Frontier market issuers have been in the mainstream of hard-currency sovereign debt markets for many years, but most have struggled to build scale and liquidity for their local-currency bonds. That could be set to change, as new indices are planned for the asset class and global institutional investors increasingly recognize the growth, return and diversification potential of these markets.
Here is why we think local-currency frontier market debt is becoming the natural complement to existing fixed income allocations in both developed and emerging markets.
Executive Summary
- We think the tradable local-currency frontier debt market amounts to some $1tn issued by around 20 countries, after growing by almost three times in the past decade.
- FTSE Russell has published the FTSE Frontier Emerging Markets Government Bond Index since 2021, and J. P. Morgan plans to launch a benchmark index later this year.
- Since inception in December 2017, our equally weighted universe of frontier markets outperformed the benchmark local-currency emerging markets debt index by almost five percentage points, annualized, with a similar maximum drawdown and substantially lower volatility.
- While drawdowns among individual issuers can be sharp, overall volatility is dampened due to low correlation between issuers, and correlation between local-currency frontier markets and other asset classes is also low.
- Local-currency denomination, the small size of the market and the relatively low participation of global investors limit exposure to global risk factors; material risk factors are local politics or weak institutions, a lack of transparency, fluctuations in foreign direct investment (FDI), and liquidity, tax and operational challenges.
- Over time we would expect liquidity and operational challenges to diminish as new benchmarks are launched and global investors become more involved.
- As many issuers have long been active in the hard-currency markets, seasoned emerging markets debt investors are likely already to have good research coverage and stand ready to meet rising investor demand for exposure.
Historical Outperformance, High Yields And Susprisingly Low Volatility
U.S. dollar total return, 2018 – 2024, December 31, 2017 = 100
Source: Bloomberg. Data as of December 31, 2024. Indices used: Equally weighted basket of bonds issued by the countries in the FTSE Frontier Emerging Markets Government Bond Index, plus Zambia (Local-Currency Frontier Markets Universe); JPMorgan Government Bond Index - Emerging Markets Global Diversified (EMD Hard Currency Index, EMBIGD); JPMorgan Government Bond Index - Emerging Markets (EMD Local Currency Index, GBI-EM); JPMorgan Next Generation Markets Index (HC Frontier Index, NEXGEM). Historical trends do not imply, forecast or guarantee future results.
