What is FM? (Pros, Cons, and Strategies)

As global markets continue to evolve, investors seek diversification to maximize returns and manage risks. One such avenue for achieving a diversified portfolio is through emerging and frontier markets. The iShares Frontier and Select EM ETF (FM) provides investors with exposure to these markets. In this blog post, we'll delve into what FM is, its advantages and disadvantages, and how to formulate investment strategies around it.

What is FM?

The iShares Frontier and Select EM ETF, often abbreviated as FM, is an exchange-traded fund aimed at capturing investment opportunities in frontier and select emerging markets. This ETF provides access to economies that are in the developmental stages, potentially offering high growth rates owing to their untapped markets and rapid economic reforms.

FM tracks the MSCI Frontier and Emerging Markets Select Index, encompassing companies that are characterized by potential for significant economic growth but come with higher risk compared to developed markets.

Key Features of FM

• Exposure to 188 companies across diverse sectors in frontier and select emerging markets.
• Investment in smaller, potentially high-growth economies that are not fully developed.
• Focus on markets from regions such as Africa, Eastern Europe, Latin America, and Asia.

FM's index filters stocks based on criteria such as double-digit annualized returns and other key financial metrics to include companies with robust growth potential and market resiliency.

FM Composition

FM comprises companies from various sectors including Financials, Consumer Staples, and Industrials. Some prominent holdings include companies like Equity Group Holdings, National Bank of Kuwait, and Zenith Bank. The ETF avoids heavy concentration in any single country or sector, aiming for diversification and risk mitigation.

Pros of FM

High Growth Potential

Investing in FM gives you exposure to markets that have significant growth potential. Many countries classified as frontier or emerging are undergoing rapid industrialization and modernization. This potentially translates to higher economic growth rates and attractive returns for investors.

Geographical Diversification

One of the biggest advantages of FM is geographical diversification. By investing in frontier and emerging markets, you reduce reliance on developed markets like the U.S. or Europe. This diversification helps mitigate regional economic downturns and political uncertainties.

Unique Investment Opportunities

Frontier and emerging markets often feature companies and sectors that are not well-represented in developed markets. Investing in FM allows for access to unique growth stories, such as the rise of middle classes in developing nations or government-driven infrastructure projects.

Cons of FM

High Volatility

Frontier and emerging markets tend to be more volatile than developed markets. Political instability, currency fluctuations, and economic reforms can significantly impact these markets, making FM a riskier investment option.

Liquidity Concerns

Stocks in frontier and emerging markets may have lower liquidity compared to those in developed markets. This can result in higher bid-ask spreads and potential difficulties in trading large positions quickly.

Higher Expense Ratio

ETFs focused on niche markets like FM often have higher expense ratios compared to their developed market counterparts. This can slightly reduce net returns over time. As of now, FM's expense ratio is around 0.80%, which is considerably higher than broader market ETFs.

FM Investment Strategies

Investing in FM requires a nuanced approach, given the higher risks and volatility associated with frontier and emerging markets. Nonetheless, a well-structured strategy can enhance returns while managing risks effectively.

Long-term Investment Strategy

FM is not suited for investors seeking quick gains. Given the high growth potential but equally high volatility, a long-term horizon of at least 10 years is recommended. Over such a period, the economic reforms and industrial growth in frontier and emerging markets may generate substantial returns.

Complementary Diversification

Because of its unique market focus, FM can serve as a strong complementary component in a diversified portfolio. Pairing FM with more stable, developed market ETFs can balance overall risk and provide growth opportunities.

Tactical Allocation

For investors with a higher risk appetite, FM can be used as a tactical allocation in the portfolio. By periodically adjusting the investment in FM based on global economic indicators and market sentiment, investors can potentially capture short- to medium-term growth in specific regions or sectors within frontier and emerging markets.

Conclusion

While FM comes with its set of challenges like high volatility and higher expense ratios, its potential for substantial growth, geographical diversification, and exposure to unique investment opportunities make it an intriguing addition to a diversified portfolio. By employing a long-term horizon and considering complementary diversification strategies, investors can leverage FM to enhance returns and manage risks effectively.