This is one of the big questions underlying the recent release of the eighth annual Failed States Index, a joint effort from Foreign Policy Magazine and the Fund for Peace. This index should give all emerging and frontier markets investors pause, at the very least to reconsider how to assess risk in markets where information availability lags far behind North American and European standards.
For those unfamiliar with it, the Failed States Index intends to rank countries according to-and this is my paraphrasing of the effort in a concise manner-how vulnerable a government is to collapse into anarchy. It takes into account a variety of inputs describing the social, economic, political and military states of affairs in 177 countries.
A quick perusal of the 2012 ranking yields a number of countries in the high risk end of the spectrum that feature prominently in several ETFs: GlobalX FTSE Colombia GXG, Guggenheim’s BNY Mellon Frontier Markets FRN, Market Vectors Africa AFK, iShares Thailand Index Fund THD, iShares MSCI Philippines EPHE, Market Vectors Egypt Index EGPT, FTSE Andean 40 AND and Market Vectors Indonesia IDX, to name just a few. And this does not include the increasing array of blue chips now depending on these very markets to sustain growth, ranging from Coca-Cola KO to General Electric GE to Glencore GLCNF.PK.
The objectivity of specific variables is certainly up for debate, but given how wide ranging the criteria are, disproportionate influence of any one variable is sufficiently mitigated, resulting in a compelling picture for the world’s frontier markets. While the so-called CIVETS acronym is gradually trending higher as a discussion framework for this niche of the investment universe (as shorthand for Colombia, Indonesia, Vietnam VNM, Egypt, Turkey TUR and South Africa EZA), the context of how Colombia is perceived vis-à-vis state failure compels a more appropriate comparison first. The following bar chart shows annualized historical returns of local stock market indices for the highest risk countries in the index that are tradable on a retail basis:
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