FINRA Warns About Investing in Nigeria, Lebanon, Other Frontier Markets

The regulator says these markets have 'heightened risks'

Ho Chi Minh City, Vietnam. Ho Chi Minh City, Vietnam.

The Financial Industry Regulatory Authority says when it comes to putting assets into countries like Lebanon, Nigeria, Vietnam, Slovenia and Argentina, investors should carefully consider the “heightened risks.”

FINRA issued an investor alert Thursday to encourage investors — and their advisors — to review the pros and cons of such investments before using them to diversify portfolios and boost performance.

"Investors seeking potentially higher returns in frontier funds should understand that the promise of higher returns always carries more risk — and the past performance of any fund is never a guarantee of future results," said Gerri Walsh, FINRA's senior vice president for investor education, in a statement.

"Before investing in a frontier fund, investors should consider whether and how such an investment might fit as part of a well-diversified portfolio," Walsh said.

While there’s no exact definition of a frontier market, the phrase tends to refer to countries that are less developed than emerging markets like Brazil, Russia, India and China.

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 in the frontier nations, FINRA notes.

This means their market depth and breadth is likely to be limited, and capital flows are probably more restricted with fewer investor participants and major companies than in the emerging markets.

Some funds invest in more than 30 frontier markets; others invest more narrowly. The same is true of their sector holdings.

Frothy Growth?

FINRA described the frontier markets as risky earlier this year, when it added frontier funds to its list of products that it was watching in terms of both advisor marketing and investor suitability.

But recent performance and investor interest may have prompted the regulatory group to issue its warning on Thursday.

The iShares MSCI Frontier 100 Index Fund (FM), for instance, is up about 15% this year, while the Morgan Stanley Frontier Emerging Markets Fund (MFMPX) has improved 14%.

The Morgan Stanley fund has about $600 million in assets. Morningstar gives it five stars. Holdings include the National Bank of Kuwait, Nigerian Breweries and Banca Transilvania.

Last year, it jumped 32.5%. The fund’s current beta (or risk measure) is 0.5. (Beta greater than 1 indicates investments are more volatile than the general market).

Other frontier-focused financial products include the Templeton Frontier Markets Fund (TFMAX), which has some $1.6 billion in assets. The four-star fund is up about 7% this year.

In 2009, the fund soared 44%, but it fell 19% in 2011.

Other ETFs include the Guggenheim Frontier Markets (FRN) and Global X Next Emerging & Frontier ETF (EMFM).

Overall, betas for funds in the frontier-markets category stand at 1.08 on a three-year basis, 1.02 on a five-year basis and 1.16 on a 10-year basis.

Frontier Roadmap

FINRA recommends that investors and advisors take four steps when investing in frontier-market products.

  • Monitor changes in index components: Understand the index that the fund tracks and also the components of that index; countries included in a frontier index can change over time.
  • Be aware of geopolitical and currency risks: Some frontier markets are located in parts of the world with unstable political or market environments, according to the regulatory organization.
  • Factor in costs and fees: Frontier fund costs and fees may be higher than in both the emerging market and in broadly diversified domestic and international managed funds.
  • Consider performance history. Frontier funds are relatively new, FINRA points out, meaning that many have limited performance histories.

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Check out FINRA Warns of Stock Scams Tied to Ebola, Other Viral Diseases on ThinkAdvisor.

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