There are several factors that differentiate an emerging market from a frontier market. These factors can vary from liquidity in the markets, to risk intensity, to return on investments in the future.
An emerging market is a market that shows progress towards becoming further advanced, and typically has a physical financial infrastructure, which includes banks, a stock exchange, and a unified currency. In addition, these economies have good liquidity, and there is a form of market exchange and a regulatory market in place. Emerging markets are sought by investors due to the prospect of high returns, as they tend to experience faster economic growth in terms of gross domestic product. Investors face challenges in currency volatility, limited opportunities in equity, and local stock exchanges that may make things difficult for foreign investors.
Frontier markets can be defined as markets that have less advanced capital markets compared to the markets in the developed world. These pre-emerging markets have potentially high returns, yet face high risks. Some risks that are often faced in frontier markets include political instability, poor liquidity, inadequate regulation, large fluctuations in currency, substandard financial reporting, and many are overly dependent on the commodity market.
The lower level of development in frontier markets provides more diversification in investment that cannot be repeated in mature markets. Frontier markets contain the least number of investors and many do not have a stock market to trade on. Many frontier markets are largely comprised of stocks in financial, telecommunications, and consumer companies that rely on monthly payments from customers.
A critical difference lies between the two sub-sectors. Emerging markets offer more liquidity and stability, but as time passes, financial analysts believe that markets will mature to the point where they no longer offer the same level of diversification that they once did. Over time, frontier markets have started to fill the gap left vacant by maturing emerging markets, to provide investors with a return on capital that is often negatively correlated with the rest of the global economy. Although the risk is higher for frontier markets, they offer similar returns to what emerging markets once did during the 1990s and the early 2000s, and some economists believe that some companies in the frontier market will experience the next world economic boom.