Time for Frontier Markets ETFs?
As the major emerging economies are beginning to mature and slow-down, they will no longer able to repeat their stellar performance of the recent past. So the investors looking for the “next big thing” in the investing world are now turning to “frontier” or “pre-emerging” markets. These countries offer compelling investment opportunities with solid growth potential and low valuations.
Although there is no strict definition for frontier markets, these are typically countries that are in the earlier stages of economic development. Their capital markets are underdeveloped and not fully/easily accessible to foreign investors.
The term “Frontier Markets” was first used by the International Finance Corporation to describe a set of small, illiquid and underdeveloped markets. Now MSCI, S&P and Russell have their own definitions of “Frontier Markets”.
MSCI Frontier Markets Index currently includes 31 countries. Most of these countries are in Middle East, sub-Saharan Africa, Southeast Asia, Latin America or Eastern Europe regions. (Read: Best Latin America ETFs for 2013 Part I and II)
Frontier markets are expected to grow faster than emerging and developed economies. Further, they have relatively lower valuations as well as higher income yield.
As emerging markets have become increasingly integrated with the global markets, their correlations with the developed markets have increased and the benefits of diversification have declined. (Read: Do Single Country ETFs provide diversification?)
On the other hand, frontier markets still have relatively lower correlations with the developed markets. Thus adding them as small satellite holdings in an investment portfolio can improve risk-adjusted returns over long term.
However the investors need to be aware of liquidity, currency and political risks of investing in these countries as they are much riskier even compared with most emerging markets.
As investing in a single country or company can lead to significant risks it makes more sense to invest in these countries through frontier markets ETFs that invest in large number of countries and companies and thus spread out risk. (Read: Is the Best Bond ETF in Europe?)
Guggenheim Frontier Markets ETF (FRN)
FRN seeks to match the performance of the BNY Mellon New Frontier DR Index. BNY Mellon defines frontier market countries based on the GDP growth, per capita income growth, inflation rate, privatization of infrastructure and social inequalities.
However the top countries included in the ETF—Chile (43%), Colombia (15%), Egypt (11%) and Peru (9%)--which account for about 78% of the holdings are “emerging” markets” and not “frontier” markets per MSCI and S&P.
The fund is top-heavy with about 60% of the assets in top 10 companies, while EcoPetrol, Latam Airlines, Bancolombia are the the top four holdings.
Initiated in June 2008 and with total assets of $166.8 million, the fund is the lower cost choice in this space with expense ratio of 65 basis points. It pays out 2.96% yield at present.
PowerShares MENA Frontier Countries ETF (PMNA)
PMNA is based on the NASDAQ OMX Middle East North Africa index, which seeks to track the performance of liquid companies in MENA (Middle East and North Africa) frontier countries.
In terms of country exposure Qatar (25%), Kuwait (25%), Egypt (23%) and United Arab Emirates (20%), account for majority of the asset holdings.
The fund is heavily tilted towards the financial sector that makes up about 62% of the assets. Top three holdings include Mobile Telecommunications, Qatar National Bank, and National Bank of Kuwait.
The fund was launched in September 2008 and manages assets of $16.6 million currently. PMNA charges fees of 70 basis points per year and pays a dividend yield of 2.78% as of now.
iShares MSCI Frontier 100 Index (FM)
FM--launched in September 2012--is the newest product in this group. It is based on the MSCI Frontier Markets Index, which is composed of 100 largest securities from the eligible universe, ranked by float adjusted market capitalization.
In terms of country exposure, the Gulf States dominate, with Kuwait (28%), Qatar (17%), and the UAE (11%) in the three spots out of top four, with Nigeria (13%). Like the other two ETF, financials dominate in terms of sector exposure, accounting for a whopping 54% of the total assets, while telecoms (15.8%) and energy (9.1%) round out the top three.
The fund charges an expense ratio of 79 basis points and pays out a 30-day SEC yield of 2.79% currently.
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