Everything You Need To Know About Frontier ETFs

by on September 26, 2012 | ETFs Mentioned:

With the ETF industry expanding at its rapid pace, issuers have gradually began venturing into more unconventional markets in order to differentiate new products from those already on the market. Many industry leaders have set out to offer greater levels of diversification, particularly in hard-to-reach developing economies. But when it comes to this type of exposure, most investors turn only to the most popular emerging markets to round out their international equities component. But for those looking to add yet another layer of diversification to their portfolios, frontier markets provide some of the most unique and lucrative opportunities [see Free Report: How To Pick The Right ETF Every Time]. 

Frontier markets can be thought of as “the other international stock,” covering economies that are even less developed than the Chinas and Indias of the world. These markets are flush with risk (including potentially significant political risk) but offer tremendous long-term potential as well. Think of these economies as an opportunity to invest in China 20 years ago. According to MSCI, there are 26 countries that are currently classified under the “frontier” umbrella. Some of the better known frontier markets include Argentina, Ukraine, Croatia, Kenya, Jordan and Pakistan.

Under The Hood: Frontier Market ETFs

Currently, there is only one ETF available on the market that dedicates its assets to a single frontier market: Van Eck’s Market Vectors Vietnam ETF (VNM). There are, however, three broad-based ETFs that offer exposure to this particular corner of the market and a close look under the hood reveals some striking differences between these products [create customized ETF analysis with the ETF Analyzer]:

  FM FRN PMNA
Expense Ratio 0.79% 0.65% 0.70%
Largest Country Kuwait (31%) Chile (38%) Kuwait (21%)
Largest Sector Financials (57%) Financials (33%) Financials (73%)
# of Holdings 100 39 44

First and foremost, geographical allocations vary significantly in frontier market ETFs compared to emerging market ETFs, which typically have similar weightings to specific countries in their portfolios. The newest addition to the frontier market ETF lineup, iShares’ FM, is primarily dominated by equities from the Middle East, with Kuwait given the largest weighting, followed by significant allocations to Qatar and the United Arab Emirates.

Although Guggenheim’s Frontier Markets ETF (FRN) may sound similar, its portfolio is vastly different from FM. Although it maintains some exposure to the Middle East, FRN focuses primarily on South American countries; Chile makes up roughly 38% of the fund’s total assets, while Colombia, Peru and Argentina account for more than a third of the portfolio. PowerShares’ MENA Frontier Countries Portfolio (PMNA), on the other hand, features more significant overlap with FM, targeting countries in the Middle East and North Africa.

In regards to sector allocations, all three Frontier Markets ETFs are heavily tilted towards financial stocks; FRN allocates more than a third of its assets to this sector, while FM dedicates nearly two-thirds and PMNA over 70%. Another, perhaps surprising, commonality between these funds is that although investments in frontier markets are considered to be riskier than those in emerging markets, the average 200-day volatility of FRN and PMNA are only 12.9% and 24.12%, respectively. For comparison, Vanguard’s Emerging Markets ETF (VWO) has a 200-day volatility of 21.39%, while the Emerging Market’s ETFdb Category’s range is from 12.9% to 32.73% [see also Head-To-Head: EEM Vs. VWO].

For those looking construct an all-ETF portfolio that is tilted towards the world’s developing economies, be sure to check out our Emerging & Frontier Markets ETFdb Portfolio with a free 7-day trial to ETFdb Pro.

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Disclosure: No positions at time of writing.