Why Frontier Markets Should Be Avoided

Frontier markets, such as African countries, have been receiving a lot of attention lately as an asset class to consider including in investment portfolios. (Think of them as the "emerging" emerging markets, or those countries that are investable, but less developed than emerging markets.) Some of the larger frontier markets include Qatar, Nigeria and Jordan. If you're seeking higher returns, frontier markets may be an option, but be aware of several drawbacks and risks.

For one, they're not particularly liquid, and investing in them is quite expensive from both an expense ratio perspective and a trading costs perspective. The largest frontier markets ETF is the Guggenheim Frontier Markets ETF (FRN), and it carries an expense ratio of 0.70 percent. As a basis for comparison, the Vanguard MSCI Emerging Markets ETF (VWO) has an expense ratio of 0.22 percent.

Also, the market capitalization of the FTSE Frontier 50 Index is about $55 billion. In a market-cap weighted global portfolio, frontier markets would represent less than 0.5 percent of the portfolio. By comparison, the market capitalization of General Electric (GE) alone is more than $200 billion. By excluding frontier markets, you're not "missing out" on a very large portion of the way the world allocates capital.

Frontier markets are also quite risky. Generally, you only want to invest in markets where the game is fair. Before investing in a country, I want to be sure that it has well-defined property rights, enforces strict accounting standards and is fair to foreign investors. Emerging markets countries sometimes have problems in these areas, but the risk is even greater with frontier markets. Frontier markets are often called the "emerging markets of tomorrow." You're likely better off waiting until tomorrow to invest in these countries.

Photo courtesy of www.steveconover.info on Flickr
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