Frontier life

This perception rests on the fact that emerging-country stock markets are dominated by huge corporations - national champions, state-owned enterprises (SOEs) and global multi-nationals - that have more in common with the developed world's champions. Take the constituents of the MSCI Emerging Markets index, which is as well known as any all-embracing index of emerging-markets equities, with 824 constituents spread across 21 countries and a market value of about £2,365bn - its biggest constituent is South Korea's Samsung (4 per cent of the index) followed by Taiwan Semiconductor (2.3 per cent) then China's Tencent and a clutch of Chinese SOEs - China Mobile, China Construction Bank and ICBC. These all have easily identifiable western counterparts, such as Apple, Intel, Amazon, Vodafone and HSBC.

Granted, the perception may be false. It could be unduly influenced by the nature of the index's 10 biggest constituents, which only account for 17 per cent of the index's value. Even so, it is worth examining. After all, if the equity markets of emerging countries are increasingly dominated by companies that are too big to be threatened but too bulky to move quickly, that could translate into a less volatile though slower performance from the underlying indices. Less volatility would be good, but not if it meant pedestrian growth.

No signs of convergence

Happily, the data show no sign of this. The table sets the scene. Over their respective histories, the MSCI World index - despite its name, an index only of developed-world companies - has produced annual growth slower but steadier than either the MSCI Emerging Markets index or the MSCI Frontier Markets index, which logs the progress of companies based in countries that lag behind the emerging markets. That is as it should be, yet the differential does not seem to be getting much narrower. Take the monthly returns from the three indices since 2002, the start date for MSCI Frontier Markets data, and the gap remains much the same - twice the performance from the emerging and frontier markets indices but with lots more volatility than the World index.

There is further proof that the volatility of emerging markets relative to developed-world markets is not falling if we look at the 24-month rolling standard deviation of monthly returns since 1990, the earliest date that MSCI data permits a comparison. Standard deviation quantifies the degree to which individual returns vary around their average and, in the comparison of the MSCI World and Emerging Markets indices, the two make a similar pattern except that the emerging markets' returns consistently show an couple of percentage points of variance around their average. When market returns were especially docile, say in three years 2004-06, the variance gap fell to a percentage point or less. When returns were all over the place, say in 2009-10, the gap was typically three to four percentage points. But throughout the data there is no sign that the volatility of the two markets' returns is converging.

However, one surprising feature in the data is that returns from the frontier markets have been both lower and less volatile than emerging markets' returns. Intuition indicates the opposite - that share prices for companies operating in the least developed countries should be the most vulnerable to shocks within the nations themselves and to the fickle feelings of hyper-sensitive investors.

That sentiment is a major factor driving prices, at least over a short period, is hardly in doubt. It is, for example, the most plausible explanation for this year's substantial outperformance of emerging-markets equities by developed-world equities. That outperformance - the MSCI World index rose 24 per cent in the 12 months to end-November versus just 1 per cent for MSCI Emerging Markets - says everything about investors' appetite for risk and little about the relative long-term prospects of, for instance, the US and the eurozone against India and China.

Anyway, back to the frontier markets - the table also shows the noticeable gap between the current level of the Frontier Markets index and its all-time high compared with the Emerging Markets index and - especially - the World index. This implies that, with help from mean reversion, frontier-markets equities offer better value than both developed-world and emerging-market equities. In addition, next May frontier-market indices will be re-jigged when equities from Kuwait, Qatar and the United Arab Emirates, which dominate the indices, will be re-classified as 'emerging markets'. The effect will be that frontier markets will shift further towards the edges of new growth, with a bigger weighting for both Africa and then less-developed parts of south-east Asia.

Notwithstanding the performance of the Frontier Markets index to date, that implies higher risks but also high rewards and the Bearbull Global Fund should want a slice of that action.