Vehicles for investing in frontier markets

There aren’t a lot of mutual fund or ETF options available to wannabe frontier investors. The actively managed T. Rowe Price Emerging Middle East and Africa fund is currently the fund offering that’s the most focused on frontier markets, said Gregg Wolper, senior fund analyst, Morningstar, Inc. Currently, there are no ETFs or index funds tied to the MSCI Frontier Markets Index or S&P IFCG Global Frontier Markets indexes.

However, the Claymore/BNY Mellon Frontier Markets ETF launched in June, using The Bank of New York Mellon New Frontier DR Index. Morningstar has identified more frontier ETFs in registration, including, Market Vectors Africa, Market Vectors Global Frontier, Market Vectors Gulf States, PowerShares Middle East and North Africa, and WisdomTree Middle East Dividend. Speidell said he is considering an actively managed frontier mutual fund offering in conjunction with Nicholas Applegate Capital Management. Morningstar maintains a page on its site with information about frontier market funds in registration.

Implications for advisors

Tread carefully. The volatility of individual countries may stress you and your clients, even if it doesn’t do damage to your overall portfolio. For example, if you invest in Lebanon and a civil war breaks out, you will be dealing with some angry clients, said Hoguet.

Don’t bypass traditional emerging markets for frontier markets. Emerging markets still have plenty of potential, said Todd Henry, emerging markets portfolio specialist, T. Rowe Price. Moreover, he suggested, frontier markets’ relatively low volatility may not continue.

Examine what’s in your traditional emerging markets funds. For example, T. Rowe Price’s Emerging Market Stock Fund has about 10% in frontier stocks and that may be enough for some clients, said Henry.

Consider the universe in which the fund or ETF invests. Frontier indexes’ characteristics vary significantly. For example, the MSCI index is about 70% in the Middle East, while its S&P peer emphasizes Africa (34%) and Central and Eastern Europe (46%), said T. Rowe Price’s Henry.

Examine your investment vehicle’s diversification across companies, countries, and regions or your clients may be overexposed to unsystematic risks such as currency devaluations or political upheaval. For example, close to half of the Claymore/BNY Mellon Frontier Markets ETF is invested in Poland (24.86%) and Chile (21.01%) as of May 31. Moreover, neither of those countries are considered frontier by MSCI.

Weigh the case for active vs. passive management. Frontier markets may be less efficient, offering more opportunities to find undervalued growth companies, said Henry. Moreover, there may be a significant gap between the performance of a frontier market ETF and its index because the index can’t be fully replicated. Some shares in frontier market indexes are so illiquid an ETF can’t buy them.

Despite Speidell’s argument for a whopping allocation to frontier stocks, consider starting small. As you learn, you may gain more confidence.

Susan Weiner, CFA, is a writer specializing in investment and wealth management.

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