Emerging markets exchange traded funds are starting to make a comeback. How long the rebound lasts is up for debate, but the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) is up 3.2% over the past month.
EEM and rival ETFs still have a long way to reclaim lost glory. Diversified emerging markets ETFs still have a long way to catchup to frontier funds such as the increasingly popular iShares MSCI Frontier 100 ETF (NYSEArca: FM). FM is up 7.1% while EEM is higher by just 1.4%. Last year, FM, the largest frontier ETF, surged 23.7% while EEM shed 3.7%. [Frontier ETFs Have Plenty of Fans]
“Asset managers are buying frontier markets as they seek to mitigate risk by investing in securities that don’t move in lockstep with global stocks,” report Boris Korby and Callie Bost for Bloomberg, citing David Wickham, a senior product specialist at HSBC Global Asset Management.
One source of allure for frontier markets is that these markets, which include the likes of Kuwait, Nigeria and Vietnam, are not closely correlated to U.S. and emerging markets equities. FM’s underlying index, the MSCI Frontier Emerging Markets Index. has a five-year correlation coefficient of 0.63 relative to the U.S. benchmark equity gauge, compared to 0.76 for MSCI’s emerging markets index, according to Bloomberg.
Frontier stocks are also surprisingly less volatile than some investors perceive them to be. FM’s beta against the S&P 500 is just 0.71, according to iShares data. The ETF hit consecutive all-time highs last Thursday and Friday.
FM is not the only frontier fund that investors have allocated cash to this year. The EGShares Beyond BRICs ETF (NYSEArca: BBRC) has taken in over $23 million. BBRC is a combination emerging/frontier ETF and tracks an index that allows for a quarter of the fund’s holdings to be frontier markets plays.
The Global X Next Emerging & Frontier ETF (NYSEArca: EMFM) has also seen positive flows. EMFM’s underlying index, the Solactive Next Emerging & Frontier Index, features allocations to markets such as Pakistan, Bangladesh, Gabon and Laos in addition to more traditional emerging fare like Malaysia, Thailand and Indonesia. BBRC is up 4% this year while EMFM is higher by 5.1%. [An Emerging/Frontier Combo ETF]
A large part of FM’s success since early 2013 is attributable to the ETF’s large allocations to stocks in the United Arab Emirates and Qatar, two countries that currently account for over 35% of the fund’s weight. However, those countries will join the MSCI Emerging Markets Index in May, meaning Kuwait and Nigeria will combine for almost half of FM’s weight. [Frontier Markets Could See Emerging-Style Volatility]
Investors looking to maintain ample exposure to Qatar and UAE after the move to the emerging markets index can consider the WisdomTree Middle East Dividend Fund (NasdaqGM: GULF) and the Market Vectors Gulf States Index ETF (NYSEArca: MES), which have brought in nearly $30 million combined this year.
Qatar and UAE combine for 57% of GULF’s weight and 64% of MES. Since the ETFs are dedicated Middle East ETFs, not explicit frontier funds, they can maintain large Qatar and UAE allocations even after the countries move to the MSCI Emerging Markets Index. The two ETFs are up an average of 12% this year. [The Best Middle East ETF]
iShares MSCI Frontier 100 ETF
ETF Trends editorial team contribute to this post. Tom Lydon’s clients own shares of EEM.