It was one of the hottest investment terms of the decade, but the attractions of “frontier markets” have taken a hammering as newly emerging economies suffered from the credit crunch,
Merrill Lynch says. But it is premature to write such markets off as valuations look highly attractive, the

US firm says.

Frontier markets are unlikely to be first to emerge from a global recession. Two catalysts that will end a bear market for frontier economies are higher oil prices and higher risk appetites, says ML co-head of international investment strategy,
Michael Hartnett.

“Neither [catalyst] is immediately likely,” he said in a research note, pointing out that his firm is forecasting higher oil prices, but not until next year. Meanwhile, appetite to take more risk looks subdued, he says.

However, the underlying case for frontier markets remains, Mr Hartnett says. “The secular argument for frontier [markets] has been wounded by global recession, but not fatally. The asset class remains undercapitalized and under-owned with strong growth potential.”

“Emerging Markets had 13 bear markets in the past 20 years, yet the asset class still grew from 1 per cent to 10 per cent of global market cap. As highlighted before, frontier investors must have long horizons and high risk tolerance,” he says.

Part of the problem for frontier markets is that they are now closely correlated with performance of developed economies. Between 2000 and 2008, there was a 32 per cent correlation between frontier markets and the US S&P 500 index of equities; between March 2007 and February 2009, the correlation was almost exact, at 90 per cent, according to the note, which used Bloomberg data.

The MSCI Frontier Markets index of equity returns, measured in dollars, has shown a negative return of 61 per cent over the 12 months to 27 March this year; the MSCI Emerging Markets indices has shown a 53 negative return over the same period.