In the last month there have been two exchange-traded funds (ETFs) introduced that focus on the highly sought after "frontier markets". A frontier market can be defined as a country/region that is on the brink of becoming a worthwhile investment opportunity for outside investors. Examples include Northern Africa, Vietnam, Chile, and parts of Eastern Europe.

With the emerging markets outperforming the developed markets over the last five years, is now the time for investors to put their money into these high growth countries, or is the risk of a global slowdown a deterrent? Look back on the performance of the Claymore BRIC ETF (AMEX:EEB), which doubled from its introduction in late 2006 to late 2007.

Benefits of Frontier Markets
The No.1 reason investor turn to frontier market investments is for the growth potential. Consider an investment in China or Brazil 10 years ago; you would be one very wealthy individual if you had the foresight to put money into the now emerging markets. The Brazilian stock index, the BOVESPA, has gained over 600% in the last six years. The same investment in the S&P 500 would have returned approximately 60%.

The other main reason investors should consider the frontier markets is their value for diversification purposes. Due to how many of these countries do not rely on the major countries for their economy, the frontier markets are able to trade independently of the developed nations. (For an introduction to the risks and benefits of these ETFs, read Finding Fortune In Foreign-Stock ETFs.)

Frontier Market ETFs
The first Frontier Market ETF to launch was the Claymore BNY/Mellon Frontier Markets ETF (NYSE:FRN). The ETF is heavily weighted in its top three countries which include Poland (24%), Chile (21%), and Egypt (17%). Diversification between three separate continents is a plus for the ETF; however, the lack of more exposure to Africa is a concern. The only other African country in the allocation is Nigeria, with a small 3% allocation.

Only one of the top ten holdings is traded on a US-based stock exchange, which makes this ETF valuable to the average investor. The one stock that is traded here in the U.S. is Enersis (NYSE:ENI), an electric utility company based in Chile. The stock accounts for 4% of the ETF and was down 2% during the first half of 2008.

Joining FRN is the PowerShares MENA Frontier Countries ETF (Nasdaq:PMNA). The ETF is based on the NASDAQ OMX Middle East North Africa Index. The countries with the largest exposure are Egypt (21%), Kuwait (16%), Jordan (14%), Morocco (14%), and Qatar (13%). The differences between PMNA and FRN are apparent. While FRN diversifies in several different regions of the globe, PMNA is strictly focused on one area. This can be good or bad, depending on the performance of the countries in the Middle East and North Africa.

Future of Frontier Markets
With two very different frontier market ETFs now on the market, do not expect it to stop there. Van Eck and their Market Vectors family of ETFs have filed with the SEC to roll out a number of ETFs focused on specific frontier market regions. Two that are similar to those mentioned above will focus on Africa (proposed symbol: AFK) and the Gulf States (proposed symbol: MES).

When looking at the frontier markets as an asset class in an investor's portfolio, it should not play a major role in your investment strategy. However, putting a moderate portion of a portfolio into the frontier markets could pay dividends over the long-term. One suggestion I can give for the frontier markets is that they will carry even more risk than the emerging markets, but must be viewed as long-term investments just as you would the emerging market plays. With high reward comes above-average risk.

For related reading, check out Diversification: It's All About (Asset) Class.
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Tickers in this Article: FRN, PMNA, ENI, EEB

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