Frontier Markets - 5% of portfolio?

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BogleBuddy12
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Frontier Markets - 5% of portfolio?

Post by BogleBuddy12 »

Emerging Markets are one thing. But any thoughts on digging deeper? I have a super long time horizon, I'm wondering if I could benefit from the growth of Malaysia, Vietnam, etc. There are low cost ETFs available. Maybe devoting 5% of the portfolio to this.

Burton Malkiel recommends Frontier investments from Southeast Asia. He recommends the Malaysia ETF.
John3754
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Re: Frontier Markets - 5% of portfolio?

Post by John3754 »

I'm no Burton Malkiel, but the way I see it is 5% isn't going to make or break you either way. Personally I say why bother?
traveler90
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Re: Frontier Markets - 5% of portfolio?

Post by traveler90 »

Here is the breakdown of Vanguard Emerging Markets - I don't think a separate allocation to Frontier Markets is necessary as the countries you mentioned are in here. I'm in my 20s and like a small tilt towards EM though. They account for 1/3 of my Intl holdings.

China 28.7%
Taiwan 14.4%
India 11.5%
South Africa 8.9%
Brazil 8.4%
Mexico 5.1%
Russia 4.5%
Malaysia 4.2%
Thailand 2.6%
Indonesia 2.5%
Philippines 1.8%
Poland 1.7%
Turkey 1.7%
Chile 1.4%
United Arab Emirates 0.9%
Colombia 0.6%
Egypt 0.3%
Hungary 0.3%
Peru 0.3%
Czech Republic 0.2%
Morocco 0.0%
livesoft
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Re: Frontier Markets - 5% of portfolio?

Post by livesoft »

Forget about Burton Malkiel as he's gone off into the bushes and is just whacking around in the weeds. Forget about frontier markets. When you have a $5 million or more portfolio, come back and ask again. The return (if there is one) is not going matter as much to your portfolio has rebalancing at the best times and tax-loss harvesting at the best times and keeping your expenses low.
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MnD
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Re: Frontier Markets - 5% of portfolio?

Post by MnD »

If you index, it here's what you get (iShares FM, ER=.79)
No Malaysia, very little Vietnam and real big pile of Kuwait.

It appeals to me somewhat in how unappealing it looks and it is cheaper to buy than a year ago (-11%).
If I sold one or both of my two individual stock positions and had no other ideas I would consider it I suppose.
As a global cap investor it does have some things I don't hold now. Appears to have no overlap with VWO.

Kuwait 25.87%
Argentina 13.38%
Nigeria 13.36%
Pakistan 11.08%
Kenya 6.22%
Oman 5.61%
Morocco 5.15%
Romania 4.3%
Vietnam 3.56%
Bangladesh 3.2%
Kazakhstan 2.93%
Sri Lanka 2.41%
Mauritius 1.34%
Jordan 1.14%
Other 0.52%
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BogleBuddy12
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Re: Frontier Markets - 5% of portfolio?

Post by BogleBuddy12 »

MnD wrote:If you index, it here's what you get (iShares FM, ER=.79)
No Malaysia, very little Vietnam and real big pile of Kuwait.

It appeals to me somewhat in how unappealing it looks and it is cheaper to buy than a year ago (-11%).
If I sold one or both of my two individual stock positions and had no other ideas I would consider it I suppose.
As a global cap investor it does have some things I don't hold now. Appears to have no overlap with VWO.

Kuwait 25.87%
Argentina 13.38%
Nigeria 13.36%
Pakistan 11.08%
Kenya 6.22%
Oman 5.61%
Morocco 5.15%
Romania 4.3%
Vietnam 3.56%
Bangladesh 3.2%
Kazakhstan 2.93%
Sri Lanka 2.41%
Mauritius 1.34%
Jordan 1.14%
Other 0.52%
This ETF could be worth considering.
livesoft
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Re: Frontier Markets - 5% of portfolio?

Post by livesoft »

ajacobs6 wrote:This ETF could be worth considering.
No, absolutely not, unless you need a loser to practice some tax-loss harvesting
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Maynard F. Speer
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Re: Frontier Markets - 5% of portfolio?

Post by Maynard F. Speer »

I'm in two minds ... I think low developed world growth is likely to hurt broad market investors at some point - you could say the amount of debt and stimulus it's taken to get stock markets moving so far this century is extremely concerning (the proverbial crumbling sandcastle of excrement - as a trader friend calls it)

But I also agree with Swensen, that there isn't a very happy middleground between active and passive ... There's generally investing efficiently and inefficiently

I'm not sure simply holding a frontiers ETF will achieve much .. Many would say these regions are far from efficient, much better suited to stock-pickers, and carry all sorts of risks one should be aware of (such as their reliance on commodity prices) ... I also think you also need to know when might be a good opportunity to invest ... Otherwise I'd stick with 5-10% in an Emerging Markets ETF
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rkhusky
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Re: Frontier Markets - 5% of portfolio?

Post by rkhusky »

livesoft wrote:
ajacobs6 wrote:This ETF could be worth considering.
No, absolutely not, unless you need a loser to practice some tax-loss harvesting
Sounds like a value play to me - P/E=11.4, P/B=1.6

Half is in financial services - risky?

Morningstar has 25% classified as developed (Kuwait?).
Johno
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Re: Frontier Markets - 5% of portfolio?

Post by Johno »

As mentioned, the most liquid reasonably cheap 'frontier' fund FM is oddly skewed at least at first glance. There's another ETF, FRN, with a bit different line up but not a lot different, it's much smaller though. They used to be even more Persian Gulf oriented before promotion of some other PG countries from frontier to emerging, and same relatively large changes could happen with further promotions. The total market cap, not as weighted in the fund but total, of the countries now in FM is around 1% of world. So if you were 5%, and could hardly be 5 times overweighted in emerging, the promotions effect would be fairly significant (countries going from big fish in small pond of frontier to small fish in larger pond of emerging), and arguably even 5% isn't much. Although, that argument is over used IMO, and as was suggested depends on size of portfolio. Even 1% of a big enough portfolio is lot of money which the holder might still reasonably view as a lot.

