Your emerging-market portfolio is about to get a bit more “exotic.”
Many fund sponsors have begun issuing new exchange-traded funds (ETFs) for faraway lands like Saudi Arabia and Sri Lanka. These and other such up-and-coming locales have been dubbed “frontier markets” by Wall Street and are found outside traditional emerging-market funds like the iShares MSCI Emerging Markets Index (EEM).
Characterized by very fast-growing economies and very small or hardly existent equity markets, these frontier markets aren’t known tourist hotspots, but they feature all the hallmarks of early emerging-market superstars … including a hefty dose of volatility. Still, these emerging markets that haven’t quite fully emerged could offer some of the best long term returns around.
So if you’re looking for growth from the international part of your portfolio, consider these ways of getting frontier markets to work for you.
Frontier Markets: Plenty of Rewards
The problem for many traditional emerging markets such as China and India is that they’re really not emerging anymore. Growth has slowed, and worse, many of these emerging economies have become so interlinked with the developed world that their stock markets have lost some of their ability to outperform other major courses. China is the United States’ largest trading partner, the bulk of Russian natural gas production flows towards Europe … and so on.
At this point, many developing economies only offer a fraction of their historical benefits. Fellow InvestorPlace contributor Daniel Putnam makes a compelling case to drop your EM exposure altogether. While I’m not as bearish on EMs as Putnam and still believe that quality companies can be found everywhere, he does make a major point on correlations between the developed and developing world.
Which is why investors should take a look at frontier markets.
Nations like Uganda, Croatia and Kazakhstan all offer lower correlations to other asset classes. Putnam points out that the over the last 10 years, the MSCI Emerging Markets Index has had a correlation of around 0.8 with the S&P 500. That number rises to 0.9 when comparing it to the MSCI Developed Markets Index.
However, during the same time period, the MSCI Frontier Markets Index — which tracks stocks in places like Nigeria, Pakistan and Bangladesh — showed just a 0.329 correlation with the S&P 500. Perhaps more importantly, the frontier markets index only managed to produce a 0.374 correlation with more “developed” emerging-market sisters.
In plain English, that means frontier markets provide plenty of “zig” when the broader markets “zag.”
For instance, last year, the MSCI Frontier Markets Index gained roughly 16% … at the same time more traditional emerging markets produced a whopping 12% loss.
And there’s more to love than lack of correlation.