Frontier markets shouldn’t be ignored, but that doesn’t mean they’re exactly tradable.
There has been much debate about the impact of quantitative easing and what winding it down will do to emerging markets. At the same time, little has been said about the state of frontier markets.
Investors can be forgiven if frontier markets aren’t at the top of their minds these days. After all, it’s hard enough to read the tea leaves with the current “he-said-she-said” slap fight going on in Washington, D.C.
Further, it wasn’t until recently that investors began allocating significant pockets of their asset allocation to international markets, let alone segmenting them into developed, emerging and frontier baskets.
Still, there’s a reason the Vanguard FTSE Emerging Markets ETF (VWO | B-86) and the iShares MSCI Emerging Markets (EEM | B-97) have nearly $100 billion in combined assets: Investors now think about their international equity exposure in terms of economic development level. And yet, the performance of the two largest frontier markets ETFs—the iShares MSCI Frontier 100 ETF (FM | D-93) and the Market Vectors Vietnam ETF (VNM | B-33)—has outpaced that of the broad emerging markets space.
Chart courtesy of StockCharts.com
Furthermore, investors use the ETF wrapper as their de facto tool for getting emerging markets exposure. While this is very much a positive development, the reality is the frontier markets of the world still occupy the periphery of investor consciousness.
What else could explain the fact that less than $500 million is currently invested in just three “total market” frontier ETFs? There are currently 130 different emerging market ETFs, targeting everything from single-country small-caps to infrastructure. By comparison, there are just nine frontier market ETFs, with combined assets of less than $1 billion.
Some of this has to do with investability, of course. At the top of the emerging markets food chain are countries like Brazil, China and—depending on who you ask—Korea.
These markets are home to massive multinational companies. The sheer size of these markets provides the capacity needed to allow for stable, liquid index products. In fact, China is now the second-largest economy on Earth, and closing in fast on the United States.
Investors would do well to remember that the developed, emerging or frontier label doesn’t refer to an economy’s size, but rather to things like capital restrictions, currency controls and political stability.
Frontier markets, on the other hand, are decidedly smaller, even if that’s not the means used to classify them as such. The full market cap of Vietnam is just over $30 billion, and nobody in their right mind would call Bulgaria or Serbia global economic powers.
Still, it’s surprising to see so little attention paid to a pocket of the market where so much of the world’s low-cost manufacturing and production is being shifted.