Find A Home In The Frontier

By Aaron Levitt | July 12, 2013 AAA

With slowing economic growth in China, protests in Brazil and other “issues” presenting themselves in a variety of emerging markets, investor have soured on the idea of betting heavily on these nations. Many are concerned that these countries- represented by funds like the Schwab Emerging Markets Equity ETF (NASDAQ:SCHE) –have now matured and will never see the breakneck GDP growth that has been the norm over the last 20 or years.

Given these slower growth predictions from formerly “hot” markets, investors need to look off the beaten path to find the next opportunities in the international world.

SEE: An Evaluation Of Emerging Markets

Welcome To The Frontier
At one time, emerging markets offered low correlation to the developed world. However, as these nations grew in prosperity, their fortunes became inter-twined with global economy. For example, China is now the United States' second largest trading partner. That’s why investors with long enough time limes may want to look at those nations classified as frontier markets.

Wall Street calls these emerging markets that have not fully emerged, "frontier economies." They include such nations as Vietnam, Nigeria, Croatia and Kazakhstan. Typically, these frontier environments are characterized by very fast growing economies combined with very small or hardly-existent equity markets. Add this to the often unstable political environments, and you have reason why these aren't tourist hot spots.

However, the fact that they are ignored actually makes them good investment candidates.

Many are rich in vital natural resources. Despite recent setbacks in the commodities markets, the long term global demand picture for oil, copper, gold and other commodities is still rosy and continues to increase. Secondly, these nations feature juicy demographics. Frontier markets represent roughly 22% of the world population- with nearly 60% of their citizens under the age of 30. Aside from this large population being young, they also represent a cheaper labor force than those found in other more “developed” countries. That makes them able to compete on a global stage.

SEE: Forging Frontier Markets

Perhaps the most important reason to consider the frontier happens to be the nation’s low correlations to other asset classes. Over the last 10 years, the MSCI Emerging Markets Index has had a correlation of around 90% with the MSCI Developed Markets Index. This compares with a correlation of just 70% in the 10 years prior. The MSCI Frontier Markets Index has shown just a 0.45 correlation over that time frame. That provides plenty of “zig” when the broad market “zags”.

Going Off The Beaten Path
While there are a few frontier market ADR's trading on major U.S. exchanges- such as Panama’s Banco Latino Americano de Comercio Exterior (NYSE: BLX) -most do not. Creating an allocation to these assets using individual stocks would be most daunting. For most investors, an index exchange product or actively managed mutual fund is a better choice. These can provide exposure to several different frontier markets, across several different sectors.

The oldest fund in the sector is the Guggenheim Frontier Markets (NYSE:FRN). The ETF tracks 35 different stocks from 10 different frontier nations. However, the major criticism of the ETF is that many of the countries included- such as Chile and Poland- are actually considered emerging markets, not frontier. Investors betting on the fund may not be getting true exposure to the market segment. Given that, the new iShares MSCI Frontier 100 Index (NYSE: FM) is a better bet.

The iShares fund tracks 102 different firms from such faraway places as Kuwait, Kenya and Vietnam, while including zero exposure to more traditional “emerging” markets. The frontier’s diversification benefits haven’t been lost with the ETF as FM is up 11% year to date. This compares with a 10% loss of for iShares MSCI Emerging Markets (NYSE:EEM). The ETF is expensive- with fees clocking in at 0.79%. However, considering just how illiquid some of these markets are, that might really be a bargain.

The remaining ETF's in the sector focus on the continent of Africa. The PowerShares MENA Frontier Countries ETF (NASDAQ:PMNA) concentrates its holdings in the oil and energy rich Middle East, while the Market Vectors Egypt Index ETF (NASDAQ:EGPT) and Global X Nigeria Index ETF (NYSE:NGE) can be used to hone in on opportunities in these nations.

The Bottom Line
For investors with a long term- possibly decades- timelines, adding a dose of frontier markets make sense. These emerging nations of tomorrow offer significant growth potential for investors willing to take the risks. Portfolios could be looking at the China's and Brazil's of the future. The previous ETFs – along with the Market Vectors Gulf States Index ETF (NYSE:MES) –make ideal ways to play the nations.

You May Also Like

Related Analysis
  1. Stock Analysis

    It's Still Miller Time In The Emerging Markets

  2. Stock Analysis

    Emerging Markets Bonds ETF Cheat Sheet

  3. Stock Analysis

    The 2 Most Important Numbers You Need to Know Before Investing in Emerging Markets

  4. Stock Analysis

    Time for Emerging Markets Corporate Bond ETFs? - ETF News And Commentary

  5. Stock Analysis

    Itau Unibanco (ITUB) Plans to Expand Business in Mexico - Analyst Blog

Trading Center