Emerging Markets Vs. Frontier Markets

August 8th, 2012

Courtesy of NASDAQ, a comparison of frontier markets against emerging markets:

It is a good exercise to compare and contrast the primary categories of emerging market investing: emerging markets and the sub-category, or maybe more appropriately described sibling: frontier markets.

Prior to the emergence of the term emerging markets, In the 1970s these countries were referred to as less economically developed countries or LEDCs. This referred to markets considered less developed than countries in North America, Western Europe, Australasia, and Japan.

It is claimed the term emerging markets was adopted in part because it has a more positive connotation than less economically developed countries. Credit for emerging markets as the prevailing descriptor is given to World Bank economist Antoine van Agtamael.

Frontier markets is a term used to describe countries in a much earlier stage of economic development. These countries are challenging to invest in as they have lower market capitalization and are generally very illiquid, with many lacking stock markets. The term Frontier markets was coined in the early 1990s by International Finance Corporations Farida Khambata to describe these countries, which are generally considered a subset of emerging markets. Frontier markets are attractive to investors seeking higher long term results and lower correlation with other developed markets. These countries or regions are expected to eventually ascend to emerging or even developed market status.

For investors the distinction is more important today than in the past. Previously you would buy an emerging markets fund to fill that bucket in a portfolio with the expectation that the mutual fund or ETF would cover all emerging markets, including frontier markets. These day there are many more fund options including frontier market mutual funds and ETFs, but also many frontier country-specific funds and ETFs.

This is important because the major emerging markets are seeing their phenomenal growth over the last decade or more slow considerably. And as some of the emerging markets ascend to developed status, the better returns in the coming years will likely be from frontier markets.

While most investors already own emerging market mutual funds and ETFs, many do not have nor understand the need for frontier market exposure. ETFs like the iShares MSCI Emerging Markets Index ( EEM. quote ) are very commonly held and have performed well over the past decade. While SPY ( quote ) has averaged 5.23% over the last ten years, the emerging markets index has averaged more than 14%. Thats almost 9% more per year, a tremendous difference.

Although EEM does have a lot of frontier market exposure it still has more than 50% in the BRICS countries (Brazil, Russia, India, China and South Africa). This will be fine for many investors, but others will want a greater percentage allocated to frontier markets, and in many cases specific frontier market countries.

There is one comprehensive frontier market ETF, the Guggenheim Frontier Markets ETF ( FRN. quote ). The fund is broadly diversified as follows:

Chile 37.35%

Colombia 17.90%

Egypt 10.67%

Peru 8.66%

Argentina 6.17%

Kazakhstan 5.89%

Lebanon 4.46%

Jordan 8.68%

Oman 4.43%

Bahrain 0.29%

Other -0.00%

Finally there are country specific frontier market ETFs like the iShares MSCI Mexico Investable Market Index ( EWW. quote ). This fund invests only in Mexico and is diversified among companies as follows:

America Movil, S.A.B. de C.V. (AMX L): 24.15%

Wal Mart de Mexico, S.A.B. de C.V. (WMMVF): 10.10%

Fomento Economico Mexicano SAB de CV (FEMSA UBD): 9.66%

Grupo Mexico, S.A.B. de C.V. (GMEXICO B): 5.70%

Grupo Televisa, S.A. (TLEVISACPO): 4.64%

Industrias Peñoles, S. A.B. de C. V. (PE&OLES): 3.27%

Grupo Modelo, S.A.B. de C.V. (GPMCF): 3.12%

Ultimately you need to know the difference and similarities between emerging and frontier markets. As the economic situation in the various countries changes, you may not want to be so focused on the larger, more developed emerging markets. Regional and country-specific frontier market ETFs provide you the opportunity to be invested specifically where you believe the best opportunities are.