Overview: Investing in emerging and frontier markets (Part 3 of 6)
What are frontier markets?
While there is no specific definition of what constitutes the frontier market, it essentially consists of companies and investments in nations that are economically even less developed than emerging market countries. Many of the countries don’t have their own stock exchange. The term is commonly used to describe the equity markets of the smaller and less accessible, but still investable countries of the developing world.
Frontier equity markets typically have modest market capitalization, limited investability and liquidity, and few market information sources. On the positive side, they generally possess favorable demographics and good long-term growth prospects.
Which countries fall under this category?
These frontier markets are generally concentrated in Eastern Europe, Africa, the Middle East, South America, and Asia. The biggest frontier markets are Kuwait, Qatar, the United Arab Emirates (or UAE), Nigeria, Argentina and Kazakhstan. Other countries like Croatia, Tunisia, Pakistan, and Kenya also fall in this category. Most frontier markets consist mainly of stocks of financial, telecommunications, and consumer goods companies.
Investing in frontier markets
While those with a smaller risk appetite tend to invest more in blue chip stocks like Apple (AAPL), Google (GOOG), and Microsoft (MSFT), investors willing to take on additional risk to reap high returns turn to emerging and frontier markets.
The frontier market equity is pursued by investors seeking potentially high returns. The investors are able to accept the higher risks that these types of markets are exposed to. Some of the risks an investor faces in these markets are political instability, poor liquidity, inadequate regulation, substandard financial reporting, and large currency fluctuations. Frontier market investments can have a low correlation to developed markets. As a result, they can provide additional diversification to an equity portfolio.
However, investors should be aware that frontier markets are categorically the riskiest markets in the world in which to invest. Investment holdings in this sector are typically illiquid, non-transparent, and subject to very low regulation levels as well as high transaction fees.
Popular exchange-traded funds (or ETFs) investing in these frontier markets include the iShares MSCI Frontier 100 Index Fund (FM) and the Guggenheim Frontier Markets ETF (FRN). Both these ETFs have invested heavily in financial services and energy stocks of frontier markets. While FM has heavily invested in stocks of companies based in Kuwait and Qatar, FRN leans more towards Latin America, 77%, with its investments in Chile aggregating up to 40.5%. While the FM is invested up to 50% in frontier economies, the FRN has a 98.67% frontier market exposure. The ISPX record for the Global X Next Emerging & Frontier ETF (or EMFM) is another ETF providing frontier market exposure.
Although frontier and emerging markets both fall into the same general sector of the global marketplace, there are some critical differences between the two sub-sectors. Let’s move on to understand the key differences between emerging and frontier markets.
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