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DESPITE itself at the epicenter of the global financial crisis in 2008, many commentators predicted that the American economy would be the first to pull itself out of recession. At the start of 2011, a strong recovery appeared to be well on course; the U.S. stock market had risen to levels not seen for two years, while Gross Domestic Product (GDP) figures from the fourth quarter of 2010 showed the economy to be in its best shape in almost half a decade. However, a series of recent shocks—from a spike in oil prices, to the knock-on effect of the Japanese disaster and Middle Eastern turmoil, to high-level international concern about the U.S. budget deficit—and longer-term issues of governance, political stability, and currency values are raising serious questions from European and other ex-American institutional investors about United States growth prospects.

The questions they are asking border on the chaotic: Should these pressures be seen as temporary blips, or evidence that this once untouchable market is still highly fragile and volatile? Is this an economy on the brink of collapse? When given a choice between emerging markets and America, which way should they go?

What they should be asking —at least rhetorically—is this: Is America, in spite of its collection of faults—or, perhaps, because of them—the next great frontier opportunity?

Frontier markets are characterized by high risk and, potentially, its common corollary—high return—but what exactly are the factors that define this high risk and, therefore, frontier markets themselves? Daniel Broby, Chief Investment Officer at London-based Silk Invest, a specialist frontier market fund management firm, is well-placed to answer this question. “Essentially, they are off benchmark and the primary reason they are off benchmark is due to the lack of liquidity,” he says. “Secondly, frontier markets typically are subject to a lot of political risk—frequent changes of government and/or a framework of political decisionmaking, which is seen as unrepresentative. Then, I think currency volatility is always a focus for frontier markets and something people talk about a lot. The other aspect of frontier markets is the closed nature of the share-ownership structure of some of the companies.” Despite these risks, however, Broby asserts that investors are attracted by low levels of debt, industrialization, and population growth.

With this defined, is it at all fair to compare the world’s largest economy with such troublesome upstarts? No—and yes. To begin with, the U.S. is obviously one of the most liquid markets on the planet. Yet, it was only in 2008 when the treasury and corporate bond markets, previously perceived as the most liquid part of the financial system, effectively dried up and ceased trading. Not only this, but valuation systems moved from mark-to-market to mark-to-matrix and, in some cases, mark-to-model, which are more typically found in illiquid markets such as the frontier economies.

Politically, it is hard to argue against the idea that the American polis is one of the most stable in the world. However, one—particularly, an extremely cynical London-based financial journalist— could argue that the current President has greatly increased his chances of a second term by ordering the execution of a political adversary, albeit one who admitted to the whimsical massacre of civilians in the name of religion. Additionally, his predecessor was accused by one-half of the political spectrum of winning the 2000 election by “receipt of a number of illegal votes or rejection of a number of legal votes”—certainly actions that one might more readily associate with frontier politics than with the U.S.

Perhaps more reasonably, the dollar’s recent woes provide a relatively fair comparison between the currency volatility of frontier markets and that seen in the U.S. However, it must be noted that the world’s reserve currency—at least until now—is the defacto currency in many of the world’s frontier markets, not only in the Middle East, where currencies are linked to the dollar, but also in countries where things have gone so badly wrong: Zimbabwe being a typical example. By and large, the currency of day-to-day transaction in frontier economies is that of the American dollar.

The comparison between America and emerging economies is clearly made tongue firmly in cheek. American infrastructure, governance, and economic history, no matter how jaded the observer, is a far cry from of Kenya, Zimbabwe, or Vietnam. Yet, looking at the different, but overarching, risks—oil shocks, government debt, and uncertain regulations—seen by many foreign institutional investors in the “American play” might make it closer to the frontier than many might like to think.

Asset owners and asset managers attack the fundamental question asked here from a variety of angles. Some think America to be on a steep decline. Others see boundless opportunity. No one, however, lacks an opinion. Take, for example, the impact of volatile oil prices and the effect they risk having on the American economy. Ashmore Group is a London-based investment manager specializing in emerging markets; the group manages $50.3 billion and counts government and corporate pension funds among its investors. As one would expect from a group specializing in emerging markets, Jerome Booth, Head of Research, believes the oil price spike is most damaging to the U.S.—even more so than for emerging and frontier markets. Compared with America, he says, emerging markets “clearly [feel] more of an impact” than America from external oil shocks, “but the point is the emerging markets have the tool set, the ability to cope with it, whereas the U.S. doesn’t. The U.S. is very, very constrained in what it can do about higher oil prices and there is a much more dangerous situation, there is a bigger risk that the U.S. goes into recession as a result of higher oil prices than practically any emerging country.”

However, others believe that oil price will have minimal long-term impact on the U.S. economy. Patrick Groenendijk, Chief Investment Officer at Pensioenfonds Vervoer, the Dutch industrywide pension fund for the private transport sector, is philosophical. He views the effect of the crisis in Libya, and other uprisings in North Africa and the Middle East, as causing just another temporary oil price shock—something that occurs every few years. “I don’t think Libya has that great effect and I think we will see the oil prices come down over the next couple of months. Sol don’t think this will have a permanent effect on the American economy,” he notes.

While investors were reacting to the steep rise in oil prices, Japan was rocked by an historic earthquake, with the resulting tsunami causing devastation unseen in a century. Figurative Shockwaves were felt in the U.S., with several indices dropping sharply, effectively wiping out the gains that had been made over the first quarter in the space of a week. However, Roger Gray, Chief Investment Officer for the Universities Superannuation Scheme (USS) in the U.K., believes neither the Libyan crisis nor Japanese tsunami will have a material effect in America over an institutional horizon. “Obviously, there has been a reasonable subsiding in oil prices and some of the other commodities that were getting overheated. Generally, equity markets did take a knock in the middle of March, around the time of the Japanese earthquake, but found their balance again. So, I think the suggestion from market behavior has been that it has taken these developments in its stride—the evidence suggests these are shorter-term developments,” he says.

