Frontier markets have been mainstream in EMD Hard Currency Sovereign benchmarks for a long time. However, this does not apply to the Local Currency benchmarks, in which only the more advanced set of countries in EM is represented. Creating a reasonably liquid yield curve in local currency bonds requires not only credible and predictable policies, but also a varied local investor base and a degree of institutionalization in the economic system, and that can be a challenge.
But it can be done: various countries have made the move from the index providers’ pre-frontier to frontier to mainstream categories. Some have even made it to Developed Markets classification. We currently count many African countries in this frontier universe, but there are also some in Asia and South America to provide economic and geographic diversification.
The investment case rests on the growth potential of the countries concerned, combined with the relatively high risk premiums embedded in local rates and/or cheap currencies. Using FTSE Local Currency Frontier Emerging Markets Government Bond Index (FTSE Index) data, available since 2018, this has translated into an annualized return of almost 3% in excess of the mainstream local-currency emerging markets benchmark. Over the same period, local-currency frontier markets even outperformed the J. P. Morgan Next Generation Market Index (NEXGEM) for frontier-market USD sovereign bonds.
Low international participation and a high degree of idiosyncratic risk has also meant low correlation both between local-currency frontier issuers and with other asset classes, adding to its diversification appeal.
Hurdles remain. We estimate the tradable market to be worth about $1trn. Liquidity remains a challenge, in political, legal, tax and operational risks are higher, making this more suitable for longer-term investors. For example, recently Nigeria and Egypt devalued their currencies but re-anchored expectations due to strong reform efforts, creating a more attractive entry point. As of year-end 2024, the average yield of over 10% for the FTSE Index, is roughly four percentage points higher than the yield on the J. P. Morgan GBI-EM GD Index for the mainstream local-currency markets, should pique investors’ interest.
We also note that J. P. Morgan intends to launch local-currency frontier markets index later this year that is likely to spur further investor interest. The broader investment industry stands ready to address that potential demand: the fact that many fronter market issuers have long been active in the hard-currency markets means that seasoned emerging markets investors, including Neuberger Berman, which has been invested in 12 of the 14 names in the FTSE Index, are likely already to have research coverage.
Look out for our forthcoming article on the asset class for more detail.