However, having agreed the obvious that a fund like FM is not a necessarily investment, I don't see a consistent logic for claiming to know it's a bad investment. That would seem to imply it's possible to also know with certainty how good an investment emerging, DM or US stocks are relatively. I doubt it. We can say and see of course that US stocks are more highly valued compared to their past valuation measures than foreign as a rule, but that's only a relatively vague indication, far from logically justifying 'US stocks will just serve to harvest tax losses'.

Dubious blanket statements aside, another practical thing to note about FM as constituted is that it's probably even more a play on commodities than emerging: Kuwait, Nigeria, Kazakhstan (oil); Argentina, Morocco (ag export, like soybean or phosphate), etc though some of the smaller country holdings are ones you'd think might benefit from lower oil and commodity prices, and even though 1/2 financial stocks in the countries. It's anyway been performing badly in concert with oil and commodities recently.

Some other funds with a regional focus also feature exposures which as 'frontierish'. Market Vectors Africa (AFK) for example has biggest exposure to the EM South Africa, but otherwise frontiers (Nigeria, Egypt, and some in smaller African markets) and stocks of developed country companies heavily dependent on business in Africa (Tullow Oil, US or Canadian mining companies with biggest mines there etc). Likewise it's tended to track oil/commodities and performed similarly to FM recently. The regional focus might be a virtue if one agrees with it, whereas again FM's focus will tend to shift more with frontier>EM promotions and demotions.
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Re: Frontier Markets - 5% of portfolio?

Post by alex_686 »

If I were to go frontier market I would not go with a EFT. I would go with an actively managed fund.

Index investing assumes that the markets are efficient so one can invest passively. Study after study has shown that emerging markets are not so I can't imagine with frontier markets are like.

Frontier markets are not frontier because they are small, new, and in poor countries with risky companies. Saudi Arabia is a frontier market and is none of these things. Frontier markets mean poor markets. Low liquidity and high trading spreads - this can be handled. Reporting and audit standards are low. Inside trading is permitted. Stockholder rights are minimal. etc. These are harder to handle.

Risk I can handle. I overweight my portfolio with in EM. Frontier is a different ball of wax.
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Re: Frontier Markets - 5% of portfolio?

Post by Northern Flicker »

Index fund investors do well to be careful about falling into the mindset that if there's equity capitalization somewhere, one needs to own a cap-weighted slice of it.

Index funds are a low cost way to implement an investment in an asset class for which one's asset allocation sets a non-zero allocation. The set of available index funds should not be the driver for establishing an asset allocation. The asset allocation should first be established, and then the question of implementation should be considered, whether or not an index fund will be used.

I have alot of respect for Burton Malkiel. However, his retirement activity is promoting investment business interests (for which I assume he would personally profit) that involve investments in Asian markets not classified as developed markets, a bit of a conflict of interest in using his reputation to promote these types of investments. I'm sure he does believe in what he is doing, though.
Last edited by Northern Flicker on Mon Oct 30, 2017 10:09 am, edited 1 time in total.
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Re: Frontier Markets - 5% of portfolio?

Post by Johno »

alex_686 wrote: Index investing assumes that the markets are efficient so one can invest passively. Study after study has shown that emerging markets are not so I can't imagine with frontier markets are like.
AFAIK most studies have failed to support that contention or moreover the apparently logical corollary. IOW yes EM's are less efficient than DM's/US broadly speaking, but no it hasn't been generally shown that active managers can take any more advantage of market inefficiencies on average after costs in EM's than they can in DM or US. And this isn't really a strange result. The advantage of indexing does not rest on assuming markets are efficient in a broad sense but only that for each $ that beats the index by a given degree, another $ has to trail it by the same degree. So for foreign active stock managers to consistently beat indexes in EM countries, some other type of entity *in the public market* has be consistently beaten by them. It isn't foreign index funds, by definition, and there's no particular reason to think they consistently beat other foreign institutional investors or some category of local investors trading in the public market. OTOH broader efficiency issues like state or family controlled entities shunting profit from public to affiliated private entities (or themselves directly) affects all investors in the public market, and the market doesn't have to be very efficient to see that that is happening (again why would foreign managers see this and local public market traders not see it?) and discount those stocks. So siphoning away of asset returns from the public market is arguably a major efficiency issue in EM's*, but doesn't give foreign fund managers any particular way to beat the public index.

Granted, this hasn't been studied as much if at all for frontier markets but it's not clear as a general idea that there's an advantage to active management that increases monotonically as overall market efficiency decreases.

*arguably it's more of an issue in the US too than it used to be, much larger dilution of public shareholders by stock option/grants to employees, with debate whether that incentive actually boosts underlying company asset returns enough for public investors to come out ahead or behind after the dilution. But again even if this is a growing inefficiency overall, this doesn't provide any particular advantage to active traders/managers in the public market, unless that market is really blind to which companies are diluting their shareholders more excessively than others.
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Re: Frontier Markets - 5% of portfolio?

Post by BogleBuddy12 »

alex_686 wrote:If I were to go frontier market I would not go with a EFT. I would go with an actively managed fund.

Index investing assumes that the markets are efficient so one can invest passively. Study after study has shown that emerging markets are not so I can't imagine with frontier markets are like.

Frontier markets are not frontier because they are small, new, and in poor countries with risky companies. Saudi Arabia is a frontier market and is none of these things. Frontier markets mean poor markets. Low liquidity and high trading spreads - this can be handled. Reporting and audit standards are low. Inside trading is permitted. Stockholder rights are minimal. etc. These are harder to handle.

Risk I can handle. I overweight my portfolio with in EM. Frontier is a different ball of wax.
Well said. So what vehicles do you use to invest in EM? I currently use VWO which is passive, do you prefer active? The problem is, nothing is nearly as cheap as VWO.
Full disclosure, I also own TDF (China closed-end fund), MINDX (India), and EWZ (Brazil). I like the growth opportunities of these countries and I've paired them with VWO.
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Re: Frontier Markets - 5% of portfolio?

