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Frontier Markets: An Antifragile Suggestion

International markets across asset classes have increasingly become interdependent making what should be balanced portfolios more volatile.

The internet has facilitated instant communication but intra-market and inter-market correlations result from headline noise, or 'news' depending on one's viewpoint, and the growing appetite for trading trends replacing fundamentals. The former, technical analysis, is a useful tool but it is not a replacement for sound productive investments and long-term balanced portfolios. Technical analysis in the hands of computer trading programs ("algos", "bots") and their high frequency trading cousins can and does lead to huge and nonsensical swings in individual stocks, ETFs, and entire indexes. May 6, 2010 is a well-known example with US equity markets and individual stocks undergoing wild swings: the Dow Jones Industrial Average (DJIA) plummeted 1,000 points within minutes and Proctor Gamble (PG, market cap ~USD200B) dropped 37% instantly - the second part of its name taking on new meaning. Less well known but just as crazy algo trading occurs daily and can be seen in all asset classes (stocks, ETFs, options, gold futures, etc.).

Correlated intraday trading trends are also seen real-time across international markets that are plugged into this electronic world, and their longer term performance is correlated as economic news and numbers, along with political, fiscal, and monetary policies impact developed (USA, Germany, France, etc.,) and emerging markets (China, India, Brazil, etc.,). For example a portfolio with investments in American, Chinese, and French companies as part of the S&P 500, Hang Seng, and CAC 40 respectively, would be considered by some investors a diverse equity portfolio. The 6 month plot below shows they are very much correlated and such correlation does not make a robust or antifragile portfolio which is the objective of diversified equity investments.

6 month plot ending October 4, 2013

Stock markets that are independent and therefore contribute to a truly diversified investment portfolio are frontier markets (Mongolia, Pakistan, Sri Lanka, etc.,). They trade independently of daily international news and their longer term performances are significantly less correlated to developed and emerging stock markets and economies. For example the Mongolian MSE 20 versus the MSCI World Index has a 5 year low correlation of 0.28 compared to a very high 0.91 for the MSCI Emerging Market Index versus the MSCI World Index. Few investors appear to be aware that the traditional emerging markets do not give the performance diversification they expect. Whereas frontier markets, as one part of an investment portfolio, do add true diversification creating more rounded, robust and hence antifragile investments.

In a related article I will discuss the drawback of crowd psychology, trend investing, and how they negatively impact investments and markets with huge potential.

Footnote:
Highest positive correlation: 1.0
Highest negative (inverse) correlation: -1.0
No correlation (essentially noise): 0.1 to -0.1

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.