Qatar and UAE outgrow their frontier status: Investor takeaways (Part 5 of 5)
- Better diversification by sector. Sector exposure should shift away from financials (XLF), which will still tend to dominate the index, while exposure to consumer staples (XLY) and energy (XLE) should increase.
- More exposure to true frontier markets. True frontier markets (as defined by per capita income) is anticipated to take on a greater share of the index. Combined exposure to Vietnam and Sri Lanka should nearly double from 3.25% to 7%, for example. While the exposure to each individual lower-income country will be small, the collective increase in exposure is large. Exposure to countries defined as having a per capita income below $10,000 should increase to 47% from 29%.
Market Realist – The graph above shows the new weightings accorded to the MSCI Frontier Markets 100 Index. The new weightings increase diversification by sector and give more exposure to countries with characteristics of true frontier markets instead of being lopsided in favor of high income countries like UAE and Qatar. So the reclassification is a step in the right direction.
In short, based on these reclassifying and rebalancing moves, this new frontier market index (i.e. this new “FM” station) will better embody what most investors are looking for in the asset class. The new index should offer better diversification by country and sector, and more exposure to lower income countries (and therefore more potential for faster economic growth), while still offering low correlation to other assets in investors’ portfolios.
To be sure, frontier markets are still a very volatile asset class and investors should be mindful of the typical risks associated with these exotic markets, which are still at early stage of economic development. As such, while frontier markets are worthy of an allocation, exposures should be small, with the exact amount largely a function of an investor’s risk tolerance.
Market Realist – Frontier markets are inherently volatile. But they’ve showed less volatility than emerging markets (VWO) in the past. From May 2002 to April 2013, the MSCI Frontier Markets Index’s average annualized standard deviation was 20.38%—compared to 24.07% for the MSCI Emerging Markets Index (EEM).
Frontier markets do have some risks that you need to understand fully before investing. Read our series Why frontier stocks are now a strategic asset class to learn the risks and benefits of frontier markets.
Kurt Reiman is a Global Investment Strategist at BlackRock who works directly with Russ Koesterich. He contributed to this post by providing research and investment insights.
Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/ developing markets, in concentrations of single countries or smaller capital markets.
Frontier markets involve heightened risks related to the same factors and may be subject to a greater risk of loss than investments in more developed and emerging markets.
Browse this series on Market Realist: