Saturday, July 5, 2014

How to Invest in Frontier Markets - Frontier Market ETF's Make Diversification Cheap and Easy

Less Developed Economies and Low Correlation with Developed Countries Makes Frontier Markets Attractive to Investors Seeking Diversification.

Emerging Markets were all the rage until the 2008 financial crisis - when the grits hit the fan. Previous to 2008, investors drove Emerging Market country P/E ratios to sky-high levels. Since crashing and burning, Emerging Markets have caught a second wind and soared. While long term investors may still find Emerging Markets to be attractive investments, the days of snapping up shares for fire sale prices have passed for now.

Many investors who sold during the dark days of the financial crisis are now kicking themselves for missing out on the market's subsequent rally. These investors may want to consider lesser known Frontier Markets, generally described as a notch below Emerging Markets. Frontier Markets have less developed economies and are often located in countries with considerable political uncertainty.

Because Frontier Market economies are less reliant on financing from industrialized countries, they were generally less affected during the economic downturn. The lack of correlation with developed countries is a key attraction for investors seeking diversification. Investors interested in Frontier Markets must be able to tolerate frequent and extremely volatile swings in net asset value.

Frontier Market investing used to be near impossible for the average Joe - but there are several ETF options that are relatively cheap and provide good diversification. The most prominent Frontier Market ETF is offered by Claymore. This ETF (FRN) is based on The Bank of New York Mellon New Frontier DR Index.

The index presently defines the Frontier Market countries as: Bahrain, Jordan, Kuwait, Lebanon, Oman, Qatar, United Arab Emirates, Egypt, Ghana, Kenya, Malawi, Mauritius, Morocco, Nigeria, Tunisia, Zimbabwe, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Kazakhstan, Latvia, Lithuania, Poland, Romania, Slovak Republic, Slovenia, Ukraine, Bangladesh, Pakistan, Papua New Guinea, Sri Lanka, Vietnam, Peru, Chile, Colombia, Ecuador, Jamaica, Panama and Trinidad & Tobago.

The index has been criticized as too "Emerging" and not enough "Frontier" as some of the countries included are solidly middle income. Additionally, the index is extremely top heavy. Approximately 64% of assets are concentrated in, Chile, Egypt, Columbia, and Poland. However, the index still provides broad asset allocation for a reasonable .65% annual fee.

Frontier Markets are certainly not an appropriate investment for everyone. The companies involved are usually in the early stages of growth, and any profits are typically reinvested in the business instead of paid out as dividends. Therefore, investors seeking a steady stream of income should look elsewhere. Before jumping into Frontier Markets, it is advisable to make a long term commitment to the investment. Investors who are able to ride out any short term storm will fare better in the long run.

Investors who cannot stomach price swings of 20% or more should seek a safer place to stash their money. Potential investors should also stagger their investment to take advantage of dollar cost averaging. Although dollar cost averaging isn't normally recommended for ETF's, it may be worth making four quarterly investments instead of investing the entire sum at once.

Though a commission will be charged by the brokerage for each purchase, the advantage of spreading risk is worth it. When purchasing shares, it is advisable to use a discount brokerage such as Charles Schwab or Fidelity. Premium brokerages can charge up to ten times as much.

Other Frontier Market ETF's to consider are PowerShares MENA Frontier Countries (PMNA), Market Vectors Africa Index (AFK), Market Vectors Vietnam (VNM), and Market Vectors Gulf States (MES).

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