During several years of the current slide experienced by emerging markets equities, supposedly rough-and-tumble frontier markets stood tall. Buoyed by comparable if not better growth prospects and low correlations to developed and emerging markets stocks, frontier market equities and exchange traded funds rose to some acclaim on the international investing landscape.
That acclaim turned sour when oil prices started faltering in earnest last year. This year, the iShares MSCI Frontier 100 ETF (NYSE:FM) is off 13.5 percent, a loss that is 300 basis points worse than that of the MSCI Emerging Markets Index.
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FM is not the only offending frontier markets ETF this year. It is merely the largest and to be fair, some of FM's rivals are lagging the MSCI Emerging Markets Index in more significant fashion. Some of the same problems afflicting emerging markets are wreaking havoc on their frontier counterparts, including plunging commodities demand and faltering currencies.
"However, many of the large frontier markets, such as Nigeria, Kenya, Kuwait, and Argentina, all saw their respective stock markets, and currencies, exhibit sharp declines in 2015. There are a number of reasons for these declines, including weak global demand for these countries exports, political instability, and terrorism," said Morningstar in a new research piece.
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FM's country weights underscore the ETF's vulnerability to falling oil prices. Kuwait and Nigeria, both members of the Organization of Petroleum Exporting Countries, combine for over 39 percent of the frontier fund's weight. Additionally, nearly all of the 15 countries represented in FM are commodities exporters and most are net exporters of energy commodities, including oil or natural gas.
FM's OPEC exposure could increase if index provider MSCI deems Saudi Arabia to be a frontier market. That would be a good thing...if oil prices go up, but as the newly minted iShares MSCI Saudia Arabia Capped ETF (NYSE:KSA) proves, Saudi stocks are not surprisingly correlated to oil prices.
"The investment case for frontier markets sounds enticing. Countries such as Kuwait, Nigeria, and Pakistan are at an earlier stage of development relative to emerging-markets economies. Many frontier-markets economies are entering a period of mid- to high-single-digit growth, thanks to a very low economic base, favorable demographics, growth in infrastructure spending, and, in some cases, abundant natural resources. And relative to emerging markets, certain frontier countries will benefit from the rapid adoption and dissemination of new economy services such as mobile banking and mobile payments, which should contribute to growth in the medium term," adds Morningstar.
Pakistan, 10.4 percent of FM's weight, could be elevated to emerging markets status, though that index promotion probably is not imminent. Likewise, some index providers have mulled stripping Argentina of frontier status in favor of the ominous standalone classification. Argentina is FM's second-largest country weight at 14.4 percent.
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