Choose Wisely With 'Frontier Market' ETFs

Frontier markets are on the outer fringe of the international investment community, and are considered less developed than emerging markets. 

In addition, they generally involve countries with questionable political and economic stability due to leadership missteps. 

Many of these countries are located in the Middle East, Africa, and South America -- which also represent hard-to-reach areas for new capital.  As a result, choosing the right region and opportunity can make or break your portfolio.

The largest diversified ETF in this space is the iShares MSCI Frontier 100 ETF FM, which has over $800 million invested primarily in Kuwait, United Arab Emirates, and Qatar equity securities. These three countries make up nearly 58 percent of the total portfolio allocation, which makes FM heavily weighted towards oil-rich countries in the Middle East. Despite the plethora of commodity production, the largest sector weightings in this ETF represent financial and banking stocks. 

Related: Currency ETFs Offer Access To Unconventional Markets

So far this year, FM has gained 13.82 percent and has handily beaten many other broad-based international rivals.  For the sake of comparison, the Vanguard FTSE Emerging Markets ETF VWO has been largely flat over that same time frame. 

Despite the strong performance of this broad frontier market index, several individual countries have experienced mixed results this year.  

The iShares MSCI Chile Capped ETF ECH is a portfolio of 42 stocks in South America that has lost more than three percent this year. By contrast, the Market Vectors Egypt ETF EGPT has gained more than 31 percent and is far surpassing its Middle Eastern peers.  This ETF is primarily made up of mid and small-cap financial stocks, along with select telecommunication and materials companies. 

Egypt’s strong performance is attributed to the nation's approval of a new constitution and recent stabilization on the political front after years of turmoil.

Despite the inherent risks of investing in unproven regions, many investors see these undiscovered areas as pockets of opportunity -- that can be exploited prior to these countries gaining wider acceptance among foreign investors. Typically frontier markets have more attractive valuations than emerging or developed economies, and can offer higher dividend yields as well.

It’s this very balancing act of risk versus reward that make frontier markets an intriguing investment opportunity for ETF investors.