Investing In The Frontier

July 06, 2018

Less Volatile Than US Stocks

Despite the potential for wide swings in individual countries, frontier markets as a whole appear to be less volatile than not only the broad U.S. stock market, but also emerging markets.

The average beta of the eight pure-play frontier markets ETFs is 0.80, compared with 0.99 for SPY and 1.03 for EEM.

"While each individual constituent can be volatile, a basket of frontier markets actually has lower beta than other stock market indexes," said Cucchiaro.

What's more, volatility also appears to be reduced when blending emerging and frontier market exposure in an ETF, even if there's no clear performance benefit in doing so. The average beta of the three blended EM/frontier funds is 0.60, or 25% less than that of pure-play frontier market ETFs.

Defining Frontier Markets

Because frontier markets are so dynamic, which countries fit the definition constantly changes from year to year, and from indexer to indexer.

"We in the West like to organize the world outside our borders," said Casanova. "But the definition of emerging and frontier market is always a little fuzzy."

In June, MSCI announced it would be reclassifying Saudi Arabia and Argentina, moving them from frontier markets to emerging status starting in 2019. FTSE Russell made a similar announcement earlier in the year.

Reclassifications go both ways, however. Before June's upgrade, MSCI had downgraded Argentina to a frontier market in 2009. It had also dropped Morocco to frontier status in 2013.

As large, more developed economies shift out of frontier market status, it can make the frontier market indexes they leave behind more concentrated and less liquid, at least for a little while.

But the crunch doesn't last forever. New markets develop and grow, until they too are large enough to be considered "frontier."

FTSE has classifications (or stand-alone indexes) for only 78 out of 195 countries in the world, while MSCI has classifications/indexes for 89. That means there are more than 100 countries too small and underdeveloped to qualify as frontier—any number of which could become the next Nigeria or Vietnam.

"It's almost like a professional baseball team's farm system,” said Cucchiaro. “As people get promoted into the minors and majors, it doesn't mean there's any lack of talent in the farm system."

"There's no shortage of markets that can develop and grow," he added. "It's just a question of time as to when they do."

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