One of the biggest investment trends in 2013 was the reallocation of capital away from Emerging Markets back to Developed Markets, particularly to the US. A quick look at the graph below shows the magnitude of the divergence: both small cap  (represented by the yellow line/Russell 2000 Index) and large cap (white line/S&P 500 and red line/Dow Jones Index) US stocks led the way for 2013, with international developed market stocks (green line/VEA) also had a strong year. EM stocks (purple line/Vanguard FTSE EM, ticker VWO) were pummeled.

We also graphed the MSCI Frontier 100 Index (orange line/FM) and its performance was on par with developed stocks but the index carries many limitations and was buoyed by its heavy concentration in Middle Eastern (Kuwait and Qatar) stocks. So given the exodus of capital out of less wealthy and developing countries, where does this leave Frontier Markets?

Not as bad as you might think. And here are three reasons why:

1. Frontier Markets are Hyper-Local

Frontier stock markets are usually much more isolated from global macro trends than their emerging markets brethren. Markets are dominated by local players with a low proportion of international institutional investors. While this is a negative aspect when considering the missed opportunities of QE dollars boosting markets around the world, this also means that there is relatively little capital to withdraw when investment themes change. Frontier stock markets will continue to be driven by local news, and are less vulnerable to large asset managers shifting allocations from Emerging Markets back to Developed Markets partly because few of them have any capital allocated to Frontier Markets in the first place.

2. Correlations Remain Very Low

One of the main arguments supporting an investment into frontier markets is the low correlation with both developed and emerging markets, allowing for true diversification to juice up portfolios. When we looked at the realized correlation last year of the frontier markets we follow and developed equity markets, the results were staggering. While developed markets and even the MSCI Frontier Index were highly correlated with each other, the majority of frontier markets exhibited very little correlation to the broader market. While we have not released new correlation numbers yet, the results are similar: frontier markets have continued to trade in their own world, oblivious to the world at large.

3. The Growth and Development Story

Part of the reason that money is moving away from Emerging Markets is that the growth story just isnt there anymore. Gone are the days where China posted double digit growth, with optimistic estimates now in the 7.5% range. Admittedly, that GDP growth rate is still the envy of the rest of the BRICS, with Brazil crawling at around 3%, India around 4.5%, South Africa at around 2%, and Russia at a paltry 1.2%. With lower growth rates and less attractive demographics, it has been an easy sell for most asset managers to move money back to developed markets.

On the other hand, frontier market countries remain in the early stages of their development cycle and have the upside that EM countries had 10 years ago. In Africa, you have countries like Botswana (7.1%), Nigeria (6.8%), and Tanzania (6.7%), all very much in growth mode. In Latin America there are Bolivia (6.8%), Paraguay (13%!), and Peru (around 5%), all roaring ahead. In Asia, Bangladesh (6%), Mongolia (11.5%), and Sri Lanka (7.8%) have yet to slow down. These countries are young and early in their growth cycle, with a lot of low hanging fruit to fuel further development.

Even if you are bearish on EM stocks for 2014, this should not negatively impact how you feel about frontier markets this year. While the big money funds are all moving back to developed markets, frontier markets continue to be overlooked by most investors and so opportunities continue to abound for those who know where (and how) to look for them.