Post by Maynard F. Speer »

Johno wrote:AFAIK most studies have failed to support that contention or moreover the apparently logical corollary. IOW yes EM's are less efficient than DM's/US broadly speaking, but no it hasn't been generally shown that active managers can take any more advantage of market inefficiencies on average after costs in EM's than they can in DM or US. And this isn't really a strange result. The advantage of indexing does not rest on assuming markets are efficient in a broad sense but only that for each $ that beats the index by a given degree, another $ has to trail it by the same degree. So for foreign active stock managers to consistently beat indexes in EM countries, some other type of entity *in the public market* has be consistently beaten by them. It isn't foreign index funds, by definition, and there's no particular reason to think they consistently beat other foreign institutional investors or some category of local investors trading in the public market. OTOH broader efficiency issues like state or family controlled entities shunting profit from public to affiliated private entities (or themselves directly) affects all investors in the public market, and the market doesn't have to be very efficient to see that that is happening (again why would foreign managers see this and local public market traders not see it?) and discount those stocks. So siphoning away of asset returns from the public market is arguably a major efficiency issue in EM's*, but doesn't give foreign fund managers any particular way to beat the public index.

Granted, this hasn't been studied as much if at all for frontier markets but it's not clear as a general idea that there's an advantage to active management that increases monotonically as overall market efficiency decreases.

*arguably it's more of an issue in the US too than it used to be, much larger dilution of public shareholders by stock option/grants to employees, with debate whether that incentive actually boosts underlying company asset returns enough for public investors to come out ahead or behind after the dilution. But again even if this is a growing inefficiency overall, this doesn't provide any particular advantage to active traders/managers in the public market, unless that market is really blind to which companies are diluting their shareholders more excessively than others.
Emerging Markets are a tricky one, partly because there are so many divergent parts, and partly because large-caps (in a cap-weighted index) don't actually have that much exposure to emerging economies ... So the best active funds in Emerging Markets have often come down more to the macroeconomics (and many would be labelled Asia Pacific, rather than EM)

The real emerging markets play has always been in Small-Caps, and there you're really reliant on finding a good active fund (bearing in mind even passives charge active-like management fees because these are harder to access, less liquid assets)

When you get to really inefficient markets - like China's domestic stock market - then you see the real gulf between active and passive fund performance

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Re: Frontier Markets - 5% of portfolio?

Post by jhfenton »

jalbert wrote:Index fund investors do well to be careful about falling into the mindset that if there's equity capitalization somewhere, one needs to own a cap-weighted slice of it.

Index funds are a low cost way to implement an investment in an asset class for which one's asset allocation sets a non-zero allocation. The set of available index funds should not be the driver for establishing an asset allocation. The asset allocation should first be established, and then the question of implementation should be considered, whether or not an index fund will be used.
Your second point is an interesting one. In the macro scale, I agree. Macro asset allocation is key, and should be made before picking investment vehicles. But when it comes to implementing a slice-and-dice portfolio--which mine definitely is--available investment vehicles are key to the fine tuning. I'd love to have attractive funds for international value, international small cap value, international emerging markets value, frontier markets (perhaps a combo EM + FM fund to keep reasonable market allocations), emerging markets small cap, etc.

But I haven't found any investment vehicles in those categories that I find attractive in terms of strategy, liquidity, and cost. So I settle for 15% each in developed (VEA), emerging markets (VWO), and small-mid cap (VSS) (all "blend").

I also have a 5% minimum rule at this point. With a mid-to-upper six-figure portfolio, 5% is $30K-45K. That's my lower limit for an asset class. Below that, it's not worth the trouble. (At the moment, our baseline AA is 6 x 15% and 2 x 5%.)
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Re: Frontier Markets - 5% of portfolio?

Post by BogleBuddy12 »

jhfenton wrote:
jalbert wrote:Index fund investors do well to be careful about falling into the mindset that if there's equity capitalization somewhere, one needs to own a cap-weighted slice of it.

Index funds are a low cost way to implement an investment in an asset class for which one's asset allocation sets a non-zero allocation. The set of available index funds should not be the driver for establishing an asset allocation. The asset allocation should first be established, and then the question of implementation should be considered, whether or not an index fund will be used.
Your second point is an interesting one. In the macro scale, I agree. Macro asset allocation is key, and should be made before picking investment vehicles. But when it comes to implementing a slice-and-dice portfolio--which mine definitely is--available investment vehicles are key to the fine tuning. I'd love to have attractive funds for international value, international small cap value, international emerging markets value, frontier markets (perhaps a combo EM + FM fund to keep reasonable market allocations), emerging markets small cap, etc.

But I haven't found any investment vehicles in those categories that I find attractive in terms of strategy, liquidity, and cost. So I settle for 15% each in developed (VEA), emerging markets (VWO), and small-mid cap (VSS) (all "blend").

I also have a 5% minimum rule at this point. With a mid-to-upper six-figure portfolio, 5% is $30K-45K. That's my lower limit for an asset class. Below that, it's not worth the trouble. (At the moment, our baseline AA is 6 x 15% and 2 x 5%.)
Thanks. Any thoughts on Frontier Markets then? Also, I have some VSS, but not nearly as much as you.
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Re: Frontier Markets - 5% of portfolio?

Post by alex_686 »

ajacobs6 wrote:Well said. So what vehicles do you use to invest in EM? I currently use VWO which is passive, do you prefer active? The problem is, nothing is nearly as cheap as VWO.
I prefer active. I use Oppenheimer Developing Markets A (ODMAX). I have held it for 15 years. It has a front end load. Luckily I had to opportunity to buy most it without the load. The expense ratio is high. I have liked how it has performed. That being said it has been about 5 years since I have done my manager review, which is about 2 years too long so take this with a huge grain of salt.

That being said, 10 years ago I strongly felt that emerging markets were inefficient. Now I think they are just semi-inefficient. Most EMs have done a good job of integrating themselves into the world market. On the down side this has increase their correlation with the US and world market so they are less of a diversifying asset. When I do my manager review I might find myself drifting more towards passive.

