Morningstar Magazine - December/January 2015 - 45

EXHIBIT 2

and USA indexes, although the Frontier Index
does lose some of its edge over the longer 10-year
period ( E X H I B I T 2 ).
Frontier-markets funds also tend to be less
correlated than emerging-markets funds to U.S.
equities ( E X H I B I T 3 ). During periods when
investors' risk appetite suddenly drops, short-term
volatility in emerging-markets stocks has been
exacerbated by fickle foreign fund flows. Given the
current low level of foreign ownership of
frontier-markets stocks and bonds, this asset class
has not been as susceptible to these volatile
fund flows. However, correlations should increase
as foreign ownership in frontier stocks
continues to rise.
Active Difference

Actively managed frontier-markets funds can
have different portfolios-and thus different risk
and return profiles-relative to the market
cap-weighted benchmarks. This is especially
relevant in the case of frontier markets, where the
border between frontier and emerging markets
is not consistent across index and fund providers.
Three actively managed frontier-markets funds
have existed for more than five years ( E X H I B I T 4 ).
They have each exhibited similar levels of
volatility (as measured by the standard deviation of
their returns) relative to the MSCI Frontier
Markets Index. However, these funds tend to hold
more liquid names and, at times, may invest in
some of the smaller emerging markets such as the
Philippines, Peru, and Turkey. So, it is not
surprising these funds have had correlations to U.S.
equities that are higher than those of the MSCI
Frontier Markets Index, but lower than those
of the MSCI Emerging Markets Index.

EXHIBIT 3

Risks Are More Idiosyncratic Frontier
countries tend to have low correlations with one another. As a result,
the MSCI Frontier Market Index
has exhibited lower volatility than the
MSCI EM Index.

Frontier Markets Provide More
Diversification Frontier markets are
less integrated into the global
economy and, therefore, are less
correlated to developed markets such
as the United States.
Correlation to
MSCI USA Index (%)

Standard Deviation of
Returns (%)
Index Name

3-Year

5-Year

10-Year

MSCI Frontier

MSCI Emerging Markets

MSCI EAFE

Data as of Oct. 31, 2014.

3-Year

5-Year

10-Year

MSCI Frontier

MSCI Emerging Markets

MSCI EAFE

MSCI USA

Data as of Oct. 31, 2014.

factors-some fundamental, some not, and
many of which are specific to frontier-markets
equities. An examination of some of these
factors will help illustrate the notable idiosyncrasies and challenges related to investing in frontier
markets. Frontier markets' outperformance
has primarily been a recent phenomenon and
hasn't been a consistent trend ( E X H I B I T 5 ).
Over the past two years, the best-performing
frontier markets have been the United
Arab Emirates, Argentina, Kenya, and Qatar. The

A closer look, though, reveals that frontier markets'
recent performance reflects a confluence of

capitalization-weighted MSCI indexes (in U.S.
dollars) for each of these countries returned
an annualized 69%, 58%, 41%, and 27%, respectively, through September.
Qatar's and UAE's strong performance
was supported by a rally in banks and property
companies (which dominate each country's
respective index) that were buoyed by recovering
real estate prices and rising infrastructure
spending. But a possibly bigger driver of these
markets' performance was MSCI's announcement

EXHIBIT 4

Frontier Funds Tend To Not Be Pure-Plays The universe of liquid frontier market
stocks is very small, so mutual funds may also hold emerging markets companies. As
a result, these mutual funds tend to be slightly more correlated to U.S. stocks relative
to the MSCI Frontier Index.

What's Driving Performance?

Frontier-markets equities have handily outperformed emerging-markets equities over the
past two years. This is often attributed to frontier
markets' stronger economic growth relative to
emerging markets, especially as larger emerging
economies such as China, Brazil, and Russia
have begun to slow.

Index Name

Standard Deviation
of Returns (%)

Annl. Returns(%)
Name

Correlation to
MSCI USA Index (%)

3-Year

5-Year

3-Year

5-Year

3-Year

5-Year

Morgan Stanley Frontier Emerging Markets MFMIXX

Harding Loevner Frontier Emerging Markets HLMOX

Templeton Frontier Markets TFMAX

MSCI Emerging Markets Index
MSCI Frontier Markets Index
Data as of Oct. 31, 2014.

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Morningstar Magazine - December/January 2015

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