Past few months have been quite ugly for emerging market ETFs.
The start of QE tapering coupled with slowing growth in
China has made foreign investors nervous about these
Even though emerging markets may stabilize after the current
round of panic subsides, they may not regain their past glory any
time soon. As major emerging economies are beginning to mature
and slow-down, they will no longer able to repeat their stellar
performance seen not that long ago.(Read:
Best ETF Startegies for 2014
Investors looking for the "next big thing" in the investing world
are now turning to "frontier" or "pre-emerging" markets. These
countries offer compelling investment opportunities with solid
growth potential and low valuations.
The MSCI frontier markets index surged about 26% last year while
the emerging markets index plunged more than 3%. The
outperformance continues this year as well.(Read:
3 Top Ranked ETFs that will crush the market in
What are Frontier Markets?
Although there is no strict definition for frontier markets,
these are typically countries that are in the earlier stages of
economic development. Their capital markets are underdeveloped
and not fully/easily accessible to foreign investors.
The term "Frontier Markets" was first used by the International
Finance Corporation to describe a set of small, illiquid and
underdeveloped markets. Now MSCI, S&P and Russell have their
own definitions of "Frontier Markets". (Read: E
merging Market ETFs: Any Bright Spots?
MSCI Frontier Markets Index currently includes 34 countries. Most
of these countries are in Middle East, sub-Saharan Africa,
Southeast Asia, Latin America or Eastern Europe regions.
Why Frontier Markets?
Frontier markets are expected to grow faster than emerging and
developed economies. Further, they have relatively lower
valuations as well as higher income yield.
As emerging markets have become increasingly integrated with the
global markets, their correlations with the developed markets
have increased and the benefits of diversification have
On the other hand, frontier markets still have relatively lower
correlations with the developed markets. Further, most of them
were not did not see major foreign investment inflows in the past
few years and thus are less vulnerable to QE taper. Thus adding
them as small satellite holdings in an investment portfolio can
improve risk-adjusted returns over long term.
Currency Factor in Performance
One of the reasons for outperformance of frontier markets is the
currency factor. Some of the frontier markets-which saw strong
performance in 2013 as well as this year-peg their currencies to
the US dollar or to a basket dominated by the US dollar.
As such these currencies have remained steady while currencies of
most emerging markets have suffered a lot of pain. Currency
losses have been a big factor is emerging markets' poor
What are the Risks?
Before considering frontier market investments, investors need to
be aware of liquidity and political risks of investing in these
countries as they are much riskier even compared with most
emerging markets. But risk-tolerant investors are likely to reap
significant rewards in the long-term.
Below we have highlighted some of the options available to
investors in this space.
Companies in the Gulf region have been reporting strong earnings
in the past few years and property markets have shown improvement
of late. Last year, MSCI upgraded UAE and Qatar to emerging
market status from frontier market. The upgrade is expected to
result in massive increase in capital flows to the region. (Read:
an Gulf ETFs keep glowing?
Due to expansionary fiscal policies and low interest rates,
economic activity has remained steady in recent years. Per IMF,
Qatar will grow at 5% this year, while Saudi Arabia and the UAE
will grow about 4%.
UAE and Qatar peg their currencies to the US dollar and while
Kuwait pegs its currency to a basket of currencies, the basket is
believed to be heavily weighted towards the greenback. As a
result these currencies have remained rather stable.
Market Vectors Gulf States Index ETF
WisdomTree Middle East Dividend Fund
) are the two options available to investors.
Vietnam continues to be the main beneficiary of the migration of
low-end manufacturing out of China as the producers try to take
advantage of wages that are about half of that in China. The
shift in China's policy to focus more on domestic consumption
will also benefit Vietnam as an outsourcing center.
A pickup in developed economies is good for the country as they
account for about half of country's exports, mainly apparel and
Van Eck Market Vectors Vietnam ETF
) is the only ETF option available to investors to access
Vietnam's equity markets.
Broad Frontier Market ETFs
Guggenheim Frontier Markets ETF
seeks to match the performance of the BNY Mellon New Frontier DR
Index. BNY Mellon defines frontier market countries based on the
GDP growth, per capita income growth, inflation rate,
privatization of infrastructure and social inequalities.
However the top countries included in the ETF-Chile (43%),
Colombia (15%), Egypt (11%) and Peru (9%)--which account for
about 78% of the holdings are "emerging" markets" and not
"frontier" markets per MSCI and S&P.
ISHRS-MSCI F100 (FM): ETF Research Reports
WISDMTR-ME DIV (GULF): ETF Research Reports
MKT VEC-GULF ST (MES): ETF Research Reports
MKT VEC-VIETNAM (VNM): ETF Research Reports
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PowerShares MENA Frontier Countries ETF
tracks the performance of liquid companies in MENA (Middle East
and North Africa. This fund is being closed
on February 18, 2014.
iShares MSCI Frontier 100 Index (
tracks the MSCI Frontier Markets Index, which is dominated by
Gulf states--with Kuwait (28%), Qatar (17%), and the UAE (11%) in
the three spots out of top four, with Nigeria (13%). But
remember, Qatar and UAE will be out of the frontier market index
in a few months.
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