If I go passive, low cost will not be my deciding factor. A large cap US index will basically give you the results of any other large cap US index. This is not true for EM.
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Re: Frontier Markets - 5% of portfolio?

Post by Johno »

Maynard F. Speer wrote:
Johno wrote:AFAIK most studies have failed to support that contention or moreover the apparently logical corollary. IOW yes EM's are less efficient than DM's/US broadly speaking, but no it hasn't been generally shown that active managers can take any more advantage of market inefficiencies on average after costs in EM's than they can in DM or US.

Granted, this hasn't been studied as much if at all for frontier markets but it's not clear as a general idea that there's an advantage to active management that increases monotonically as overall market efficiency decreases.
1. Emerging Markets are a tricky one, partly because there are so many divergent parts, and partly because large-caps (in a cap-weighted index) don't actually have that much exposure to emerging economies ... So the best active funds in Emerging Markets have often come down more to the macroeconomics (and many would be labelled Asia Pacific, rather than EM)

2. The real emerging markets play has always been in Small-Caps, and there you're really reliant on finding a good active fund (bearing in mind even passives charge active-like management fees because these are harder to access, less liquid assets)

3. When you get to really inefficient markets - like China's domestic stock market - then you see the real gulf between active and passive fund performance
1. I'm not sure the point here. I guess it's fair to parse within EM like any other category, but my point is that it's not the general finding of research that active management does better in the investing space generally recognized as 'EM funds' than it does in DM or the US, contrary to the previous poster's statement. The latest S&P Indices v Active Scorecard has almost 90% of EM active funds trailing their benchmarks over last 10yrs, which is worse than the average for all DM and US stock fund types.
http://www.spindices.com/documents/spiv ... d-2014.pdf

As I pointed out, the reasons for that might have to do in part with what 'inefficient' actually means. Some forms of inefficiency are real but still don't give any advantage to active public market managers. They might be a concern for EM investment, but not a reason to go active.

2. The SPIVA shows a distinctly lower % of foreign small cap (not just EM) funds trailing benchmarks though still 58% over 10 yrs. But in a less obvious case like this the roughness of the methodology might cause more serious question (we don't care exactly what % but by how much, nor even that as much as we care whether high/low performance is replicable so we can choose a winning fund based on past performance; if 90% of the funds are underperforming by the rough measure it's unlikely the true picture we want will be favorable, for 58% it might be). Still the implication that one would greatly overweight small cap emerging goes back to the point of choosing the assets first, implies a huge skew if the relatively tiny cap of EM small were to be a significant % of one's portfolio, though granted the basic discussion is about frontier where you only invest 1% at cap weight.

Anyway a reaction by somebody with emerging mainly in VWO (which just recently changed from tracking large cap to all cap index BTW), 'oh maybe I should have an active fund instead because EM's are inefficient' is groundless based on any evidence I know of, under the natural assumption the active fund is also broad EM, not some small part of EM.

Also future isn't the past and I'd be agnostic as to whether say VSS (Vang all world ex-US small cap ETF) is going to perform worse than active funds. If I agreed to overweight small cap, I'd personally buy VSS. For a long time many people argued active was the only way to go in US small and that's not well supported either in research.

3. China is a special case in many ways. What's true there wouldn't necessarily be replicated in equally or more backward countries economically, even with primitive capital markets, if the level of official interference in the market, dual market and so on, isn't also similar and it's hard to think of examples where that's true.
Last edited by Johno on Wed Jul 15, 2015 4:42 pm, edited 3 times in total.
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Re: Frontier Markets - 5% of portfolio?

Post by nisiprius »

Don't buy for some asset class just because someone puts a clever marketing name on it. "Emerging markets" aren't necessarily emerging, for example.

As for "frontier markets" Google tells me the term was coined by Indian economist Farida Khambata, but I can't find any explanation for the choice of the word "frontier," which according to the dictionary is supposed to mean "1. An international border. 2. A region just beyond or at the edge of a settled area. 3. An undeveloped area or field for discovery or research." All the definitions that come up in Google include some glurge about high growth "potential." Right. Of course they do. They have higher growth potential because they are smaller, and have further to... potentially... grow.

Let's suppose for the sake of argument that Total International is incomplete because it fails to include Argentina, Mauritius, Sri Lanka, etc.

(Argentina? How did Argentina get onto the list of frontier markets? It's had a stock market since 1854. Answer: it didn't grow up and join the frontier markets, it used to be an "emerging" market, and slipped down into the "frontier" markets. I guess it didn't "emerge.")

According to Vanguard,
No matter which index is used, frontier markets collectively represent less than 1% of the global market.
So if you want to repair the deficiency in Total International, you don't want 5% of your portfolio, you want, at most, 1% of your entire stock allocation. So if you had a $1 million portfolio, with 60% in stocks, you would want to add $6,000 worth of "frontier" markets.

Personally, I can't name the capital of Mauritius, the biggest corporation in Kenya, or the name of the stock market in Latvia. Can you? For me, any investment in these markets couldn't be based on "investing in what I understand," it would have to be blind trust in someone's advice--or a gambler's hunch.

My personal opinion is that this is trendy nonsense.

If some index provider has total international index that includes these stocks at global cap weight, and Vanguard decides to change to using that index, I wouldn't quit using Total International, but I see no reason to be in any hurry to add them--much less overweight them.
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Re: Frontier Markets - 5% of portfolio?

Post by lack_ey »

Well, investing history seems to indicate that bigger gains are made investing in uncomfortable places, so if you're going to gamble, maybe here's a place. (with the knowledge that there are innumerable counterexamples)

As noted above, 5% would be a massive overweight compared to the global market capitalization for equities.
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Re: Frontier Markets - 5% of portfolio?

Post by Maynard F. Speer »

lack_ey wrote:Well, investing history seems to indicate that bigger gains are made investing in uncomfortable places, so if you're going to gamble, maybe here's a place. (with the knowledge that there are innumerable counterexamples)

As noted above, 5% would be a massive overweight compared to the global market capitalization for equities.
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Re: Frontier Markets - 5% of portfolio?

