An ETF That Takes You to the Frontier

And you thought frontiers were only for the likes of Daniel Boone and Captain Kirk.

After what seems like eons, the first of what will be several (PowerShares and WisdomTree each have one in the hopper as well) frontier market ETFs has finally listed, making the space accessible to the average investor.

The Claymore/BNY Mellon Frontier Markets ETF ( FRN) listed on Thursday with ticker FRN.

Frontier markets, simply explained, are one or two steps behind emerging markets in terms of things like modernization, regulation and other standards of development.

One big difference between the two types: More-mature emerging markets usually endure normal bull and bear market cycles, but frontier markets also take in the story that is happening on the ground.

For example, Vietnam has garnered a lot of attention for its economic dynamism, and investment capital has flowed in over the past decade, seeking to exploit the young-but-large population that is willing to work very hard and relatively cheaply.

This sort of effect tends to make the booms and the busts larger in magnitude, which is part of the maturation process, and this is something to keep in mind before committing any of your own capital to the space.

The last two years of trading in the Vietnam Opportunity Fund ( VTOPF) are a perfect microcosm for this effect. The runup is attributable to capital flowing in. The whoosh down is the result of too much capital, contributing to a 25% inflation rate.

Coincidentally, or maybe not, FRN does not have exposure to Vietnam. Its largest country weight is Poland at 24.86%, followed by Chile at 21.01% and Egypt at 17.73%. The country weightings get much smaller from there.

Poland and Egypt make sense as frontier markets, but I would think of Chile as more of an emerging market. Chile is the only country choice that seems questionable to me in a "frontier" fund.

The sector makeup favors financials at 37.27%, telecom at 16.24%, materials 13.46% and energy at 11.61%. This makes perfect sense because most, if not all, countries have a big bank, a big phone company and a big energy company. The heavy weight to materials belies the natural-resource theme that has helped countries like Kazakhstan and Peru to become more economically relevant than they once were.

Most folks will not recognize the names held in the fund, but some of them are fairly large, widely held and written about, so looking under the hood will not be impossible. It will be easy to find information on larger holdings like Bank Pekao, Orascom Telecom and Kazmunaigas.

FRN has 42 holdings with an average weighted market cap of $10.9 billion (probably bigger than you thought) and the fee is capped at 0.65%.

Frontier markets are an asset class. At times, the asset class will be a good hold; at times not. As mentioned above, there will soon be other funds that come to the market, and they will be much different than FRN.

Anyone interested in the space will need to decide for themselves what the best way in will ultimately be, but this area is worth exploring, the recent events in Vietnam notwithstanding.

For one thing, frontier markets appear to have shrugged off the financial crisis and bear market. I believe this is because of the story-on-the-ground aspect of the frontier space that is a less powerful catalyst to emerging and developed markets.

That the frontier is now accessible, and that soon there will be choice, is a huge plus for investors -- but as the recent action in Vietnam and the meltdown in the GCC countries a couple of years ago show there will be periods of extreme volatility, which begs for moderate exposure.

At the time of publication, Nusbaum was long VTOPF personally and on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

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