(This article was originally published Tuesday.)
--Frontier stocks touted for their low correlations to U.S.,
European and emerging-markets equities
--Such stocks also are considered risky and volatile
--Many advisers urge clients to avoid them
By Matthias Rieker
When a high-net-worth client approached Michael Fein three weeks
ago with the idea of investing in frontier markets, the financial
adviser reacted with a mix of interest and caution for one of
2013's hottest investments.
The client, a physician in his 70s, had cited the nearly 26%
return of the iShares MSCI Frontier 100 (FM) exchange-traded fund
last year and wondered whether exposure to countries like Qatar and
Nigeria would benefit his investment portfolio.
"I said you should buy it in your personal account, I am not
following it for you," Mr. Fein, president of CIC Wealth Management
in Baltimore, recalls telling the client.
Mr. Fein has a small portion of his own money invested in
frontier stocks, which are touted for their low correlations to
U.S., European and emerging-markets equities.
But frontier stocks also are widely considered risky and
volatile, making them unsuitable for his client's retirement
portfolio. "I would never take the fiduciary responsibility of
putting that into my client's portfolio," Mr. Fein says.
This middle-ground, invest-at-your-own-risk advice reflects the
hesitation of many advisers when their clients express interest in
mutual funds and ETFs focused on frontier markets.
In most cases, independent advisers and even some large advisory
firms recommend investors stay away from frontier markets for their
managed accounts. "We believe that most clients can build
well-diversified portfolios that meet their financial goals without
an allocation to frontier markets," a spokeswoman for Edward Jones
says.
Frontier markets are expected to develop into emerging markets
over time. Argentina is among them, as well as Romania, Kuwait,
Botswana and Vietnam. Those countries are considered risky places
to make bets because their governments are often unstable and in
some cases corrupt, while economic growth is volatile.
Concerns about the suitability of investing in frontier markets
have captured the attention of securities regulators. The Financial
Industry Regulatory Authority three weeks ago added frontier
markets to its examination-priority list.
"Heightened risks associated with investing in foreign or
emerging markets generally are magnified in frontier markets," said
Finra, noting that frontier markets offer few investment
opportunities, low liquidity and poor investor protections.
For now, the economic expansion in frontier markets is expected
to continue into 2014. "The long-term catch-up...for frontier
markets remains intact," Citigroup Global Markets Inc. said in a
recent research report. This economic growth is being fueled by
growing populations, rising productivity and increasing foreign
investments, Citi said.
So far, overall investment into frontier funds has remained low.
Last year, it was less than half of a percent of total mutual-fund
inflows, according to Pershing LLC, a unit of Bank of New York
Mellon Corp. (BK) that provides custodial and other services to
investment advisers.
Aside from institutional investors such as pension funds,
investors in frontier markets were mostly high-net worth
individuals attracted to areas less tied to developed and other
emerging markets, says Sandy Bolton, Pershing's director of
investment solutions.
James Cahn, the chief investment officer of the Wealth
Enhancement Group in Plymouth, Minn., says frontier funds have a
place in diversified investment portfolios. "You've got growth,
you've got great valuations," he says.
If a client wants to capture a bit of this market to help
diversify a portfolio, exposure should never exceed 2% or 3%,
several advisers say.
But Mr. Cahn warns: "If there is a selloff, it's sharp."
That is what worries regulators, and Finra's "red flag" means
advisers "better have a really good justification as to why that
product was suitable for that particular client," Ms. Bolton
says.
"It's putting a greater burden on broker-dealers to have a
really robust due-diligence department within their firm to be able
to go through all these different funds and come out and say
whether they want their adviser to be even selling them," she
adds.
In addition, some of the mutual funds focused on frontier
markets have already shut their doors to new money because of
limited investment opportunities. That could overinflate the values
of rival ETFs, an outcome that would be difficult for the average
retail investor to know, Ms. Bolton says.
Some firms are already cautious. "We are planning to enhance
investor education about frontier funds to make certain that
clients are well aware of the risks as well as the opportunities
associated with them," a spokesman for Wells Fargo & Co.'s
(WFC) brokerage unit Wells Fargo Advisors says.
Other firms, however, remain committed. "We do make frontier
funds available," a spokeswoman for Charles Schwab Corp. (SCHW)
says. "There are no changes planned at this time."
Write to Matthias Rieker at matthias.rieker@dowjones.com
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