Q: You obviously like emerging markets. Which emerging market countries will take the lead going into 2015?
A: In 2015, some of the smaller emerging, and even frontier markets have the potential to do well because that is where we have seen some of the best valuations and growth. I’m a little bit more concerned about some of the larger emerging markets.
Market Realist – The graph above compares the price returns of the iShares MSCI Frontier Markets 100 (FM) and the iShares Emerging Markets (EEM) over the last 24 months. The former has given a whopping holding period return of 37.2% compared to -1.4% of the latter.
Despite the run-up in the frontier market stocks, there are many reasons why you may consider investing in the space. Firstly, the World Bank predicts that many of these markets will grow at double-digit rates in the coming years.
Secondly, exposure to frontier markets helps diversify a portfolio consisting of just U.S. and emerging market stocks. The correlation between frontier markets and the S&P 500 (SPY)(IVV) is 0.41. The correlation between emerging markets and the S&P 500 is quite high at 0.82, considering monthly returns for ten years. Global equities (QWLD) are becoming highly correlated. However, frontier markets still provide diversification benefits in the interconnected world.
Please read the next part of this series to see whether China (FXI) is currently a good bet.