FRN Invesco Frontier Markets ETF

iShares, the San Francisco-based ETF giant, is looking to expand its lead in the foreign fund space with the launch of its newest ETF, the MSCI Frontier 100 Index Fund (FM). The company already dominates the country-specific ETF world thanks to having some of the first—and so far only—funds to track stock markets in a variety of often overlooked nations around the world, and is undoubtedly hoping to maintain its lead in the regional ETF market as well.

This is important as the company is seeing huge levels of competition in the regional ETF space, and for good reason as these segments tend to be, on average, more popular than individual country ETFs due to their more diversified exposure. Furthermore, until the launch of FM, this was one of the few areas of the international ETF world in which iShares didn’t have a fund, suggesting that this was long overdue for the world’s biggest ETF issuer.

Frontier Markets in Focus

The MSCI Frontier 100 Index Fund (FM) will give investors exposure to a basket of ‘frontier’ markets from around the globe. However, the term ‘frontier’ market doesn’t nearly get the level of play in media circles that terms like ‘emerging market’ do, so some investors may be wondering what the key differences are between the two types of developing economies (see Three Overlooked Emerging Market ETFs).

Basically, frontier markets are generally considered by investors to be one step below emerging markets and thus even more risky. However, this also means that they have incredible growth potential as well, making them interesting compliments for portfolios seeking more international exposure.

Generally speaking, this means that frontier nations do not have market capitalization or liquidity levels that are anywhere approaching emerging market countries, let alone developed ones like the U.S. or Japan. Additionally, due to these lower liquidity levels, stocks and funds in this space tend to have lower correlation levels than emerging and developed nation equities, meaning that they could be a decent source of uncorrelated returns in an increasingly integrated world (see Frontier Market ETF Investing 101).

Countries that are often included in this classification include a number of rich but closed-off markets in the Middle East such as Jordan or Kuwait, countries that have a great deal of investor restrictions despite having sizable GDPs such as Argentina, and Asian markets like Sri Lanka and Bangladesh which have tiny markets and pretty undeveloped economies.

As you can see from this smattering of countries above, frontier markets actually include a pretty diverse mix of economies. It is also a good idea to point out that a nation’s GDP per capita—which is often used to help distinguish an emerging market from a developed nation—is pretty much irrelevant when it comes to frontier markets, as some of the richest and the poorest nations find their way into frontier market indexes.

With this approach and by using an MSCI-based benchmark, FM ends up with a portfolio of roughly 100 stocks from about 20 different nations. The product will charge 79 basis points a year in fees, meaning that it will be a relatively expensive choice when compared to the other names already in the frontier market world (read Three Emerging Market ETFs to Limit BRIC Exposure).

From an exposure perspective, financials dominate the index, accounting for a whopping 57% of the total. Rounding out the top three are telecoms (15.8%) and energy (9.1%), suggesting that the portfolio will be heavily concentrated in a few choice sectors.

From a national viewpoint, the Gulf States dominate, as Kuwait (30%), Qatar (15.8%), and the UAE (11.9%) take the top three spots. Beyond these three, Nigeria gets a double digit allocation while the rest of the top seven is rounded out by Pakistan, Kazakhstan, and Argentina.

ETF Competition

Currently, there are two other ETFs in the frontier market universe, the Frontier Markets ETF (FRN) from Guggenheim, and the MENA Frontier Countries Portfolio (PMNA) from PowerShares. These two aren’t the most popular funds, but they do combine to hold just over $165 million in assets.

When looking at country and sector exposures, these couldn’t be more different than the new FM fund from iShares. FRN puts a heavy focus on Latin American securities, while PMNA only holds securities in the Middle East and North Africa, meaning that it forgoes exposure to popular frontier nations like Argentina, Nigeria, and Kazakhstan (see Forget Argentina, Buy These Latin America ETFs Instead).

With that being said, investors should note that financials are an important part of all three funds and that there seems to be no real escaping the banking exposure, although FRN admittedly does the best job. It should also be pointed out that from an expense perspective, FM is pretty weak, costing more than either one of the already available products on the market.

Still despite this expense ratio difference and the heavy focus on financials, FM could be an interesting choice for some investors who want more frontier market assets. After all, it still provides a relatively well diversified portfolio across regions and it has, arguably, less of a focus on a particular part of the globe than either FRN or PMNA (see Time to Get Regional with Bond ETFs).

This could be especially important when comparing FRN to FM, as FRN includes assets from countries like Colombia and Chile, two nations which many don’t really regard as ‘frontier’ anymore. Given this, some investors who are willing to pay a little more in expenses might want to give the new iShares fund a closer look, especially if you are looking for relatively uncorrelated assets in markets that do not usually find their way into your portfolio.

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(FM): ETF Research Reports
 
GUGG-FRONTR MKT (FRN): ETF Research Reports
 
PWRSH-MENA FRON (PMNA): ETF Research Reports
 
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