Post by alex_686 »

Johno, you bring up some good points. 3 responses.

First, be careful in using indexes to benchmark performance, you may be using the wrong ruler when measuring. For ease, most studies chose an index and see how funds preform. However, the portfolio manager might not be managing to that index. "mismatch" error is very high in EM funds. I am not saying that the average fund outperforms the average of the market – that is not mathematically possible. Evaluating is hard.

Second, indexes are just models or the real world, and EM indexes have a relatively low fidelity compared to the developing market counterparts. I will point out that passive funds also lag. So at this point everybody lags the index.
Johno wrote:OTOH broader efficiency issues like state or family controlled entities shunting profit from public to affiliated private entities (or themselves directly) affects all investors in the public market, and the market doesn't have to be very efficient to see that that is happening (again why would foreign managers see this and local public market traders not see it?) and discount those stocks. So siphoning away of asset returns from the public market is arguably a major efficiency issue in EM's*, but doesn't give foreign fund managers any particular way to beat the public index.
This is just not true. Funds can underweight countries with poor investment protection laws. They can be activist in improving corporate governance. They can walk away from individual companies. If liquidity is low and spreads are high, a active fund can skip that market. Now, why would foreigners be better at this than the locals? Locals have a home basis, just like many Americans overweight US stocks. Locals might be legally restricted to their home market. The government might be propping up the stock market with direct buying through a pension fund or indirectly by putting high local requirements on state supervised insurance funds. etc. Now, I can find cases where locals are better than foreigners. Active funds offer advantages in these situations, not slam dunks.
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Re: Frontier Markets - 5% of portfolio?

Post by Johno »

alex_686 wrote:
First, be careful in using indexes to benchmark performance, you may be using the wrong ruler when measuring. ...Evaluating is hard.
Johno wrote:OTOH broader efficiency issues like state or family controlled entities shunting profit from public to affiliated private entities (or themselves directly) affects all investors in the public market, and the market doesn't have to be very efficient to see that that is happening (again why would foreign managers see this and local public market traders not see it?) and discount those stocks. So siphoning away of asset returns from the public market is arguably a major efficiency issue in EM's*, but doesn't give foreign fund managers any particular way to beat the public index.
This is just not true. Funds can underweight countries with poor investment protection laws. They can be activist in improving corporate governance. ...If liquidity is low and spreads are high, a active fund can skip that market.
There are cases where particular funds (of many kinds) are hard to capture by benchmarking to indexes, particularly if funds try to have particular risk characteristics different from plain stock exposure; this is a common problem evaluating 'alternative' type funds. But, for straight up equity funds even EM or frontier, I don't really buy that. Even if such funds did something that ended up pretty different than the index, even if the index has 'low fidelity', the index is still a benchmark of some relevance to that area of the market, they still failed to do beat it almost 90% of the time, which must include many cases of trailing it significantly, whereas we know index funds relatively rarely trail indexes by much, even in EM. No active manager is pitching his fund upfront as 'OK I'll almost surely trail the index, but...'

On the third point I gave an example where important inefficiency might affect investors but not actually give much opportunity for active managers to benefit. It's true they can over/underweight countries which they typically do, but in the limit avoiding inefficiencies which suck some of the return out of public markets is going to turn a fund into only quasi-EM if it avoids all markets where that's a problem. And again, the overall statistics seem to say they seldom succeed in beating broad EM index by doing this anyway.

Trailing an index for 10 yrs is a reasonable benchmark for unsatisfactory performance for an active fund and 89+% is a quite high %. As to Maynard's claim that active works better for *small cap* EM, I'd say the data from S&P is inconclusive: 58% of small cap DM/EM trail last 10 yrs, but depending how much they trail and how persistent the over/under performance of various funds is (by which past performance might be used to pick a good fund) the S&P data don't disprove his statement. But when you get to almost 90% of general EM trailing...ifs or buts about indexes aren't going to change the basic conclusion: per S&P's data, general EM isn't even as fertile a ground for active managers as US or DM, or not as fertile for investors in their funds, after expenses.
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stratton
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Re: Frontier Markets - 5% of portfolio?

Post by stratton »

Weird. FRN used to be 2/3 EM. Now it appears to be 100% frontier.

Kuwait 15.21 %
Nigeria 14.55 %
Argentina 13.84 %
Pakistan 10.53 %
United States 9.88 %
Kenya 9.76 %
Oman 6.18 %
Panama 5.78 %
Kazakhstan 4.99 %
Romania 4.48 %
United Kingdom 3.97 %
Poland 0.84 %

I'm surprised nothing is listed for South Africa. A lot of African stocks from smaller countries are listed there.

Paul
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Re: Frontier Markets - 5% of portfolio?

Post by Leeraar »

stratton wrote:Weird. FRN used to be 2/3 EM. Now it appears to be 100% frontier.

Kuwait 15.21 %
Nigeria 14.55 %
Argentina 13.84 %
Pakistan 10.53 %
United States 9.88 %
Kenya 9.76 %
Oman 6.18 %
Panama 5.78 %
Kazakhstan 4.99 %
Romania 4.48 %
United Kingdom 3.97 %
Poland 0.84 %

I'm surprised nothing is listed for South Africa. A lot of African stocks from smaller countries are listed there.

Paul
I would not invest a dime in this.

South Africa? You mean the corrupt and incompetent government that bribed their way to host the soccer World Cup? That recently hosted the perpetrator of genocide in Darfur as a state guest?

The GDP of South Africa is $350 billion. Yes, bigger than Greece. But, the economy and markets are still very much subject to manipulation and corruption.

I could go on, but I think "Frontier Markets" is synonymous with "basket cases". It is very naive to think you can invest there and not be a sheep for the shearing.

L.
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Re: Frontier Markets - 5% of portfolio?

Post by Northern Flicker »

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Maynard F. Speer
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Re: Frontier Markets - 5% of portfolio?

