Understanding Risk and Volatility in Frontier Markets
Frontier markets investing can seem intimidating and confusing. Two of the terms most frequently used interchangeably and confused in their actual meaning are risk and volatility. Both of them apply to most investment categories.
Boiled down to its simplest definition, risk refers to the possibility that you will lose your money if (for example) the company in which you are invested has a reversal of fortunes or even goes bankrupt. The risks to an investment with which you might be familiar are multiplied in frontier markets investments. Volatility refers to the degree to which the value of shares in that company might rise and fall dramatically but does not imply that you will necessarily lose your investment. Reducing risk sounds like it is the same as reducing volatility, but in absolute terms, these are two different strategies.
You can reduce risk by becoming very familiar with various emerging and frontier markets investments and avoiding investments that have “trouble” written all over them.
You can reduce volatility by including two types of investments in your portfolio: You can include frontier markets investments that do not correlate with developed markets investments. This means that the two types of investments do not move in the same direction at the same time. Put another way: Not all of your investments are zigging and zagging at the same time. You can also include some bonds or bond funds in your portfolio, which act to reduce volatility since they do not zig or zag at all.