PowerShares Turns To The Frontier

April 25, 2008

Firm files for its first frontier markets ETF, which would cover the Middle East and Africa.

Invesco PowerShares is at the forefront of yet another investment trend with its most recent filing. The firm submitted a prospectus to the Securities & Exchange Commission for a frontier markets exchange-traded fund.

The PowerShares MENA Frontier Countries Portfolio will track the Middle East and Africa Frontier Countries Index, which covers 50 stocks-five each from Nigeria, Lebanon, Egypt, Morocco, Oman, Jordan, Kuwait, Bahrain, Qatar and the United Arab Emirates. Components must have market capitalizations of at least $500 million, and a six-month average daily traded value of at least $1 million. The index is rebalanced quarterly and takes into account foreign ownership and foreign ownership restrictions at each review. Components that have hit their foreign ownership limits are removed from the index. The index provider was not identified.

Investors have begun to turn to frontier markets as they display continued outperformance in comparison to developed and emerging markets and as emerging markets begin to correlate more closely with developed markets in terms of performance. However, there are not a lot of vehicles that allow investors to access these markets, and in the United States, there are no ETFs or exchange-traded notes covering this area at all. (Two Deutsche Bank ETFs covering frontier markets as a whole and Vietnam were recently launched in Europe. Read the story here.)

The proposed PowerShares fund is interesting because it focuses on the Middle East and Africa, excluding frontier markets in Europe, Asia and Latin America. However, if the point is diversification, those two regions might actually be the best choices, because they encompass almost exclusively frontier markets, with a few emerging markets thrown in. Their relative geographical isolation from developed markets could mean lower correlations with those markets.

The index's threshold for inclusion is rather high in comparison to, say, S&P's minimum required float-adjusted market capitalization for its S&P Select Frontier Index, which is just $100 million. The S&P Select Frontier Index includes 30 of the largest and most liquid stocks in S&P's frontier index family; the smallest component at the end of February had a market cap of about $320 million.

The requirement that the components to the index that will underlie the PowerShares ETF be at least $500 million in size seems a little extreme by comparison. After all, half the point of investing in frontier markets is to gain exposure to stocks that don't behave like the stocks in developed and emerging markets. The larger the company, the more exposure it likely has to the international economy and the more likely it is to fall in line with global trends. However, one question is whether, with foreign dollars seeming likely to pour into foreign markets as soon as investment opportunities are presented, the larger stocks might be the ones best equipped to deal with the influx. Smaller companies may be more likely to experience artificially inflated prices.

Read the prospectus for the new fund here.

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