Frontier markets on the verge of emerging

Not a necessity

The question boils down to this, Rocco says: "Do you really want to have two emerging-market funds on top of large-cap and small-cap international stock funds?" His answer: "Most individuals can safely ignore frontier-market funds."

That's not to say investing in frontier markets doesn't carry benefits. The bigger emerging markets are now crowded with investors. "So it's harder to find bargains and rapidly growing stocks that first attracted people to emerging markets," says Gregg Wolper, another Morningstar analyst. "Going to frontier markets affords more of an opportunity to discover the most overlooked companies."

But the few mutual funds that specialize in frontier markets have short track records -- generally less than five years. They have high expenses -- sometimes more than 2 percent, compared to about 1.65 percent for emerging-market funds in general and about 1.3 percent for actively managed domestic U.S. stock funds, according to Morningstar.

Meanwhile, during their short time in existence, most of the funds haven't produced stellar returns, with some substantially lagging the Morningstar emerging-market fund average over the past three years.

"There's a possibility of a high return, but no guarantee," Wolper says. "These aren't the kind of things that people should enter and expect to make a lot of money with their eyes closed."

High volatility

Most of the frontier funds are small, with assets of about $100 million. That can make them more volatile. Until last summer, RDM Financial Group of Westport, Conn., had some of its clients' money in a fund that invests in emerging and frontier markets. "We sold it because we were trying to lower volatility in the portfolio," says Michael Sheldon, RDM's chief market strategist.

Some of the frontier market funds invest in numerous regions, while others specialize in one or two. You may want to stick with the broader focus to increase diversification and reduce risk. "Frontier countries are distinct, and there is a lot of diversity among countries," says Acadian's Mehta. "Correlations between frontier markets and emerging markets are low, as are correlations between frontier markets themselves."

King and his colleagues at Signature like countries in Africa and Asia, because they fit its "eat, drink, shop and bank" investment themes. "Those are the companies we like to own," he says. "We like consumer companies because the quality of earnings is more consistent. They aren't as tied to commodity prices as energy and mining companies."

In Vietnam, retail sales have grown about 20 percent a year since 2005, King says. People in frontier markets are quite familiar with developed-country lifestyles, thanks to the Internet. And they "have a desire to consume the same things we do," he says.


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