A handful of exchange traded funds are looking to give investors access to frontier markets, or countries that are less developed than traditional emerging markets.
A handful of exchange traded funds are looking to give investors access to frontier markets, or countries that are less developed than traditional emerging markets.
Claymore Securities Inc. of Lisle, Ill., was the first to launch such an ETF on June 12.
The Claymore/BNY Mellon Frontier Markets ETF gives investors access to as many as 41 countries, including Bahrain, Bangladesh, Bulgaria, Croatia, Egypt, Ghana, Kazakhstan, Lebanon and Pakistan.
At least five other frontier ETFs are planned from Invesco PowerShares Capital Management LLC of Wheaton, Ill., and WisdomTree Investments Inc. and Van Eck Securities Corp., both of New York.
Not surprisingly, industry experts said frontier ETFs should be approached with caution.
"Frontier investing is something that should only be done in strict moderation," said Jeff Ptak, director of exchange traded securities analysis at Morningstar Inc. of Chicago. "These are very volatile regions." But for an investor who knows the risks "there can be a place" for frontier ETFs, he said.
Tom Lydon, president of Global Trends Investments, a Newport Beach, Calif.-based firm that manages $75 million in assets, said he is open to using frontier ETFs. Emerging markets like China and Brazil are becoming more correlated with developed markets, he said. As a result, it makes sense to move to the next level, Mr. Lydon said.
There is no doubt that the correlation of emerging markets to the Standard & Poor's 500 stock index is much higher than that of frontier markets, said Christian Magoon, president of Claymore Securities and head of its ETF group.
For example, between January 1996 and May 2008, the MSCI Emerging Markets Index had a correlation of 0.69 with the S&P 500, while the S&P Frontier Markets Index had a correlation of 0.20, he said.
A correlation of 1.0 would indicate perfect correlation.
Of course, not all frontier ETFs will follow the same frontier index.
WisdomTree Middle East Dividend Fund will follow the WisdomTree Middle East Dividend Index, a fundamentally weighted index that measures the performance of Middle East companies that pay regular cash dividends on shares of their common stock.
The PowerShares MENA Frontier Countries Portfolio will follow an index called the Middle East and Africa Frontier Countries Index, for which an index provider has yet to be named.
An index provider has also yet to be named for indexes underlying the Market Vectors Africa ETF, Market Vectors Global Frontier ETF and Market Vectors Gulf States ETF, all from Van Eck.
When more is known about them, investors will want to take a close look to determine whether the ETF they are considering truly does invest in frontier markets, analysts caution.
For example, the Claymore frontier ETF follows The Bank of New York Mellon Frontier DR Index.
"We think this is one of the broadest indexes available," Mr. Magoon said. That leads to greater stability, he said.
That may be true, but Mr. Ptak said investors in the Claymore fund who expect a lot of exposure to continental Africa — a region commonly thought of as a frontier market — had better think again.
Apart from Egypt, which represents 17.73% of the portfolio, the third largest country weighting, the only African country represented is Nigeria at 3.09%, the eighth largest country weighting.
The largest country weighting is in Poland (24.86%), and the second largest is Chile (21.01%).
That may change eventually.
In addition to being a broad index, the Claymore frontier ETF is relatively fluid, Mr. Magoon said. It is rebalanced quarterly, at which time new countries can be added or dropped, he said.
"It's really kind of a dynamic process," Mr. Magoon said. "That's important because frontier markets are changing quickly."
And while retail products that give investors access to such markets are still relatively new, he said he believed investors would warm to frontier ETFs.
Claymore has talked with advisers about how they might use its ETF, and they have said they may "blend" it into the portion of the portfolio they have set aside for emerging markets, Mr. Magoon said.
That makes sense, according to Mr. Lydon. As emerging markets become more developed, frontier markets should be included in the mix, he said.
E-mail David Hoffman at dhoffman@investmentnews.com.
