Three Reasons To Consider Frontier Markets (FM)

Del Stafford: With a growing number of ETFs providing access to frontier markets, it’s important to take a step back, understand the category and assess whether these equities are right for your portfolio.

Frontier markets, sometimes referred to as “pre-emerging markets”, are countries with equity markets that are less established – places like Argentina, Kuwait and Bangladesh.   They tend to be characterized by lower market capitalization, less liquidity and, in some cases, earlier stages of economic development.  As you can imagine, they can be particularly hard to access for foreign investors.

Given that frontier markets are smaller and hard to access, what’s the draw for an investor?  There are a few potential portfolio benefits to be aware of:

1)    Widen scope. Frontier markets give investors the opportunity to broaden their global exposure, widen their capitalization spectrum and even gain access to particular areas of growth.  For investors looking to complete their international investment exposure, frontier markets can sometimes literally be “the final frontier” of their portfolio.

2)    Diversification. As emerging markets mature and become increasingly coupled with global developed economies, their risk/return characteristics begin to resemble those of their developed market counterparts.  Frontier markets have exhibited a low correlation to emerging and developed market, making it a diversifier to most portfolios.

3)    Access to growth. Many frontier market countries have low debt-to-GDP levels and offer high economic growth rates when compared with emerging and developed markets.  In addition, it’s estimated that ~30% of the global population currently resides in frontier markets – consumers of the future as these countries continue to develop.

When considering an investment in frontier markets, it’s important to note that all exposures are not created equal.  The fact that these markets are hard to access can be reflected in the type of securities that some frontier market indexes include.  For example, some of these indexes include few if any truly local frontier market stocks, opting instead for U.S and European listed depository receipts, or even up to 50% or more in emerging markets securities.

What differentiates the MSCI Frontier Markets 100 Index (the benchmark for the recently-launched iShares Frontier Markets ETF (NYSEARCA:FM), is that the index puts a strong emphasis on tradability in a number of ways, such as requiring a minimum liquidity level for securities.  Because of this, the index includes 100% frontier market equities, rather than relying on emerging market equities to make up for lack of liquidity in frontier markets.

In my next post, I’ll share how we see our clients implementing a frontier markets strategy in their portfolios.

Sources: MSCI, Bloomberg, World Economic Outlook

Written By  Del Stafford From The iShares Blog

Del Stafford, CFA, is a Managing Director and Global Head of iShares Product & Investment Consulting, a group that consults directly with investment advisors to provide in-depth market and product expertise for iShares offerings, as well as customized portfolio consulting support. In this role, his team conducts bespoke client portfolio analyses to assist with asset allocation, risk evaluation and portfolio structure decisions. Del joined iShares in 2008, then part of Barclays Global Investors (BGI), which merged with BlackRock in December 2009. Del spent over 16 years at The Vanguard Group, where he recently worked with the firm’s current and prospective defined benefit plan clients to structure custom investment solutions. He also worked as Senior Portfolio Manager within Vanguard’s Fixed Income Group, with responsibility for managing institutional, separately managed and stable value portfolios. Del holds the Chartered Financial Analyst® designation and is a member of the CFA Society of San Francisco. He earned an MBA from LaSalle University and a BS in finance from Bloomsburg University.

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