Less Developed Economies and Low Correlation Make Frontier Markets Attractive for Diversification
Emerging markets were all the rage until the 2008 financial crisis—when everything hit the fan.
Prior to 2008, investors drove emerging market P/E ratios to sky-high levels. After crashing and burning, those same markets caught a second wind and soared.
While long-term investors may still find emerging markets attractive, the days of snapping up shares for fire-sale prices have passed for now.
Looking Beyond Emerging Markets
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 market
However, because frontier market economies rely less on financing from industrialized nations, they were generally less affected during the global economic downturn.
This lack of correlation with developed countries is a key attraction for investors seeking true portfolio diversification.
Still, anyone interested in frontier markets must be able to stomach frequent and extremely volatile swings in value.
How to Access Frontier Markets: ETF Options
Frontier market investing used to be nearly impossible for the average Joe. Today, several ETF options provide relatively cheap and convenient diversification.
The most prominent frontier market ETF is offered by Claymore: the Claymore/BNY Mellon Frontier MicroCap ETF (FRN), which tracks The Bank of New York Mellon New Frontier DR Index.
The index defines frontier market countries across several regions:
Middle East & Africa: Bahrain, Jordan, Kuwait, Lebanon, Oman, Qatar, UAE, Egypt, Ghana, Kenya, Malawi, Mauritius, Morocco, Nigeria, Tunisia, Zimbabwe
Eastern Europe & Asia: Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Kazakhstan, Latvia, Lithuania, Poland, Romania, Slovak Republic, Slovenia, Ukraine, Bangladesh, Pakistan, Papua New Guinea, Sri Lanka, Vietnam
Americas: Peru, Chile, Colombia, Ecuador, Jamaica, Panama, Trinidad & Tobago
Criticisms of the Index
The BNY Mellon Index has drawn criticism for being too "emerging" and not enough "frontier," as several included countries are solidly middle-income.
Additionally, the fund is top-heavy. Approximately 64% of its assets are concentrated in just four countries: Chile, Egypt, Colombia, and Poland.
Despite these drawbacks, the ETF still provides broad asset allocation for a reasonable 0.65% expense ratio.
Who Should (and Shouldn't) Invest?
Frontier markets are certainly not appropriate for everyone.
Companies in these markets are usually in their early growth stages, meaning profits are typically reinvested back into the business rather than paid out as dividends. Investors seeking steady income should look elsewhere.
Before jumping in, it is best to make a firm, long-term commitment. Investors who can ride out short-term storms will fare better over time.
If you cannot stomach price swings of 20% or more, look for a safer place to stash your money.
Smart Execution: Dollar-Cost Averaging & Brokerage Costs
Potential investors should consider staggering their entry to take advantage of dollar-cost averaging.
While dollar-cost averaging isn't always recommended for ETFs due to trading fees, making four quarterly investments instead of buying all at once can be worth it to spread out your market risk.
When purchasing shares, use a discount brokerage like Charles Schwab or Fidelity to keep commission costs low. Full-service brokerages can charge significantly more for the exact same transaction.
Other Frontier Market ETFs to Consider
PowerShares MENA Frontier Countries (PMNA)
Market Vectors Africa Index (AFK)
Market Vectors Vietnam (VNM)
Market Vectors Gulf States (MES)
