FINRA recently issued an Investor Alert, “Frontier Funds: Travel with Caution.” In the Alert, FINRA explains that “frontier funds” are those which invest in securities of companies in countries with developing markets, such as Argentina, Lebanon, Nigeria, Slovenia, and Vietnam. FINRA is concerned that frontier funds are piquing investor interest as a way to diversify assets beyond the established international and more developed emerging markets and with the possibility of potential gains. Investing in frontier markets, however, entails heightened risks.
Frontier economies tend to be smaller, and their markets for trading securities less developed, than emerging economies such as Brazil, Russia, India and China, according to FINRA. In addition, FINRA explains that the legal, financial accounting and regulatory infrastructure of frontier markets may be weaker or less developed, and political stability may be more of a concern than those of more established markets. Frontier markets also may have restricted cash flow, less investor participation, fewer large global companies, and limited international trade compared to established and emerging economies. Notwithstanding these drawbacks, says FINRA, frontier market countries also tend to have populations that are achieving gains in education and entrepreneurship, leading to an expanding economy and rising standard of living.
FINRA stated there are a limited number of funds whose particular focus is frontier markets, and each fund is distinct. For example, some funds invest in more than 30 different frontier markets, while others focus on frontier markets in a particular region, such as Asia, Africa, or the Middle Ease, or even a single country. Other funds focus on a single or small number of economic sectors, such as banking , energy, or agriculture, in various frontier markets. Alternatively, some funds track an index encompassing many countries that are considered to be frontier markets. In addition, some funds may include both frontier markets and larger, more developed emerging markets. Global or international funds also may have a stake in frontier markets.
All funds registered under U.S. law must provide investors with a prospectus, which includes information regarding the fund’s investment objective, major holdings or index it tracks, historical returns, and information regarding fees and risks. FINRA warns investors to read a fund prospectus carefully, evaluate the fund’s risks, and be aware that most frontier funds are intended for “aggressive growth.”
FINRA’s Alert offers the following tips to avoid problems:
- Know which frontier markets the fund invests in. Risk factors vary by country–and no two countries share identical risk elements. Read the fund’s prospectus to determine whether you are buying a fund that is or may become broadly diversified across many frontier markets, or that narrowly invests in only a few frontier markets, sectors or a single region or country.
- Monitor changes in index components. If you are investing in a frontier ETF or index mutual fund, make sure you know and understand the index that the fund tracks and also the components of that index. Be aware that the components or “constituents” of an index can change, potentially affecting the return of the fund. For example, components of the MSCI Frontier 100 Index are undergoing changes after Qatar and the United Arab Emirates–which accounted for more than 30 percent of the value of the MSCI index–were reclassified from “frontier” to “emerging” markets. Following a transition period over several months, these markets will no longer be represented in the index.
- Geopolitical and currency risks are real. Be aware that some frontier markets are located in parts of the world with unstable political or market environments. Regional conflict, civil unrest and regime change are all significant risk factors, as is the risk that currency exchange rates may fluctuate, resulting in changes in the value of a given fund.
- Factor in costs and fees. Frontier fund costs and fees can be higher than their emerging market peers, and significantly higher than broadly diversified domestic and international managed funds. Even small differences in expenses can make a big difference in your return over time, so it’s important to know just how much you are paying for your investment. Use FINRA’s Fund Analyzer to help you compare how sales loads, fees and other fund expenses can impact your return. ETFs have a fee structure that includes trading fees, which can add up if you plan to actively buy and sell.
- Learn as much as you can about the fund manager. Understanding frontier markets and managing investments is a specialized skill. Research the fund manager’s professional experience, including fund management tenure and performance record. Research the professional background of a fund manager and the broker selling you the fund using FINRA BrokerCheck.
- Performance History. Frontier funds are relatively new and most have limited performance histories. Like all investments, performance may fluctuate. You can lose money.
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