By: Brittany DeDiego, Fall 2014 Student Intern
Brazil and China might sound like a fun, exotic vacation spots, but should they be a hotspot for investing? FINRA has posted an investor alert for “frontier funds” that invest in developing securities markets such as Argentina, Lebanon, Nigeria, Slovenia, and Vietnam. Americans may choose to invest in foreign markets as a way to diversify and spread investment risk among foreign markets and economies, and to take advantage of the potential for growth in the emerging market. However, there is also a high risk associated with these frontier investments because of the level of uncertainty associated with these developing markets.
There is no exact definition of a frontier market. In general, they tend to have less developed securities markets and be in countries with emerging economies. These markets are also smaller, with fewer global companies and may have restricted or limited capital flow. They also have fewer safeguards relating to the legal, financial accounting and regulatory infrastructure. Political instability can also be a cause for concern. Other common characteristics of frontier markets include improvements in national education and entrepreneurship, an expanding economy, and a rising standard of living.
Frontier funds may focus on several frontier markets, a specific region’s markets, or just one or two markets. If the fund is registered under U.S. law, the investment firm is required to provide the investors with a prospectus containing details about the investment objectives, major holdings or index that the frontier fund tracks, historical returns on the investment and important information about risks and fees.
In addition to the risks specific to frontier funds, investing internationally carries additional risks that all investors should be aware of. First, the exchange rate between the foreign currency and U.S. currency may increase or decrease your return. Second, there may be dramatic changes in market value, as is always possible in any market. Third, political and social instability can negatively influence foreign markets. Fourth, there is a lack of liquidity due to lower trading volumes and fewer companies in the market. Fifth, there may be less information available and the information available may not be in English. Sixth, you may not be able to pursue legal remedies in the U.S. and you might have problems collecting on a U.S. judgment in a foreign country. Finally, foreign markets operate differently than U.S. markets and might not report stock trades as quickly and might not have the same protections provided domestically.
If you are considering investing in a frontier fund, FINRA has some great tips here on how to help you avoid problems down the road. The SEC also provides excellent information on international investments here.