Frontier 100: High risk, high potential

Emerging markets feature imperfect protection for private property, government interference in markets and the affairs of companies, low liquidity, low transparency and volatile economies. Frontier markets aren't even up to the emerging stage; they're pre-emerging.

The vehicle we favor for getting exposure to these high risk markets is the iShares MSCI Frontier 100 Index Fund (FM), which was created in September 2012.

The ETF tracks the performance of the MSCI Frontier 100 Index, which is a subset of MSCI's broader Frontier Index. The Frontier 100 includes the 100 largest and most liquid companies in the parent index.

In practice, the Frontier 100 has a 28% allocation to Kuwait, 17% to Qatar, 13% to Nigeria, 12% to United Arab Emirates, 4.6% to Pakistan and the rest to various other countries.

Financial issues represent the largest exposure with 54%, while telecomm services makes up 14%, industrials 12%, energy 8.5%, consumer staples 7% and materials 3%, with utilities and health care accounting for the rest.

The fund is reviewed twice a year to bring its number of securities back to 100 (should any components drop out) and to ensure that no country represents more than 50% of the portfolio.

The current top 10 constituents are National Bank of Kuwait, Mobile Telecom (also Kuwait), Emaar Properties (UAE), Kuwait Finance House, Nigerian Breweries, Qatar Industries, KazMunaiGas Exploration (Kazakhstan), Qatar National Bank, Al Rayan Bank (Qatar) and Qatar Telecom.

Collectively these companies represent about 41% of the portfolio. The individual companies in the Frontier 100 have great stories. We did not know, for instance, that Guinness sells more beer in Nigeria than it does in Ireland!

Right now, however, what's more important is that the MSCI Frontier Markets Fund has a P/E ratio of under 12 and an expense ratio of 0.79%. The fund achieved a return of 8.01% in the first quarter of the year.

The big story is that the potential returns from frontier markets are sizable. These markets are coming off a very low base, and once their economic development begins, progress can be meteoric.

We've seen it before with the emerging markets, and the frontier markets are traveling a familiar road.  We'll put a buy rating on iShares MSCI Frontier Markets Fund.