Searching For Frontier Markets In Frontier Funds

March 23, 2010

Frontier market exchange-traded funds make it easier than ever to access these once elusive, high-stakes economies. But before buying, investors should look under the hood, as not everything is always as it seems.

Frontier markets are more accessible than ever, thanks to a growing lineup of exchange-traded funds. But the current crop of ETFs is uneven, with two funds by Van Eck the only ones that come close to delivering on their promise of distilled investment exposure in this high risk/high reward sector.

The problem is that although several products position themselves as "frontier market funds," many have significant emerging market holdings. Emerging markets tend to be more stable and developed than frontier markets, and also have higher correlations to developed markets.

And that’s the rub. As thinly as frontier-market stocks might trade, and as fraught with geopolitical and economic risk countries in that sector might be, they represent a viable way for investors to diversify their portfolios precisely because they have low correlations to emerging or developed markets. They are usually full of natural resources too, fueling and echoing growth in places like China or

"It doesn't mean you can't benefit from these funds," says Alec Young, international equity strategist for S&P Equity Research. "You just have to be careful with what you're buying."

MSCI and FTSE have both released lists of countries designated as "frontier markets," with much crossover between the two. The MSCI classification, which comprises 25 countries, is more inclusive than FTSE’s, and includes countries like Ukraine, Kuwait and

Truth In Advertising

Van Eck’s fund, the Market Vectors Vietnam ETF (NYSEArca: VNM) is the sole single-country frontier market security currently available. The Southeast Asian country’s economy is booming, with growth this year projected to be between 6.5 percent and 8.2 percent, according to the World Bank. Also, its population of 86 million has an average age of less than 25, which means labor and social-service costs are likely to be relatively low, as more people enter the workforce than leave it.

is certainly a newcomer to watch," says Peter Zeihan, vice president of strategic intelligence at Stratfor, an Austin, Texas-based global intelligence company.

VNM has returned 3.14 percent so far this year and 11.5 percent since inception—broadly similar to the MSCI Frontier Markets Index, but with almost four times as much volatility. So far, VNM has $123.5 million in assets.

VNM Performance

VNM, which launched last August, tracks a benchmark of both Vietnamese and non-Vietnamese companies generating at least half their revenues from the country. About 70 percent of the index is currently invested in Vietnam-domiciled companies.

Its annual cost to investors is 0.99 percent, compared with 0.65 percent for the MSCI Brazil Index Fund (NYSEArca: EWZ) and 0.55 percent for the MSCI Australia Index Fund (NYSEArca: EWA)—two popular ETFs from iShares that hone in on single countries in emerging markets and developed markets, respectively.

ETF fees tend to get higher the more remote and difficult to access given target markets are.


Van Eck is also marketing the Market Vectors Gulf States ETF (NYSEArca: MES), which has more than 90 percent of its investment exposure in frontier-market Arab nations that are members of the Gulf Cooperation Council (GCC). About a third of MES’ holdings are in Kuwait, a quarter in the United Arab Emirates, a fifth in Qatar, a tenth in Bahrain and just shy of 5 percent in

"A lot of the countries in the GCC—with the exception of
Saudi Arabia
—are linked into global trends in a positive way," Zeihan said. "I think Kuwait and
both have bright futures ahead."

MES has an expense ratio of 1.00 percent. It has attracted $10.4 million in assets, and gained 43.2 percent in the past year and 9.7 percent so far in 2010.

The WisdomTree Middle East Dividend Fund (NYSEArca: GULF), which tracks a fundamentally weighted benchmark index of Middle East companies that pay regular cash dividends, has almost two-thirds of its holdings in frontier countries, though more than a quarter of its investments are in the emerging market countries of Egypt and Morocco. It has gained 31.8 percent in the past year and 7.51 percent this year. It has $12 million in assets.

Not-So-Frontier Frontier Funds

Finding a fund that puts as much emphasis on frontier markets as the two Van Eck ETFs VNM and MES, or even WisdomTree’s GULF is, for now, not really possible. Investors buying an ETF with “frontier” as part of its name are likely to get more emerging market exposure than they might be interested in.

Take the Claymore/BNY Mellon Frontier Markets ETF (NYSEArca: FRN). The fund tracks domestically and internationally listed securities from frontier markets, as defined by their levels of GDP growth, per capita income growth, inflation rates, privatization of infrastructure and social inequalities.

But almost two-thirds of FRN’s holdings are in emerging markets. Chile makes up 30.82 percent of the fund, Egypt 15.0 percent, Colombia 11.5 percent and
Poland 10.3 percent. None are considered frontier markets in either the MSCI or FTSE indexes. The biggest country holding of a "true" frontier market is
, at 6.73 percent.

The skewed allocation also explains why FRN's returns behave more like an emerging market fund than a frontier fund. Although frontier markets generally fell or held steady in 2009, FRN jumped 78.34 percent. Year-to-date, the fund has risen 5.46 percent. It has $31.6 million in assets.

PowerShares MENA Frontier Countries Portfolio (NasdaqGM: PMNA) comes closer to honoring its name, but still falls short. It tracks companies that either do most of their business or have the majority of their assets in the
Middle East and North African region.

It has meaningful holdings in the frontier space, including positions of 18.8 percent in the UAE, 13.5 percent in Kuwait and 11.3 in
Jordan. But it leans heavily on countries such as Egypt and
Morocco, where it has 22 percent and 15.2 percent invested, respectively. It has attracted $13.8 million since its 2008 rollout.

The Market Vectors Africa Index ETF (NYSEArca: AFK), which tracks companies either domiciled in Africa or that do the bulk of their business there, is centered on the more successful countries on the continent, namely emerging market countries, such as South Africa and Egypt. It even holds an 11 percent position in U.K.-based companies.

Despite their lack of purity, it's worth taking a look anyway at some of these so-called frontier funds because it’s possible many of them have bright futures.

"Just imagine if you had bought into the BRIC countries, back when they were still considered 'frontier,’" said S&P’s Young, referring to Brazil, Russia, India and
, widely considered the four cornerstones of modern emerging markets investing.


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