Every investor should allocate a portion of his or her portfolio to emerging markets. Most often, the phrase “emerging markets” calls to mind the BRIC: Brazil, Russia, India and China. But these countries have developed vibrant, reasonably well- regulated markets. They’re simply not the frontier markets they once were.
Guggenheim Frontier Markets (FRN), on the other hand, offers exposure to the next frontiers for investment, with holdings in far- flung destinations such as Kazakhstan, Nigeria and Qatar. In recent months, the exchange-traded fund (ETF) has traded at a small but persistent discount to its net asset value, reflecting the ongoing turmoil in the Middle East and concerns over flagging emerging-market growth.
A little more than 10 percent of the fund’s assets are allocated to equities in Egypt, a country that just concluded its first round of parliamentary elections following the ousting of longtime president Hosni Mubarak. Although the nation’s stock market has declined by more than 40 percent in 2011, the peaceful elections have contributed to a rally in Egyptian equities. Domestic investors drove the gains, as foreigners sold off equities amid fears that Islamist parties could dominate Egypt’s newly elected parliament. These fears appear to have been justified; the Muslim Brotherhood is expected to carry about 45 percent of the parliament’s seats.
Nevertheless, confidence among domestic investors is encouraging because they make future gains more sustainable as the political climate normalizes. However, inflation continues to rise—the first true economic challenge faced by the new government.
But one can only endure frontier life for so long. The ETF investment also offers exposure to traditional emerging markets.
Chile, Colombia, Argentina and Peru account for 70 percent of the fund’s assets. Chile alone accounts for more than a third of the ETF’s portfolio. The Chilean market has come under pressure from worries about the health of the global economy; Chile’s export-based economy depends heavily on global copper demand.
Chile is an economy in transition. One of the nation’s greatest assets is its youthful population and rising household incomes. Chile is also a nation of savers, with a private savings rate of more than 21 percent of disposable income. This savings rate has buoyed the country’s economy; Chile’s debt-to-gross domestic product ratio runs at just 6 percent.
Economic transitions don’t occur overnight. But Chile’s deep trade relations with China will hold it in good stead in the interim. China is Chile’s primary export market, and recent policy shifts suggest that the mainland is ready to kick growth into high gear after years of aggressive monetary policy tightening. China recently surprised markets by cutting banks’ reserve requirement ratio by 0.5 percent, the first such move in three years.
Stronger growth from China will fuel demand for a laundry list of commodities, including copper, which Chile has in abundance.
Although there’s more volatility to come, Guggenheim Frontier Markets remains a top ETF to own.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.