Investing In The Frontier

July 06, 2018

[This article appears in our August 2018 issue of ETF Report.]

In 2014, frontier markets had a brief moment in the sun, as high-flying returns from smaller, riskier countries like Vietnam and the United Arab Emirates ignited investors' imaginations.

Since then, however, interest in frontier markets has all but evaporated, and they remain an obscurity to most investors.

However, there's still plenty to love about frontier markets—particularly their potential for juicy, outsized returns long term.   

Frontier markets are "like deep value investing," said Perth Tolle, founder of Life + Liberty Indexes and emerging markets expert. "As they're coming from an often abysmally low base, they have the greatest potential for growth."

Exploring The Economic Frontier

By now, most people "get" emerging markets: They're investable markets, like China or Brazil, whose economies are characterized by an expanding middle class, improving social stability, rising purchasing power per capita and brisk economic growth.

In contrast, frontier markets are countries whose economies are even less developed and accessible than those of emerging markets, but which are still considered investable.

"Generally, frontier markets are smaller, and they've seen rapid GDP growth," said Lourdes Casanova, director of the Emerging Markets Institute at the SC Johnson School of Business at Cornell University. "Their economies tend to be very dynamic."

Often, frontier market economies rely heavily on a single industry or sector: agriculture, for example, or oil production. They may have just opened to foreign investment, like some Gulf nations; or they may already be highly developed with a very small population, like Estonia. Either way, frontier markets are characterized by smaller market capitalizations and lower liquidity than emerging or developed markets.

Frontier markets also tend to exhibit low correlation to other asset classes, even to emerging markets. Over a roughly six-year period, the iShares MSCI Frontier 100 ETF (FM), a good proxy for vanilla frontier market ETF exposure, showed only a 0.54 correlation to common U.S. stocks and emerging markets ETFs. FM's correlations to other asset classes, like commodities, bonds and gold, were even lower (see table below).

 

Asset Correlations With Frontier Markets
Fund   SPY EEM AGG GSG EFA GLD FM
SPDR S&P 500 ETF SPY - 0.76 -0.17 0.32 0.84 -0.07 0.54
iShares MSCI Emerging Markets ETF EEM 0.76 - 0 0.39 0.81 0.09 0.54
iShares Core US Aggregate Bond ETF AGG -0.17 0 - -0.08 -0.12 0.35 -0.09
iShares S&P GSCI Commodity-Indexed Trust GSG 0.32 0.39 -0.08 - 0.38 0.18 0.26
iShares MSCI EAFE ETF EFA 0.84 0.81 -0.12 0.38 - 0.01 0.53
SPDR Gold Shares GLD -0.07 0.09 0.35 0.18 0.01 - 0.02
iShares MSCI Frontier 100 ETF FM 0.54 0.54 -0.09 0.26 0.53 0.02 -

Source: PortfolioVisualizer.com; data from Sept. 13, 2012 to July 2, 2018

 

Big Swings In Single Countries

When frontier markets hit it big, they really hit it big—think Saudi Arabia, for example; or Vietnam, which is often considered the fastest-growing country in the world. In Q1 2018 alone, Vietnam's GDP grew 7.4%.

Nigeria is another good—if under-the-radar—example. Over the past 12 months, the Global X MSCI Nigeria ETF (NGE) rose 19.4%, handily outperforming all other frontier market ETFs (see table below), as well as the U.S. stock market, emerging markets and total world markets (as measured by the SPDR S&P 500 ETF Trust (SPY), the iShares MSCI Emerging Markets ETF (EEM) and the iShares MSCI ACWI ETF (ACWI), respectively).

 

Frontier Market ETFs
Ticker Fund Expense Ratio AUM (M) Spread YTD 1 Year 3 Year 5 Year Beta
Pure Play Frontier Markets ETFs:
FM iShares MSCI Frontier 100 ETF 0.79% $569.92 0.09% -10.50% 4.26% 2.41% 4.13% 0.98
VNM VanEck Vectors Vietnam ETF 0.66% $363.10 0.08% -11.13% 8.34% -1.91% -0.52% 0.73
ARGT Global X MSCI Argentina ETF 0.59% $150.81 0.21% -22.54% -6.67% 10.66% 11.76% 0.56
FRN Invesco Frontier Markets ETF 0.70% $65.90 0.25% -7.21% 3.60% 4.50% 0.26% 0.73
NGE Global X MSCI Nigeria ETF 0.88% $60.26 0.97% -0.09% 19.44% -14.70% -15.14% 1.05
PAK Global X MSCI Pakistan ETF 0.87% $51.00 0.38% -9.53% -26.13% -5.16% --    0.95
AGT iShares MSCI Argentina and Global Exposure ETF 0.59% $46.98 0.16% -22.18% -6.71% -- --    0.56
GULF WisdomTree Middle East Dividend Fund 0.88% $18.70 1.98% 12.73% 18.78% 2.60% 5.97% 0.8
Blended EM/Frontier Market ETFs:
AFK VanEck Vectors Africa Index ETF 0.84% $67.41 0.64% -7.02% 7.80% 0.21% -0.60% 0.49
BBRC Columbia Beyond BRICs ETF 0.58% $62.98 0.93% -7.36% 0.59% -0.66% -1.13% 0.63
EMFM Global X Next Emerging & Frontier ETF 0.56% $15.99 0.94% -12.05% 0.10% 0.18% --    0.69

Sources: ETF.com, FactSet; data as of June 29, 2018

 

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