Frontier Market ETF Leading Emerging Market Rally - ETF News And Commentary

By Sweta Killa,

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After a lackluster 2013, emerging markets have shown a nice comeback in recent months on low valuations and attractive stock prices. Most stocks in the developed world have become pricey, compelling investors to pull out their money from these markets and park them in cheaper ones.  

In particular, frontier or "pre-emerging" markets have been the biggest beneficiaries of this trend and are leading broad emerging market funds by wide margins this year. This is especially true as iShares MSCI Frontier 100 ETF ( FM ) added about 13.6% in the year-to-date time frame compared to the gains of 3.8% for the most popular Vanguard FTSE Emerging Markets ETF ( VWO ) and 2.7% for iShares MSCI Emerging Markets ETF ( EEM ).

This trend is likely to continue given encouraging fundamentals in these countries and the fund's impressive new holdings post index rebalancing (read: Invest in Surging Frontier Market ETFs ).

Frontier Market Outlook

Frontier markets offer huge diversification benefits and strong growth relative to the emerging and developed economies. Though the stock markets in the frontier countries are smaller and less liquid, these have more room for upside than the emerging markets, and have relatively lower correlations and higher income yields.

In particular, the frontier markets are in the early stages of development and are in the verge of emerging as most of the countries are performing remarkably. For example, Nigeria recently overtook South Africa to become Africa's largest economy and it has a low debt/GDP ratio, rising population, higher oil prices and accelerating growth, which are likely to provide further boost to the economy.

Unlike the emerging markets, most of the frontier countries have seen steady currency fluctuations in the past several months as these often peg their currencies to the U.S. dollar or to a basket dominated by the U.S. dollar. In addition, stocks in these countries are trading at attractive levels given their lower valuations than the developed and emerging market stocks.

Further, these have been less impacted by the Fed taper, suggesting their strength in the taper-trodden world (read: Frontier Market ETFs: Better International Investments? ).

However, investors should note that frontier markets are risky investments due to the lack of liquidity, political instability, large currency fluctuations, financial reporting concerns and substandard development. Yet, these provide compelling investment opportunities for risk-tolerant investors who have a strong stomach for extreme volatility.

FM in Focus

FM tracks the MSCI Frontier Markets 100 Index, which has undergone major changes in its semi-annual rebalancing on May 14 as MSCI upgraded United Arab Emirates (UAE) and Qatar to emerging market status from frontier markets. Both countries account for more than one-third of the portfolio in the index.

Post rebalancing, both UAE and Qatar will be removed from the index, providing investors better country diversification and a true frontier markets exposure. The index will be dominated by Kuwait with 30% share (up from 20%) followed by Nigeria at 20% (up from 13%). Holdings in Pakistan, Oman, Argentina, Kenya and Morocco will also rise from the current 3-4% range to 5-7% (read: Invest in the Middle East with This Top Ranked ETF ).

The three largest additions to the MSCI Frontier Markets Index are Pakistan Tobacco Company (Pakistan), K Electric (Pakistan) and CGI (Morocco). Further, two Nigerian firms - Forte Oil Plc and EcoBank Transnational Inc. - will be added to the index.

From a sector look, the rebalancing will reduce the proportion of heavy weighted financials in the index and increase the allocations to the consumer staples and energy sectors. All changes in the ETF and the index will be reflected early next month.

The ETF has amassed around $833 million in its asset base since its inception and trades in solid volume of about 265,000 shares per day in average. The fund charges 79 bps in annual fees from investors.

Technical Look

From a technical perspective too, FM is poised for further surge in the coming months. The fund recently made a new high of $38.75 and its short-term moving average (9-Day EMA) is still comfortably above the mid and long terms (50 and 200-Day EMA), suggesting continued bullishness for this ETF. Further, RSI is close to 40, still indicating an uptrend in the fund's price (see: all broad emerging market ETFs here ).

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ISHARS-EMG MKT (EEM): ETF Research Reports

ISHRS-MSCI F100 (FM): ETF Research Reports

VANGD-FTSE EM (VWO): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: UAE , EEM , FM , VWO

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