Frontier markets exchange traded funds, led by the iShares MSCI Frontier 100 ETF (NYSEArca: FM), have witnessed a noticeable uptick in popularity this year. From a return perspective, the adulation is well-deserve.
Year-to-date, FM has surged 18.5% while the iShares MSCI Emerging Markets Index (NYSEArca: EEM) is down 4.6%. The PowerShares MENA Frontier Countries Portfolio (NasdaqGS: PMNA), a frontier fund with a heavy emphasis on Middle East and North Africa nations, has 8.5%.
The success of frontier market equities, which hail from countries such as Argentina, Kuwait, Nigeria, Pakistan and Vietnam, is not hard to explain. Global investors see favorable demographics and perceive those nations and others like them to be at similar stages in their growth stories today as China, Brazil, India and others were earlier this century. [Frontier Markets Could Soon be a Buy]
In what is often a surprise to the novice frontier markets investor, these markets are less volatile than emerging markets and usually feature surprisingly low correlations to U.S. and emerging stocks. For example, the standard deviation for FM’s underlying index is below that of the MSCI Emerging Markets Index.
However, some analysts worried that as more international money flows into frontier markets that stocks in those countries will see increased correlations and an uptick in volatility. [Frontier Markets Losing Some Shine]
“With such limited capacity, strong inflows into frontier-markets stocks will likely drive markets higher. However, any sudden pull-back by foreign investors could result in brutal declines,” said Morningstar ETF analyst Patrica Oey in a recent note.
Her comments jibe with what other market observers have said about frontier stocks. Earlier this year, Sam Vecht, who manages the BlackRock Frontier Investments Trust, said that the time is now to invest in frontier markets because as more Westerners learn of the advantages offered by these markets, volatility will increase. [Frontier Markets More Stable Than Developed Peers]
For their part, ETF issuers have not been deterred by an increase in volatility that has yet to materialize in earnest. The EGShares Beyond BRICs ETF (NYSEArca: BBRC) recently switched to a new index to boost the fund’s frontier markets exposure. Two weeks ago, Global X introduce the Global X Next Emerging & Frontier ETF (NYSEArca: EMFM) and that ETF already has more than $12.3 million in assets under management. [Global X Debuts Frontier/Emerging Markets ETF]
Perhaps the biggest concern about frontier market indices is one that will certainly come to pass: The loss of Qatar and the United Arab Emirates to emerging markets status. Those nations’ stocks have been stellar performers and the two are seen as economically advanced and politically stable relative to the likes of Argentina and Nigeria.
How that promotion affects FM, in particular, will be worth watching. FM is benchmarked to an MSCI index and it what MSCI that promoted Qatar and UAE to emerging market territory. Currently, the two countries combine for over 32% of the fund’s weight. When they leave in 2014, Kuwait and Nigeria will dominate FM.
iShares MSCI Frontier 100 ETF
