Why Passive Investing in Frontier Markets Has Been Left Behind


Passive investing through ETFs is here to stay. Not only have the overall assets under management in ETFs grown massively over the past decade, but so has the breadth of different types of ETFs available. Niche ETFs have gained in popularity, usually focusing on specific technology themes (eg. video games, cybersecurity, electric cars) or on leveraged directional trades (eg. 3x bullish or bearish ETFs on commodities).

But conspicuously absent from this explosion of new ETFs have been products focused on frontier markets. We have seen Global X release a few region specific ETFs in frontier markets, such as their funds focused on Nigeria or Pakistan, but they remain extremely tiny even relative to other niche ETFs. Their lack of popularity is glaring in a year where asset allocators have pivoted towards international stocks, with emerging markets ETFs among the best performing this year.

Why Frontier Markets Have Been Ignored In The ETF World

There are multiple reasons for frontier markets not booming even as international and emerging markets ETFs are.

Lack of Quality Products

The most obvious reason is the lack of good ETFs offering exposure to frontier markets. The best one remains FM, the iShares MSCI Frontier 100 ETF. Here is a quick comparison between it and its much more popular emerging markets focused cousin:

Name iShares Core MSCI Emerging Markets ETF iShares MSCI Frontier 100 ETF
Inception 18-Oct-12 12-Sep-12
AUM $39.7 billion $0.65 billion
Volume 6.955 million 0.155 million
Expense Ratio 0.14% 0.79%
Companies Held 2016 114
% Assets in Top 10 22.60% 36.90%
Region Breakdown IEMG FM
Asia 67% 21%
Africa 6% 17%
Europe 9% 15%
Latin America 11% 18%
Middle East 1% 28%
North America 2% 0%

We opted for IEMG rather than EEM since it was launched at roughly the same time as FM; they have similar assets under management. FM’s assets under management and volumes are less than 2% of IEMG’s. It also has a expense ratio that is 65 bp more than IEMG while offering exposure to 1902 less companies.

While FM’s regional breakdown seems to offer greater diversity than IEMG, it is focused in a few countries. Breaking down holdings by industry does not make FM look better, with almost 40% of holdings focused on financials. On the other hand, part of the reason that IEMG is so weighted towards Asia has been the outperformance of Asian tech darlings like Tencent, Samsung, and Alibaba.

Yes, building ETFs in frontier markets must be much more costly than in more developed markets, but the current offerings could be so much better than they are right now, especially for the cost.

Lack of Competition

Vanguard’s presence in the ETF market has driven down expense ratios across the board as investors have become more cost conscious. The best example is in the emerging markets space, where Vanguard’s ETF product, VWO, currently offers a startling 0.14% expense ratio. Previously, the market leader was iShares’ EEM, which still charges a staggering 0.72% to its owners. Unsurprisingly, VWO now has almost double the AUM of EEM, and iShares had to launch IEMG with an identical expense ratio just to compete.

Unfortunately, Vanguard has no frontier markets ETF product or else the current situation would be much better. While there have been some launches of niche ETFs focused on specific countries, what the market really needs is a frontier market ETF with low costs and greater diversity.

Simplifying Investing: The Rise of Robo-advisors

The rise of ETFs has come hand-in-hand with the rise of robo-advisors, companies that offer to manage your portfolio for a flat fee and with intuitive websites. By using low-cost ETFs instead of traditionally expensive mutual funds, a lot of people have ditched financial advisors and moved their investments to these new companies.

This trend is a positive one for many people who do not follow markets as closely as we do. The number one question for most people when it comes to investing is “What should I invest in?”, and these companies simplify the process.

However, no robo-advisor is treating frontier markets as its own asset class, with emerging markets the most exotic investment in most people’s portfolios. As money continues to flow into these asset allocation platforms, the disparity between emerging and frontier markets will continue to grow.

The main reason they do not allocate to frontier markets is because the market just isn’t big enough, and there aren’t good products that offer uncorrelated returns. It is hard to justify owning FM when you can buy IEMG and get most of the benefits. But there isn’t a better product yet because there is no money flowing into the space. So it’s a catch-22 at the moment.

Hope For The Future?

Just because the situation is bad now, does not mean that it will always be this way. We have seen the popularity of fringe assets like cryptocurrencies go mainstream this year. International and emerging markets have also bounced back strongly this year, which bodes well for foreign stocks in general. The bar is also so low right now that it is hard for it to get much worse.

There is little reason for frontier markets to languish in obscurity forever. Technology gets cheaper every year and a significant number of the frontier markets we watch have modern trading infrastructure at their exchanges, allowing for ETF issuers to trade on them if needed. Also, as investors own increasingly similar portfolios, this leads to higher correlations between existing asset classes. This is a golden opportunity for frontier markets, where its low correlation to the rest of the world will shine. All it takes is for a viable ETF (please, Vanguard) for investors to begin taking notice.

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