While investors shunned emerging markets in 2013, riskier frontier markets racked up stellar gains – but can they stage a repeat performance this year given valuations are no longer as attractive?
John Lomax, head of global emerging market equity strategy at HSBC, says if and when emerging markets begin to perform better, frontier markets could be vulnerable to outflows. For the moment, however, the bank continues to favor frontier markets.
(Read more: Is Sri Lanka the new investment darling?)
"Frontier markets still have some intrinsic advantages, in terms of long-term growth prospects and some valuation parameters, such as dividend yield," Lomax wrote in a report on Tuesday.
"In relation to liquidity, the share of frontier market exposure in the average emerging market fund has increased noticeably over the past year," he added.
Ho Chi Minh CityRob Whitworth | The Image Bank | Getty Images
While frontier markets are trading at higher price-to-earnings (PE) and price-to-book (PB) ratios compared with emerging markets, the former is expected to offer a higher dividend yield in 2014. Frontier equities are forecast to pay a dividend yield of 4.4 percent versus 3 percent for emerging equities, according to HSBC.
Exotic market picks
Among the world's least developed markets, HSBC has an exotic mix of markets that it is positive on this year, namely Argentina, Kazakhstan, Kenya, Nigeria, Oman, Qatar and Vietnam.