At one point during the month, the VIX, an index that measures the U.S. market’s implied volatility, surged to over 26 – nearly two times its average of 14 this year1.
U.S. stocks ended the month as the clear winner returns-wise, but they also had some of the highest volatility of any region. Frontier markets stand in contrast. While stock prices declined –falling oil prices and a rising U.S. dollar hurt oil producers Nigeria and Kuwait – frontier markets overall moved less significantly than the U.S. To illustrate my point, let’s look at two funds. While both U.S. and frontier markets saw higher volatility over the month, the iShares Core S&P 500 ETF (IVV) ended with a standard deviation of 17.45% vs. 16.83% for the iShares MSCI Frontier Markets 100 ETF (FM).2 As this chart shows, IVV also experienced a greater change in volatility in October.
Change in Volatility During October1
This result was not unexpected. Nor was the longer-term behavior of frontier markets:
- Even with the recent decline, frontier market stocks, as measured by the MSCI Frontier 100 Index, have generated strong results: up over 14% year to date through October, and over 19% for the past 12 months.
- Frontier markets provided investors with a yield cushion of 2.44% (12-month trailing yield for the MSCI Frontier Index) vs. 1.79% for the S&P 500
- From a portfolio positioning standpoint, frontier markets continued to serve as a useful diversification tool, with low correlations not only to other major asset classes but among the constituent countries themselves.2 This intra-country diversification can help reduce volatility, as we saw in October.
I’ve previously written about why we like frontier markets. This recent bout of volatility in the U.S., as well as our expectations for increased volatility going forward, only strengthens the case for being as diversified as possible, including making frontier markets a strategic slice of your portfolio. And with valuations more attractive, now may be a good entry point to capture the meaningful growth potential of these “pre-emerging” countries.
How to get a seat at the frontier markets table
Not all frontier market funds are created equal, and differences among funds are more pronounced because of the relative newness of the asset class. For investors considering the potential benefits of frontier markets, and willing to take on their related risks, iShares MSCI Frontier 100 ETF (FM) offers:
1. Pure frontier markets exposure. While many other funds in the category blend both frontier and emerging markets exposure, FM is the only dedicated frontier markets ETF according to MSCI country classifications.
2. Diversification. FM provides exposure to up to 20 countries, helping to mitigate the volatility associated with concentration risk.
3. A bias towards liquidity. Its index is a subset of roughly 100 of the largest and most liquid stocks of its broader parent index. Individual stocks are selected using a special process that focuses on trading volume and shares available. We believe this level of scrutiny can be particularly important in underdeveloped markets where liquidity is key.
1 Bloomberg daily data from January 1, 2014 to October 31, 2014.
2Volatility measured by Bloomberg average 30 day rolling, from December 2010 to December 2013.
3 Source: MSCI monthly correlations from December 2010 to December 2013.