prone to fluctuations than other emerging markets, such as China. The MCSI Frontier Markets Index, a leading index for measuring frontier markets, is up more than 19 percent this year, vastly out performing developed and more traditional emerging markets.
So far this year, foreign investors have pumped in some $2.2 billion dollars into foreign markets. This compares with outflows of only $720 million dollars. While this might not seem like much in the context of multi-trillion dollar financial markets, for small emerging countries this amount of funding can be immense.
[drizzle]Foreign Investment a Double Edged Sword
For emerging markets, the inflow of cash provides much needed financing for economic development. With the Cold War over, money is no longer being used the United States or former Soviet Union to buy allies. And roaring nineties have long since cooled off, so many wealthy countries are simply no longer as generous with their development funding.
Private markets, however, can provide access to financial resources for companies located in emerging markets. While development markets have largely stagnated over the last few years, emerging markets are still enjoying relatively high levels of economic growth. So for many investors, these frontier markets are looking more attractive than ever before.
A reliance on foreign cash, however, carries risks with it. For one, investors could cause a bubble to build, and when it pops, the country could be left off worse than before foreign investment started to flow into the country.
When bubbles pop, companies risk losing huge portions of their value. This can lead to financing and funding issues, which can restrain both company and economic growth. Turbulent markets can also cause banks to get could feet, and suddenly loans and other forms of financing can dry up practically over night.
Second, investors invest by purchasing assets, buying bonds, and through other activities. There’s always a risk that investors could come to control too much of local assets, crowding out locals. Many countries, however, do place restrictions on foreign investment. Meanwhile, currency fluctuations can affect bond repayment, loan repayment, and other things.
Could Bubble Be Building?
Enthusiasm has a tendency to build bubbles. As investors begin to pour into any market, asset values inevitably rise, and yet far too often they rise well beyond any economic justification. A combination of the belief that markets will continue to rise, and more savvy investors looking to cash in on profits before the market corrects itself can cause bubbles to form.
Some hedge fund managers are already concerned that bubbles are building in various markets. Kemal Ahmed, the manager for Investec Asset Management’s frontier portfolio, among others, warned that investors trying to cash in on returns in emerging markets are getting “desperate.”
Meanwhile, the global economy itself has suffered turbulence over the past few days with major markets, like the United States and Europe, suffering set backs. These set backs could encourage even more investors to head abroad with their money, but at the same time if major markets suffer a downturn, frontier markets will almost certainly be impacted.
With global markets suffering set backs, and rather wild swings being experienced in currency markets, the risk of a serious crisis developing in emerging markets is real. While investors have been flocking to these countries due to their high economic growth, any setbacks could send investors fleeing.