Investing in frontier markets: What DFIs need to know

The World Bank’s 2025 Global Economic Prospects report uncovered how the world’s poorest countries have fallen behind in the past 15 years. Incomes have barely increased, with annual per capita growth averaging less than 0.1 percent over that period. These economies suffer from inadequate infrastructure and consist largely of subsistence farming and small informal businesses.

Investing in these “frontier markets” brings many challenges for investors, from macroeconomic volatility to a capricious legal and regulatory environment. That means they are outside the consideration of most commercial investors. As a result, they receive very little foreign portfolio investment (stocks and bonds) and very little foreign direct investment. Their domestic financial sectors are also small: domestic credit to the private sector averages just 26 percent of GDP in economies classified as least developed countries (LDCs) by the UN.

The challenges that make investing in frontier markets difficult for commercial investors also apply to development finance institutions (DFIs). But DFIs also face – for good reason – constraints that other investors do not. They must invest in firms that can comply with policies on responsible investing. Their hands-on investment processes entail high transaction costs. When investing directly, DFIs want to deal with larger firms that can absorb large sums, but there are few large firms in frontier markets. While DFIs can use local intermediaries to help reach smaller firms, it can be challenging to find ones that comply with their standards, and that have a viable business model that aligns with their objectives.

These challenges make investing in frontier markets one of the hardest things a DFI can do. But it is also one of the most important. In the absence of commercial investment, DFIs play a critical role in bridging financing gaps and investing in the places that need it most. And experience shows that these investments can also be profitable.

These issues will be a key part of the conversations at this year’s UN General Assembly meetings, as recognition grows of the need for greater support for frontier markets. To help frame these discussions, here are six lessons policy makers should know.

It also requires persistence. Smart investment opportunities in frontier markets are harder to find, and investors will face hurdles that take time to overcome. DFIs need dedicated teams that are prepared to confront a range of environmental, social and business integrity issues. And they must accept that the investment process will take longer. If DFIs understand this, and even better – work together – investments can see success. The Africa Resilience Investment Accelerator (ARIA), for example, is a coalition of development finance institutions including British International Investment, FMO (the Dutch DFI), and Proparco (the French DFI). Launched in 2021, its goal is to mobilise long-term investment opportunities in Africa’s frontier economies. Since its founding, ARIA has unlocked more than $45 million in DFI investment and helped local businesses become investment-ready. To date, it has delivered 40 technical assistance projects to 30 companies in frontier markets.

Something we often hear from investees in frontier markets is that they face challenges that can only be overcome through a good working relationship with local government.  

It is possible to invest profitably in frontier markets. However, DFIs’ development mandates mean that they will sometimes make investments with a risk/return combination that purely commercial investors would not accept. For example, we might expect a low-single-digit return from a portfolio of investments in LDCs, shading into low-single-digit negative returns in the very poorest group of low-income countries.

The volume of capital deployed in frontier markets will always look small when compared to larger economies. This needs to be clearly understood and communicated from the start. Otherwise, there is a risk of success being mistaken for failure, resulting in loss of support.

Risky enterprises call for risk-bearing capital. But the most risk-bearing instrument, equity, can be hard to use in countries where equity investors’ rights are badly protected. Frontier markets often need flexible mezzanine debt products, which have some of the risk-bearing characteristics of equity, and the ability to lend in local currencies, to take foreign exchange risk away from borrowers. 

Businesses in frontier markets often need smaller amounts of capital, best delivered via intermediaries. But it can be hard to find a partner with a successful business model that is also aligned to the objectives of DFIs. That means that sometimes DFIs must create their own partner organisations to solve development problems where no investable solution exists. One example is Gridworks, an electricity transmission and distribution platform founded by BII, responding to a need for providers serving that market in Africa. Gridworks is now developing projects to distribute electricity in Burundi and build grids in isolated cities in the DRC.

Working in frontier markets is not about individual actors taking credit; it is a team endeavour and requires humility. But if DFIs adapt their approaches, they can give frontier markets the best chance of growing their economies and fulfilling the aspirations of their citizens – while also making solid, profitable investments.