Frontier markets feel the love as emerging peers crumble

A street crossing in Dhaka, Bangladesh, Asia.
Michael Runkel | Robert Harding World Imagery | Getty Images
A street crossing in Dhaka, Bangladesh, Asia.

As emerging markets continue to fall from grace, their less high-profile frontier peers are stealing some of the spotlight.

A recent report from Bank of America Merrill Lynch showed that while some $2.1 billion exited emerging market funds from January to mid-August, frontier market funds saw inflows of $1.5 billion in the same period.

The shift in sentiment is also reflected in equity markets in the past week. While Fed's "taper tantrum" triggered a 3.6 percent loss in the MSCI Emerging Markets index, the MSCI Frontier Markets index gained 0.25 percent in that time.

"Right now frontier is very exciting," Mark Mobius, executive chairman of Templeton Emerging Markets Group told CNBC this week. "These frontier markets, particularly in Africa, are growing at a tremendous pace... this is the place to be at this stage of the game."

(Read more: Africa has greater potential than India: Stanchart)

The 'frontiers' consist of 30 typically undeveloped countries with the potential for rapid rates of economic growth, such as Bangladesh, Iraq and Mozambique.

According to Thomas Hugger, CEO and fund manager of Hong Kong based investment firm Asian Frontier Investments, the reason why frontiers haven't suffered as much is because they are relatively less dominated by foreign capital, compared to somewhere like India.

"Frontier markets, especially Asian frontier markets, are less correlated to the outside world," said Hugger. "Foreigners have little impact in these countries. Indeed, Sri Lanka and Pakistan, for example, have even seen positive inflows over the past few weeks."

Frontiers offer huge potential because their stock markets have lagged far behind the pace of economic growth in these countries, Hugger noted. Gross domestic product growth among all the frontier markets averaged 6.9 percent in 2012 and is forecast to grow by 7.2 percent in 2013, he said.

"This has led to unbelievably low valuations for these markets, which are trading at a huge discount to stocks in the Philippines and Indonesia for example," Hugger added.

(Read more: Brutality scorecard: Which emerging stocks have it the worst?)

Still, some analysts warn of the low levels of market liquidity and the high risk of corruption and violence entrenched in these frontier markets that have put risk-adverse investors off in recent years.

"If things go wrong you cannot get out, this is as speculative as you can get," said Paul Krake, founder of Hong Kong investment firm View From the Peak: Macro Strategies.

Krake said investors need to weigh up the attraction of "amazing opportunities" with the kind of unprecedented risks which are common to frontier markets.

(Read more: Emerging markets mauled by bearish investors)

"With any form of speculative investment you can have some real winners and you can have some disasters. There is corruption and violence and there's all this stuff you have to take into account," he said.

Hugger acknowledged that the risks were higher but said investors could easily mitigate these risks by spreading their investments across different frontier markets and different sectors within each country.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie