The iShares MSCI Frontier 100 ETF (NYSEArca: FM) is up 21% this year compared to an almost 7% loss for the iShares MSCI Emerging Markets ETF (NYSEArca: EEM).
That out-performance has frontier markets, often perceived as less liquid and more rough and tumble than their emerging peers, trading at a slightly higher valuations. In reality, that scenario is not surprising because frontier markets, as measured by FM, have delivered positive returns, while emerging markets from China to South Korea to Russia have been described as inexpensive all year. [These EM ETFs may be Gaining Momentum]
“At this point, FM equities actually command about a 5% premium over EM, even though the premium has historically gone to EM. This reversal makes FM look somewhat expensive, even if it does have more room to recover than either emerging or developed market equities,” writes Michael Ide for ValueWalk.
Some investors may view the valuation premium now commanded by frontier markets as risky because of looming changes to FM. Equity markets in Qatar and the United Arab Emirates, a combined 32% of FM’s weight, have made significant contributions to this year’s upside for frontier stocks. In May 2014, those countries shed their frontier status and depart for the MSCI Emerging Markes index, meaning Kuwait and Nigeria will dominate FM. [Frontier Markets Lose Some Shine]
Citigroup notes “frontier markets are still 47% below their pre-crisis peak, compared to EM 22% below their peak,” but adds that increased investor interest in frontier markets is making value harder to find, according to ValueWalk.
Analysts have also expressed concern that as more Western investors embrace frontier stocks, volatility and correlations to emerging stocks could rise. Low correlations to developed and emerging stocks has been a source of attraction for investors considering frontier equities. [Frontier Markets Could See EM-Style Volatility]