Oil spikes and tsunamis, regardless of the tragic devastation and lives lost, are but pebbles compared to the boulder that is the American budgetary issue. While some were earlier than others in registering complaints, investors and commentators increasingly have been concerned about the buildup of U.S. debt. This year will see a projected deficit of 10% to 11% of GDP—the same order of magnitude as the weakest European countries— while the debt-to-GDP ratio has reached a post-war high. As a result, ratings agencies have pounced. Most notably, Standard and Poor’s (S&P) now has put U.S. Treasury bonds on “negative” watch, an action unthinkable a few short years ago, but all too common in emerging markets, where high costs of government borrowing are a fact of life—if anyone is willing to lend them capital to begin with. However, despite the S&P warning, an odd thing is happening: U.S. bonds are extremely expensive with correspondingly low yields, usually an indicator of safety. PIMCO’s Bill Gross can publish letters to his heart’s content, but where is this mythical selloff? Andrew Milligan, Head of Global Strategy for Edinburgh-based Standard Life Investments, which manages $256.9 billion for institutional and private investors, has an answer. “The answer lies in the relationship between U.S. fiscal and monetary policy,” he says. “The U.S. central bank still is buying bonds under its Quantitative Easing (QE2) program, while giving very strong signals that it does not expect to raise interest rates for the foreseeable future.” However, there is concern that this situation could change drastically when the QE2 program ends this summer and, don’t forget: The U.S. Congress constantly is arguing over whether to raise its debt limit. Nothing would be more frontier market-like than a government default—or even the threat of one, if House Republicans have their way.

Once QE2 is over, many believe that America’s chickens will come home to roost. Ashmore’s Booth, for one, describes the U.S. Treasury market as “a bubble.” The fact that 50% of Treasurys are owned by central banks “is a massive risk factor,” he says. “The concentration of investor base is a problem for any asset class, particularly when it is owned by a central bank, or central banks, which is certainly the case in the U.S. Treasury market. You are not getting paid for it either; people are not being paid to buy Treasury risk or U.S. sovereign risk,” he notes.

While there is no ignoring the high deficit, and the impact this has on the U.S. Treasury market, not everyone takes Booth’s extreme view. Gray of the USS acknowledges government debt is still “a long-term risk factor” and that the Treasury market yields are historically low. However, this relates to a period both recently and prospectively when growth is likely to be sub-par or slower than the buoyant levels seen, for example, in the 1990s. He says: “The world is growing, but it is not growing very quickly. Inflation risks have been confined largely to commodities and to certain emerging markets that are linked by currency to the U.S. I think we are probably in an era of relatively low bond yields, so it may be a bit expensive…but we do not subscribe to the view that there is a bubble.”

The fact that PIMCO—the world’s largest bond investor—recently sold off $7 billion of U. S. Treasurys is certainly a sign that it is an asset class losing its appeal, according to Pensioenfonds Vervoer’s Groenendijk. He says: “Other asset managers are way underweight with their U.S. government bond exposure. High yield and credit -there is still some value to be found, but they have had a good run already. So, I definitely think equities are the most attractive place to be now when it comes to the U.S. financial market.” However, even equities will not hold a long-term temptation for investors, some worry—especially if the capital gains tax is raised, as some Democrats have proposed and all Republicans fear. Additionally, Groenendijk believes that many firms will bring their capital expenditure forward to this year to benefit from changes in depreciation regulations, resulting in a sharp drop in capital expenditure the following year and possibly thereafter. He also worries about future political compromises made in order to deal with the country’s fiscal health. “I think that those factors together will make for a very uncertain 2012,” he says. “People understand that, at some point, we will see higher taxes and less spending. Some think this will not affect the economy, but I think a large number of investors see that this will affect the economic growth forecast in a negative way and, therefore, make it less attractive to invest in the U.S. market.”

So, does this all mean that CIOs will be rushing their pension boards into a hastily prepared meeting to discuss their U.S .investment? Roger Gray adamantly denies this is the case. As the last few months have not had any impact on his investment mandate, he does not think drastic action is required. While he believes there is still some adjustment in the property market and deleveraging in the household sector, there is no doubt that the American economy is flexible enough to withstand this. “A longer-term worry about America is to do with the household borrowing position and, more significantly, the public sector [debt], but we don’t really have an extreme view on the U.S.,” he says. “Our buyers think U.S. equities are somewhat dear in a global context.”

The traditional definition of frontier markets puts them on the extreme end of the geographical investing spectrum. As Silk Invest’s Broby points out, they are typified by undeveloped financial markets and regulation; difficult-to-access capital, for governments and private business; and are prone to Dutch Disease due to an overreliance on commodities. Tongue-in-cheek, compare this to America. Hard to borrow capital? Not yet, but depending on the outcome of the debt ceiling debate, possibly. Weak financial regulation? Questionable. Illiquid markets? Hardly, but history serves as a warning. Commodity-dependent? Less so than they’d like, sometimes.

More seriously, there are extreme uncertainties in the American economy—ones that, while different from frontier market risk factors, combine to paint a picture not wholly different from these investment upstarts. Oil shocks, political gamesmanship, and negative debt-rating outlooks: Taken together, such hazards create an environment fit only for the strong of heart. Of course, there is a reason people invest in frontier markets: With great risk can often come concomitant reward. Definitions aside, perhaps this is the most appropriate way of all to look at the American Frontier.