Frontier ETFs: Looking for the next China

But are they ready for prime time?

April 2, 2014

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story_images_south-african-mountain-roadExchange-traded funds (ETFs) giveth—and they take-eth away. That is, if you believe those who say ETFs are to blame for the big sell-off in emerging markets happening right now—see this post from last month, which points a finger at flighty retail investors using ETFs as an easy way to hop in and out of these markets fast.

But as ETF investors pull their money from emerging markets, that money is showing up a little further down the capital markets food chain apparently: in frontier markets. Consisting of countries whose markets and economies aren’t quite ready for prime time (think Kuwait and Vietnam), frontier economies have long-drawn attention from institutional investors keen to get in on the ground floor in markets with favourable demographics and a willingness to embrace growth.

Or, emerging markets 2.0, if you will.

To see the shift in action, Bloomberg takes a look at the fastest growing ETF focused on developing countries—the iShares MSCI Frontier 100 fund, with top holdings in Kuwait and Qatar. Assets under management jumped to $594 million based on $465 million of inflows and returns of 23%. This as emerging markets-focused products suffer outflows and the MSCI BRIC Index dropped 4% in this quarter.

Countries such as Russia, Brazil and China held the global economy back from the brink of total darkness post-2008—investors are now looking for the next big thing. Frontier markets could contain the next China—another transformational growth story to generate outsize returns.

BlackRock’s frontier market fund invests more than half its assets in securities from Kuwait, Qatar and the United Arab Emirates, and it holds significant stakes in companies from Nigeria, Kenya and Vietnam. It’s up 7.1% this year, according to Bloomberg, compared with a 1.6% decline in the MSCI Emerging Markets Index.

The thing about frontier markets, however, is that overnight success isn’t the name of the game. Political instability is often at play and, like emerging markets a couple of decades ago, a lot of frontier markets have bumps in the road they still need to overcome.

And if emerging markets ETF outflows are any kind of sign, ETF investors aren’t often the most patient investors. Frontier markets need patient capital to attain meaningful economic growth and political progress. Still, ETFs are bringing the spotlight to these markets so investors can see for themselves what they’re about. And that can’t be all bad.

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