Investors seeking diversification away from emerging market equities flocked to frontier market (FM) equity funds in 2013. The category is small but growing, amassing a record $3.7 billion last year in mutual funds, ETFs and other investments. Although Frontier funds are a relatively new category within the massive ETF industry, assets allocated to funds offering frontier exposures more than doubled in 2013 and now stand at $835 million.
The draw? In the current market environment, investors want potentially higher long-term growth rates, reduced risk through low correlation to U.S. equity markets, and a virtually untapped investment opportunity, to name a few. What's more, the MSCI FM Index has historically been less volatile than the MSCI EM Index and the S&P 500. While individual companies and even countries can be highly volatile within frontier markets, taking a diversified approach by owning a basket of companies and countries can surprisingly lead to a much less volatile overall investment.
S&P 500, MSCI EM & MSCI FM Historical Volatility
However, recent headlines touting turmoil in several FM nations are forcing some to wonder if these havens are worth the hype. Last month, the president of Nigeria suspended the governor of the nation's central bank, sparking a selloff in the financial markets.
Tensions in Ukraine are also escalating. Protests broke out after President Viktor Yanukovych turned down an EU trade deal in exchange for Russian financial support, leading to his eventual ouster. The nation's currency fell to a new low against the U.S. dollar. Ukraine's interim government went on to call the unofficial presence of Russian troops at border posts in Crimea a "declaration of war" and put security forces on high alert. What's more, Ukraine is now appealing for a $15 billion bailout from the International Monetary Fund. These events have led many to wonder if the rush into frontier market equities has run its course. Some go so far as to conclude the sector is overvalued.