Post by Maynard F. Speer »

Leeraar wrote:
stratton wrote:Weird. FRN used to be 2/3 EM. Now it appears to be 100% frontier.

Kuwait 15.21 %
Nigeria 14.55 %
Argentina 13.84 %
Pakistan 10.53 %
United States 9.88 %
Kenya 9.76 %
Oman 6.18 %
Panama 5.78 %
Kazakhstan 4.99 %
Romania 4.48 %
United Kingdom 3.97 %
Poland 0.84 %

I'm surprised nothing is listed for South Africa. A lot of African stocks from smaller countries are listed there.

Paul
I would not invest a dime in this.

South Africa? You mean the corrupt and incompetent government that bribed their way to host the soccer World Cup? That recently hosted the perpetrator of genocide in Darfur as a state guest?

The GDP of South Africa is $350 billion. Yes, bigger than Greece. But, the economy and markets are still very much subject to manipulation and corruption.

I could go on, but I think "Frontier Markets" is synonymous with "basket cases". It is very naive to think you can invest there and not be a sheep for the shearing.

L.
I believe $1 invested in S.Africa would've turned into $3,372 since 1990, while the S&P 500 would've only returned $1,248

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Robert T
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Re: Frontier Markets - 5% of portfolio?

Post by Robert T »

.
One argument sometimes put forward is that as Frontier Markets (FM) 'will' be an increasing share of the overall market now's a good time to get exposure to these markets:
  • • The weight of emerging markets in the MSCI All Country World Index increased from 1% in 1987 to 13% today.
    • Today the MSCI Frontier Markets index accounts for less than 1% of the global stock market.
A caveat – not all frontier/EM markets perform well or there would be no EM/FM asset class - so no guarantee of an increasing market share.

However, as we know an increasing equity market share does not automatically equal higher equity returns. The increase in market share of MSCI EM from 1% to 13% does not imply a 13 fold higher return than the rest of the market. Annualized returns from 1988-2014 for MSCI EM (11.6%) were higher than US (10.8%) and EAFE (5.3%), but start 1 year later in 1989 (when EM market share was still 1%), and you get the following:
  • Annualized return: 1989-2014 (from DFA Matrix Book 2015)

    10.6% = MSCI EM
    14.4% = Dimensional EM Value
    12.4% = Dimensional EM Small

    10.6% = US CRSP1-10
    12.0% = Dimensional US Large Cap Value
    14.8% = Dimensional US Small Cap Value
    13.1% = Dimensional US Small Cap

    4.5% = MSCI EAFE
    9.2% = Dimensional International Small Cap Value

    What EM mainly provided for a US tilted portfolio over this period was diversification (similar returns but low correlation). EAFE has had tough period.
Frontier markets are currently no cheaper than EM: Current valuations: P/BV (as of June 30) according to MSCI.
  • MSCI US = 2.87
    MSCI EAFE = 1.71
    MSCI EM = 1.55
    MSCI FM = 1.57
On country concentration in the index MSCI EM seemed even more concentrated than MSCI FM at inception.
  • • In 1988 the MSCI EM index comprised only 10 countries, Malaysia (34%) and Brazil (19%) accounting for over 50% of the index. Today the MSCI EM index comprised 23 countries, China (25%), South Korea (14%), Taiwan (13%) accounting for about 50% of the index.
    • Today the MSCI Frontier Markets index comprised 24 countries with Kuwait (21%), Nigeria (15%), and Argentina (11%) accounting for close to 50% of the Index.
Does “political risk” vs. “economic risk” matter – which is arguably higher in FM? DFA has specific country inclusion criteria for their EM funds that they feel must be met in order to accept the assumption that market prices reflect relative value in the included countries. These criteria are:
  • (i) The country must have no restrictions on the repatriation of capital
    (ii) The country must be governed by a rule of law and must have an adequate judicial system to ensure enforcement of contracts
    (iii) The country has no major discriminatory and adverse tax treatment for foreigners
    (iv) Payment vs. delivery of settlement contracts
    (v) Adequate trading volume and adequate trading infrastructure
    See http://www.ifaarchive.com/media/images/ ... mg_mkt.pdf

    As of a result, historically the number of countries included in the DFA EM fund has been lower than the Vanguard EM fund (MSCI EM index).

    Have these criteria made a difference? Returns to DFA EM have been higher than Vanguard EM. Not exactly sure of the source of the difference – whether its from their country inclusion criteria (less ‘political risk’ relative to ‘economic risk’), or from their country cap weighting (about 15% portfolio cap than can lead to a slight smaller cap/value tilt relative MSCI EM).

    And over last 12 years: Annualized retrun: 2003 – 2014

    MSCI EM = 13.1%
    MSCI FM = 9.5%
Currently I don't have a separate allocation to FM. No plans to add.

Robert
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Re: Frontier Markets - 5% of portfolio?

Post by jhfenton »

ajacobs6 wrote: Thanks. Any thoughts on Frontier Markets then? Also, I have some VSS, but not nearly as much as you.
Every so often, I look for an attractive investment vehicle for frontier markets. I haven't found one yet (at least not that I have access to for cost-effective dollar-cost averaging).

But...when/if VWO gets to a full allocation of China A shares--at which point VWO might be close to 50% China--I will probably be more inclined to diversify my emerging markets 15% into something with less (non-US) single-country exposure. That could be a regional EM fund (Latin America, maybe), a frontier markets fund, an emerging markets small cap fund (one with less exposure to China), or something else. I probably wouldn't count it as a separate asset class, just part of my 15% EM allocation.

But for now, I'm content with VWO. It's exposures are reasonable. It's expenses are low. It's available commission-free from Vanguard and TD Ameritrade. And I trust Vanguard.
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Re: Frontier Markets - 5% of portfolio?

Post by pauliec84 »

Robert T wrote:.
What EM mainly provided for a US tilted portfolio over this period was diversification (similar returns but low correlation).
Robert, as always thanks for the thorough post. I think what is most appealing about frontier markets are their potential to, like emerging markets, provide another low correlated equity asset to the portfolio. That is, while the risk/return profile may not look great on the asset level, it may look at lot more appealing at the portfolio level.

