Hedge Fund Managers Head For the Frontier

No, they are not donning a Stetson, cowboy boots, and a six gun to fight Indians in the Wild West, where I live. Their never ending reach for yield is taking them beyond junk bonds and high dividend stocks to small, sub-emerging markets so far off the radar that many don't even have stock indexes. Checked your weighting in the Ivory Coast lately? How about Sri Lanka, Tanzania, or Kuwait? I think not.

So far this year, frontier funds have taken in $1.1 billion in new investment, compared to the previous record of $443 million in 2007. Many of these markets are extremely cheap using conventional valuation metrics. They boast rock solid balance sheets, ironically because many never rated high enough to borrow in public markets.

In exchange for higher returns, managers are accepting higher risk, which in these places may involve the odd expropriation, government overthrow, insurrection, revolution, and terrorism.  They also don't have much liquidity to offer. They are definitely your "Roach Motel" market; you can check in but you can't check out. Where markets exist, there are frequently heavy weightings in single sectors, like banks.

Expect a lot of volatility. The MSCI Frontier Markets Index plunged 55% in 2008, compared to 32% for the S&P 500. You can't buy these stocks online, and opening local brokerage accounts often involves wading through a morass of tedious capital and foreign exchange regulations. How many Dong (Vietnam) do you want to keep on your position sheet?

Claymore offers an ETF (FRN), while mutual fund alternatives are available through Morgan Stanley (FFD) and Templeton (TFMAX). Some countries, like Columbia (GXG) already have dedicated ETF's and have been among the best performing markets of 2010. I have written about frontier markets in the past and similar investment themes like the N-11. Expect to hear a lot more from these quiet back waters of the global capital markets.

By. Mad Hedge Fund Trader