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Frontier Market ETFs Deliver Returns

Paul Britt

As emerging markets (EM) have stumbled over the past year, many market strategists have called for a more subtle approach to gaining exposure to the developing world; namely, by picking single countries or regions rather than owning the whole basket.

That makes sense. EM countries in Latin America differ greatly from those in Asia, and the presence or absence of Korea and Taiwan in a broad EM fund, because of index rules, further highlights the need to have something other than a monolithic view of the space.

Clearly a single-country ETF is much less diversified than a multicountry basket, which raises the bar for diligence and research.

ETFs that split the difference—offering a subset of EM countries—combine some diversification with a themed focus, but come with their own bets. For example, ETFs canvassing the BRIC countries of Brazil, Russia, India and China are currently a contrarian play, while the EGShares Emerging Markets Consumer ETF (ECON | C-40) tilts hard toward the EM consumer by design.

As alternatives in this light, I’d offer frontier market ETFs:the iShares MSCI Frontier 100 (FM | D-94) and the WisdomTree Middle East Dividend ETF (GULF | F-89). (More on ETF.com’s fund scores in a moment.)

Both funds are dominated by Persian Gulf countries; namely Qatar, the United Arab Emirates and Kuwait. They share similar sector exposure too, led by financials, telecoms and industrials, and carry little energy exposure.

Frontier markets sound extremely risky, but the funds’ recent performance has been remarkable, not only in terms of strong returns but also for low volatility.

The chart below shows these two funds held up against an emerging markets proxy, the iShares MSCI Emerging Markets ETF (EEM | B-100). I choose FM’s inception as the start date for the chart since it’s the newest of the three funds.

Returns FM GULF EEM
Returns FM GULF EEM

GULF and FM stand out for strong returns for the period, 61.3 percent and 37.4 percent, respectively, compared with -4.3 percent for EEM.

Both FM and GULF have delivered lower daily volatility for the period compared with EEM, and with the SPDR S&P 500 ETF (SPY | A-98), for good measure.

Volatility FM GULF EEM SPY
Volatility FM GULF EEM SPY

FM and GULF also offer low correlation for U.S. equities, another plus in a portfolio context. Dennis Hudachek noted this last year and the trend continues today.

Correlation_FM GULF EEM
Correlation_FM GULF EEM

Our fund reports show that price-earnings multiples (P/E ratios) for FM and GULF are also in line with EEM, despite EEM’s lagging returns.

Reality Check

Clearly there’s a due diligence task here as there would be with a themed emerging market ETF.

Stock markets in Qatar, the UAE and Kuwait have all enjoyed steady gains lately, no doubt driving FM’s and GULF’s attractive performance. Investors in FM and GULF are betting these trends will continue.

Data for the three countries from Trading Economics looks pretty stable:low inflation, low unemployment and moderate rather than torrid growth. Still, investors will need to spend some time researching markets that may be completely unknown to them.

Now, about those low ETF.com letter grade scores:Accessing frontier markets isn’t cheap or easy. New York’s trading day barely overlaps with local exchanges, making price discovery a challenge, and the liquidity of underlying shares is very thin, especially for GULF. Still, FM’s shares trade with impressive daily volume and decent spreads. For help trading either fund, consider contacting the capital markets team at either fund’s issuer. Holding fees are high as well.

Concentration risk looms large here too—and in names most of us have never heard of. For example, few of us can rattle off the tickers of the Kuwaiti banks that top the holdings list.

Still, the fact that ordinary investors can access these markets with practicality at all is something of a minor miracle.

It’s hard to make a full-throated call to pile into these funds without doing more legwork, but their recent performance—especially held against that of emerging markets—suggests it may be worth the time.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Britt at pbritt@etf.com .


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