Do you have any sense of how including a slice of frontier markets in a standard portfolio has effected standard deviation / 2008 downside compared to a portfolio that has not?
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Re: Frontier Markets - 5% of portfolio?

Post by Johno »

Robert T wrote:.
Frontier markets are currently no cheaper than EM: Current valuations: P/BV (as of June 30) according to MSCI.
  • MSCI US = 2.87
    MSCI EAFE = 1.71
    MSCI EM = 1.55
    MSCI FM = 1.57
On country concentration in the index MSCI EM seemed even more concentrated than MSCI FM at inception.
  • • In 1988 the MSCI EM index comprised only 10 countries, Malaysia (34%) and Brazil (19%) accounting for over 50% of the index. Today the MSCI EM index comprised 23 countries, China (25%), South Korea (14%), Taiwan (13%) accounting for about 50% of the index.
    • Today the MSCI Frontier Markets index comprised 24 countries with Kuwait (21%), Nigeria (15%), and Argentina (11%) accounting for close to 50% of the Index.
Does “political risk” vs. “economic risk” matter – which is arguably higher in FM?
On price book I concur on MSCI's quote for the index, but for some reason the reported P/B of the ETF FM is pretty different, 2.84 a/o same date. Market Vectors Africa (which I mentioned as a 'frontierish' regional fund), reports 1.32. VEMAX/VWO, 1.9. The respective reported PE's of those funds are 16.23, 12.98 and 17.2. The FM fund PE is also substantially higher than MSCI's quote for the index, which as earlier mentioned is ~11-1/2.

On concentration it's true that major EM indicies were and are also pretty concentrated in a few countries. But, one must consider the implications now of concentration in the world's second biggest economy, China v concentration in a random little country, Kuwait. That's not to say the former concentration is necessarily preferable, just pretty different. As jhfenton said, one might actually view some FM exposure now as a partial antidote to VWO's growing concentration in China, especially in light of index change wrt A shares.

Also to repeat, FM (and AFK) have been and probably IMO will be even more correlated to commodities than VWO. VWO has big resource exporters and over/undershoots in growth in China compared to expectations affect commodities disproportionately compared to other large economies as well as affecting stocks there. Still the recent performance of frontier tracks commodities more closely and that makes sense IMO considering the countries and how much of public market related activity in those countries involves commodities. IOW if one doesn't like a commodity comeback story that's another reason not to like FM (or AFK) or vice versa, though either way might be a reason to expect relatively lower correlation from FM.

On political risk or corruption, for fun I took the weighted average of Transparency International perceived corruption scores for FM and VWO, which came out 36 and 43 respectively. That makes Brazil the average country corruption perception-wise in VWO, its neighbor Argentina closest to the average in FM, not really a big difference. The US is 74, some north European/Nordic countries and Singapore are in the mid 80's to low 90's. That's not a measure of political risk per se or even the effect of actual corruption on investors per se, but my general impression is that the difference in FM v VWO 'non-economic' risk isn't necessarily that great.
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Re: Frontier Markets - 5% of portfolio?

Post by Robert T »

pauliec84 wrote:
Robert T wrote:Do you have any sense of how including a slice of frontier markets in a standard portfolio has effected standard deviation / 2008 downside compared to a portfolio that has not?
pauliec84,

You can try adding in the combinations you want to test - annual series only starts in 2003 https://www.msci.com/resources/factshee ... ex-net.pdf

For 75:25 stock:bond ETF portfolio I track in M*, with 13% of stock in EM it did not add much/anything - at least so far. Replacing EM with FM lowered returns and SD for no change in Sharpe. 50:50 EM:FM - lowered return and SD with 'almost undetectable improvement in Sharpe.

2003-2014: Annualized return [%] / SD / Sharpe Ratio

10.3 / 16.1 / 0.630 = Using 100% MSCI EM
10.1 / 15.6 / 0.630 = Using 100% MSCI Frontier Markets
10.2 / 15.8 / 0.632 = Using 50:50 MSCI EM:Frontier Markets

Had to expand the Sharpe decimal places to find any benefit.

Robert
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Re: Frontier Markets - 5% of portfolio?

Post by dc81584 »

0% for me, and I, too, have several decades before I will need to touch my retirement money. Emerging markets are volatile enough, thank you very much, and I only hold the market weight in those.
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Re: Frontier Markets - 5% of portfolio?

Post by pauliec84 »

You can try adding in the combinations you want to test - annual series only starts in 2003 https://www.msci.com/resources/factshee ... ex-net.pdf

For 75:25 stock:bond ETF portfolio I track in M*, with 13% of stock in EM it did not add much/anything - at least so far. Replacing EM with FM lowered returns and SD for no change in Sharpe. 50:50 EM:FM - lowered return and SD with 'almost undetectable improvement in Sharpe.

2003-2014: Annualized return [%] / SD / Sharpe Ratio

10.3 / 16.1 / 0.630 = Using 100% MSCI EM
10.1 / 15.6 / 0.630 = Using 100% MSCI Frontier Markets
10.2 / 15.8 / 0.632 = Using 50:50 MSCI EM:Frontier Markets

Had to expand the Sharpe decimal places to find any benefit.
Robert. I appreciate the thorough analysis. Hard to draw to strong of conclusions from just 12 years of data. In absence of empirical data it may be worthwhile to relay on theory, and given the fractional weights of Frontier Market in the global portfolio not much of the case to be made for it there.

Only case seems to sort of the (perhaps misguided) hope that Frontier Markets will fufil the role of emerging markets over the past few decades of being an asset with low correlation and high return relative to the developed equity markets. I was surprised to see the fund has gathered $586 million in assets. So at least some people are buying that story.
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Re: Frontier Markets - 5% of portfolio?

Post by Robert T »

.
This Vanguard review shows the following global market shares: https://personal.vanguard.com/pdf/s357.pdf

For MSCI: As of September 30, 2012

US = 47.09%
Developed-ex US = 40.01%
EM = 12.54%
FM = 0.36%

Perhaps I will reconsider/revisit when/if the FM market share increases.

