Not enough investment capital is flowing into emerging and frontier markets despite potential for strong returns and the opportunity to help the world’s poorest communities, according to a recent report from the Global Impact Investing Network.
“Unlocking the Potential of Frontier Finance” found “that investors require more clarity” about how “to address the challenges” of investing in these markets and the opportunities for success.
“There are a lot of vulnerable populations that could benefit from the companies that receive this capital, and from the strengthening of supply chains that comes along with impact investment,” said Rachel Bass, research manager at GIIN and the report’s lead author, told Karma.
The New York-based nonprofit analyzed 40 investments in emerging and frontier markets. “Frontier finance” investments are aimed at helping help low- and lower-middle income groups in the countries, and according to GIIN, the landscape is diverse. The investments came from for-profit and nonprofit investors on five continents, and from a mix of sources.
The cash largely went to small, growing businesses. The transactions in the report ranged from $49,000 to $6.4 million, with an average size of $1.1 million.
But investors, particularly from other countries, deploy little capital in emerging and frontier markets. Bass said this trend means opportunities are still out there.
“It suggests to us that there’s potential to really scale that market segment, while still creating deep impact alongside financial returns,” said Bass. “About three-quarters of our sample was targeting risk-adjusted, market-rate returns, and a clear majority said that they were either meeting or exceeding their returns expectations.”
Emerging markets like Brazil and India are familiar to most investors. Frontier markets are smaller and lesser known, and they present fewer avenues for foreign investors to enter.
Despite their risky reputation, emerging and frontier markets can be a hedge because their performances are said to be less correlated to global markets. For example, customers in emerging and frontier markets may deal in cash, which isolates them from swings in global currency markets, Amy Wang, who leads the debt team at PG Impact Investments, told Karma. Her firm is a for-profit impact investing shop profiled in the GIIN report.
“There are certain sectors that are proven, and where the market is actually very non-correlated with traditional markets,” Wang said.
The GIIN report said that investors should look for new, more flexible ways to invest in these markets, including revenue-based repayment models and evergreen funds.
“Often in frontier and emerging markets, you’re investing where there is limited financial infrastructure,” said Bass. “Playing a role in helping demonstrate the viability of different investment products, and in investing itself as an exercise, contributes to field building.”
Yet the perception that emerging and frontier markets pose unique risks, including fluctuating currencies and political upheaval, is perhaps overstated. Investors in the GIIN survey cited more nuts-and-bolts concerns, such as business execution and management.
A Contrarian Investment
Clemente Cappello, the founder and CIO of Sturgeon Capital, a London-based hedge fund that has been investing in countries including Mongolia and Kazakhstan, sees advantages in investing in the Silk Road region, such as interest rates that are low, but still higher than developed markets, strong population and GDP growth. The markets are prime for an investor who prefers going against the herd, he said.
“It’s a region that nobody really pays attention to, so it’s a little bit of a contrarian investment,” Cappello said.
According to the GIIN report, achieving the UN’s Sustainable Development Goals by 2030 would require $2.5 trillion flowing annually to emerging markets — about five times the current level of impact investment.
GIIN made five recommendations to help close that gap, including improving financial instruments, building more partnerships between investors and entrepreneurs, and developing a record of success.
“It’s a market segment that increasingly has evidence about its performance, both impact and financial,” Bass said. “Our hope is that this work can help unlock more capital flows, and leverage that capital effectively to generate returns and to create high-impact for some of the people in the world who need it most.”