Frontier Funds—Travel With Care
"Frontier funds" that invest in securities of companies in countries with developing securities markets—like Argentina, Lebanon, Nigeria, Slovenia and Vietnam—are gaining investor attention. Some see investing in frontier funds as a way to diversify assets—going beyond funds that invest in established international and other more developed emerging markets. Frontier funds are also sparking the interest of some investors who are lured predominantly by potential gains.
FINRA is issuing this alert to caution those interested in funds that invest in frontier markets to carefully consider the heightened risks in these markets. Frontier fund investments may provide potential diversification and periods of higher returns than can be obtained through more traditional investments. But products or asset niches that promise higher returns nearly always carry more risk—and the past performance of any fund is never a guarantee of future results.
There is no precise definition of a frontier market, or a country classified as such—but words like "small" and "illiquid" are often used to describe these markets.
Frontier economies tend to be smaller, and their markets for trading securities less developed, than emerging economies such as Brazil, Russia, India and China. In addition, compared to more established markets, 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. Financial market depth and breadth also may be more limited, and capital flows may be more restricted. Frontier markets may have less investor participation, fewer large global companies and limited international trade compared to established and emerging economies.
At the same time, frontier market countries are often characterized by populations that are making strides in education and entrepreneurship, an expanding economy and a rising standard of living.
Currently, there are a limited number of funds that focus specifically on frontier markets. Just as every frontier market is different, so is every frontier fund. Some funds invest in more than 30 frontier markets around the globe. Others invest more narrowly, perhaps focusing on only one region such as Asia, Africa or the Middle East—or even one country. Some mutual funds and exchange-traded funds (ETFs) may concentrate their holdings in a single or small number of economic sectors—such as banking, energy or agriculture—within various frontier markets. Others may track an index that encompasses virtually all of the countries in the frontier market universe. Still other funds invest in both frontier and the generally larger and more developed emerging markets, and some global or international funds may allow for sizable allocations to frontier markets.
A frontier fund that is registered under U.S. law—whether it is a mutual fund, ETF or closed-end fund—is required to provide investors with a prospectus that details the fund's investment objective, major holdings or index that it tracks, historical returns and information about fees and risks. Think of this prospectus as your "frontier market guide," complete with advisories and warnings. Read it carefully before you invest. Most frontier funds are designated for "aggressive growth" and described as high risk. Investors interested in frontier funds should carefully consider whether and how such an investment might fit as part of a well-diversified portfolio.
Before You Invest
Like any investment, frontier funds have their pros and cons. Before you invest, here are some tips to help you 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.
As with any investment that holds out the potential for greater returns, it pays to ask whether you are willing to take on the higher risk that comes with it. In short, are you comfortable with a higher risk of significant investment losses? If not, an investment in frontier funds may not be a destination you want for portfolio.
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