If you haven’t heard of frontier markets yet, get ready, as this area is the popular new kid on the block! Basically, frontier markets are the smaller, lesser-known cousins of emerging markets. Think: Kuwait, Nigeria, Argentina, Pakistan, Kenya, Morocco, and more. These are countries that are at an earlier stage of development relative to emerging markets countries (e.g. Brazil, Russia, India, China, etc.) and in general, are entering a period of strong expected growth due to favorable demographics, infrastructure spending, and an improving business environment.
Although one may think because they are less developed that they’d be more volatile, a recent study by LR Global showed that they are not. In fact, they are not as volatile as emerging markets or even developed ones! Part of this has to do with their limited exposure to the global financial system. Up until just recently, there hasn’t been much public access to these markets. As such, because they have seen lower inflows of foreign capital, they are generally less affected by what goes on elsewhere.
Another thing to be excited about is the diversity of the frontier countries’ economies and market drivers. Hence, they have low correlations with one another… and low correlations with everything else in your portfolio.
So back to the school blackboard: Does anyone recall why low correlations are good? I know some of you may be tired of hearing me repeat this constantly, but it’s important…
Low correlations produce a smoothing effect to your overall portfolio returns,
which minimizes downside, and ultimately leads to better long-term results.
At DWM, we believe frontier markets should receive a minority allocation (2-5%) of a client’s overall equity exposure. And we use the iShares MSCI Frontier 100 ETF (symbol: FM) to get it. This ETF tracks the MSCI Frontier Markets 100 Index. Constituents of the MSCI Frontier 100 Index have to meet minimum liquidity thresholds. Typically, FM will hold about 100 underlying securities, thus providing ample diversification. There are a few other frontier markets options out there, but we believe FM currently represents the only frontier ETF market play with appropriate liquidity. As an extra bonus, it carries a much lower expense ratio (0.79%) than its actively managed peers. Return-wise, it has been putting up attractive numbers, up over 16% YTD at the time of this writing, and up about 50% since the start of 2013. We are cautiously optimistic that this type of solid performance can continue.
If you seek exposure to the next group of countries that are both primed for rapid economic expansion and can potentially provide diversification to your overall portfolio, FM is the ETF for you.
If you have any questions about frontier markets or other investment styles, don’t hesitate to contact us.