Are There Opportunities In Frontier Markets?

by: Christopher Lum Lee

Looking back to the beginning of 2012, the emerging markets have had grouped fluctuations - nevermind the day-to-day fluctuations, but I'm talking about a couple of months low and a couple of months high, then repeat.

Let's look at the charts for both the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) and the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO) to illustrate this point:

EEM Chart

Looking at this chart, up until just before July 2012, the price action remained between the 42 to 45+ range before spending the next six months between -38 to 40+ before repeating the first pattern from January 2013 to just before June 2013, and we repeat again.

But recently the emerging markets have had a really bad rap because of things going on with the emerging markets' currencies. I won't get into those specifics because the focus of this commentary is different. In this article, I advocated for investors to keep some exposure in emerging markets in their portfolio. This was met with criticism, of course, though I contend that you should keep the emerging market exposure only if you're a long-term investor with a long horizon and not at a trade!

While I still think emerging markets present great opportunities - especially at the current price action, I've developed an interest in the frontier markets.

Before I continue any further I want to again stress that my comments apply to long-term investors with longer time horizons ... not short-term traders!

I've looked at various ETFs that invest in frontier markets, and have found that they aren't entirely consistent in the countries they invest in, as opposed to the EEM and VWO where the countries they invest in almost mirror each other. The EEM weighting was taken from the EEM's iShares page while the VWO weighting was taken from their annual report from the VWO page.

Country EEM Weighting VWO Weighting
China 18.91 21.0
Brazil 10.18 14.6
Taiwan 12.15 13.2
South Africa 7.09 9.4
India 6.38 8.8
Russia 5.86 7.0
Mexico 5.36 5.4
Malaysia 3.89 4.7
Thailand Unspecified 2.9
Indonesia 2.44 2.7
Chile Unspecified 2.0
Turkey Unspecified 2.0
Poland Unspecified 1.7
Philippines Unspecified 1.5
Colombia Unspecified 1.1
Other 17.74 2.0

So far you've seen that the EEM and VWO trade almost in tandem and have almost the same exposures with a few percentage points varying here and there. Despite this, looking at frontier markets is where things can get a bit more interesting. Here, I'll show you the exposures of the iShares MSCI Frontier 100 Index Fund (NYSEARCA:FM), Guggenheim Frontier Markets ETF (NYSEARCA:FRN), ISPX record for Global X Next Emerging & Frontier ETF (NYSEARCA:EMFM), and the PowerShares MENA Frontier Countries Portfolio (NASDAQ:PMNA).

Country Breakdown

The iShares MSCI Frontier 100 Index Fund country breakdown is as follows: Kuwait (30.81%); Qatar (15.83%); United Arab Emirates (11.90%); Nigeria (10.57%); Pakistan (4.84%); Kazakhstan (4.05%); Argentina (3.36%); Oman (3.24%); Bangladesh (2.80%); and other (12.62%).

The Guggenheim Frontier Markets ETF country breakdown is as follows: Chile (37.04%); Colombia (14.43%); Argentina (10.74%); Egypt (9.91%); Peru (4.56%); Kazakhstan (4.42%); Lebanon (3.56%); Nigeria (3.26%); Poland (2.44%); and Czech Republic (1.98%).

The ISPX record for Global X Next Emerging & Frontier ETF country breakdown is as follows: Asia Emerging (33.77%); Latin America (20.29%); Europe (18.84%); Africa (9.76%); Middle East (6.93%); U.S. (2.51%); Australia (2.21%); Canada (2.14%); and Asia Developed (0.03%).

And the PowerShares MENA Frontier Countries Portfolio country breakdown is as follows: Kuwait (21.01%); Egypt (19.83%); Qatar (19.69%); United Arab Emirates (19.07%); Morocco (8.35%); Jordan (7.19%); Lebanon (2.47%); and Oman (2.40%).

You can find out more details about these individual ETFs by going to the ETF Database.

Looking at the geographical breakdown, we see that the frontier markets consist of a vast amount of foreign jurisdictions and each of these ETFs have a variety in their breakdowns. Unlike the regular emerging market ETFs, you can get a better variety and a real choice in what you invest in with the frontier markets.

Opportunities in Frontier Markets

In the article I cited at the beginning of this commentary, I believe that emerging markets pose a great opportunity for investors because when you get into emerging markets, you're getting into an economy that is still in the early stages of development. What does that mean? That means that in the future when the emerging economies do achieve prosperity, you can see an exponential return on your investment! The good thing about emerging markets in the present is that you have various ETFs that you can choose from to invest in not only the entire emerging market sector, but in individual countries.

However, frontier markets don't have that luxury in the present. Therefore, the ETFs I cited above would most likely be your best bet plays to get into these markets. Taking into account what I just said about emerging markets and the potential to gain returns, I believe that the frontier markets are a much better opportunity for investors. The caution I have to make at this point is that because frontier markets are below emerging markets in terms of maturity, the already long-term investor has to have a longer time horizon. Some of these frontier markets may be plagued with economic woes and political strife, but we see that those economies have come through worse times in the past.

In time, I believe that frontier markets will mature to becoming comparable to emerging markets. My logic about emerging markets is that they will soon no longer be emerging markets because they will have emerged. In time, I also believe that frontier markets will graduate to become what we consider to be emerging markets and can further out become developed markets. There is truly a lot of potential out there for these jurisdictions and I invite everyone to at least look at these ETFs I've listed above!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FM, FRN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I have exposure to emerging markets in my Roth IRA through the American Funds New World Fund (MUTF:NEWFX).

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