Robert
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Re: Frontier Markets - 5% of portfolio?

Post by MossySF »

Regardless of the merits of Frontier Markets, 5% is not enough to move the needle. For a while, I tried this with 2 FM ETFs and a FM mutual fund. It's just not worth the effort for a 5% allocation. 12.5% minimum (100/8) -- if your stomach can handle a number that high, then consider it.
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Re: Frontier Markets - 5% of portfolio?

Post by Northern Flicker »

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Re: Frontier Markets - 5% of portfolio?

Post by Waba »

In terms of skating where the puck was, I think the interest in EM is based on past glory and dont think EM indices are that attractive from a risk/reward perspective. So in my mind FM is the new EM for those seeking opprotunity and dont mind the volatility.
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Re: Frontier Markets - 5% of portfolio?

Post by Waba »

Leeraar wrote: I could go on, but I think "Frontier Markets" is synonymous with "basket cases". It is very naive to think you can invest there and not be a sheep for the shearing.
Ugly is good imho. For a value investor who is used to having a portfolio of basket cases, FM would make a nice fit. Not so much if you look for sleep good at night investments.
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Re: Frontier Markets - 5% of portfolio?

Post by White Coat Investor »

ajacobs6 wrote:Emerging Markets are one thing. But any thoughts on digging deeper? I have a super long time horizon, I'm wondering if I could benefit from the growth of Malaysia, Vietnam, etc. There are low cost ETFs available. Maybe devoting 5% of the portfolio to this.

Burton Malkiel recommends Frontier investments from Southeast Asia. He recommends the Malaysia ETF.
For what it's worth, I think you're asking the right question. The right allocation for Frontier Markets is 0-5%.
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Re: Frontier Markets - 5% of portfolio?

Post by leonard »

A 5% allocation to any asset class isn't going to effect the outcome of your portfolio materially, so is really not worth the effort.
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Re: Frontier Markets - 5% of portfolio?

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Re: Frontier Markets - 5% of portfolio?

Post by am »

are there any markets that are not in developed, emerging or frontier? Are there any countries that are "below" fromtier level? Just curious.
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Re: Frontier Markets - 5% of portfolio?

Post by nedsaid »

This is an interesting concept but I would think that many Emerging Market funds would have an allocation to Frontier Markets. The other thing to think about is that Frontier Markets would be less transparent and regulated than the Emerging Markets. It really is the wild west out there. Emerging Markets provide enough extra octane for my portfolio, I don't see a need for Frontier Market Funds.
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Re: Frontier Markets - 5% of portfolio?

Post by sawhorse »

jalbert wrote:Six frontier market countries are in the Eurozone, so your investment would be denominated in Euros:

Cyprus, Malta, Lithuania, Estonia, Slovakia, and Slovenia.

-jalbert
What exactly makes a country considered developed or emerging or frontier? Is it at the fund's discretion?
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Re: Frontier Markets - 5% of portfolio?

Post by White Coat Investor »

leonard wrote:A 5% allocation to any asset class isn't going to effect the outcome of your portfolio materially, so is really not worth the effort.
I tend to draw the line at 5%, but the same argument could be used at 2% or 10% or whatever. It's a continuous variable. There isn't actually a line where something is or isn't worth the effort. The lower the correlation and the higher the long term returns, the more useful a small slice can be.
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Re: Frontier Markets - 5% of portfolio?

Post by leonard »

EmergDoc wrote:
leonard wrote:A 5% allocation to any asset class isn't going to effect the outcome of your portfolio materially, so is really not worth the effort.
I tend to draw the line at 5%, but the same argument could be used at 2% or 10% or whatever. It's a continuous variable. There isn't actually a line where something is or isn't worth the effort. The lower the correlation and the higher the long term returns, the more useful a small slice can be.
In this case - I think the 5% rule of thumb is good enough.

I don't the think the exercise to determine the "right for you" value of this continuous variable is worth effort.

Sometimes good enough is good enough.
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Re: Frontier Markets - 5% of portfolio?

Post by lack_ey »

sawhorse wrote:
jalbert wrote:Six frontier market countries are in the Eurozone, so your investment would be denominated in Euros:

Cyprus, Malta, Lithuania, Estonia, Slovakia, and Slovenia.

-jalbert
What exactly makes a country considered developed or emerging or frontier? Is it at the fund's discretion?
It's whatever you consider it, seeing as nobody can agree on the distinctions. For a fund, it's up to them, though if you're looking at an index fund, inclusion is going to be based on the index provider's methodology. They look at market structures and hold meetings to decide this stuff.

For example, see some docs from FTSE:
https://kapost-files-prod.s3.amazonaws. ... t_2012.pdf
http://www.ftse.com/products/downloads/ ... latest.pdf
http://www.ftse.com/products/downloads/ ... Update.pdf
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Re: Frontier Markets - 5% of portfolio?

Post by sawhorse »

lack_ey wrote:
sawhorse wrote: What exactly makes a country considered developed or emerging or frontier? Is it at the fund's discretion?
It's whatever you consider it, seeing as nobody can agree on the distinctions. For a fund, it's up to them, though if you're looking at an index fund, inclusion is going to be based on the index provider's methodology. They look at market structures and hold meetings to decide this stuff.

For example, see some docs from FTSE:
https://kapost-files-prod.s3.amazonaws. ... t_2012.pdf
http://www.ftse.com/products/downloads/ ... latest.pdf
http://www.ftse.com/products/downloads/ ... Update.pdf
Thanks a lot, that's very interesting especially the first document. After that document, I'm pretty hesitant about frontier markets. If Russia only passed 8 of the 21 criteria and is classified as emerging, how poorly do the frontier countries perform on those tests?!

I also have to wonder if a country should be required to meet every criterion to be considered developed. The only thing keeping the Czech Republic from being considered developed is the lack of an advanced derivatives market. The lack of such a market isn't necessarily a bad thing.
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