When the stock market turns ugly, the quest for “non-correlated assets” intensifies. And some investors think they’ve found a reliable new non-correlated asset – “frontier markets” – which include Pakistan, Kuwait, the United Arab Emirates (UAE) and other markets throughout Africa and the Middle East.  Now we have been following such at Wildcats for some time now, but they are getting increasing media coverage in the face of the subprime mess.  As noted in a recent Wall Street Journal article:

“…frontier markets have notched big gains in recent years. Bangladesh has more than tripled since 2004. Bulgaria was up nearly fivefold before a recent selloff. Lebanon and Jordan have nearly doubled in the past year.

James Yang

But while frontier markets offer high-return potential, they can also implode. Vietnam’s stock market, for instance, more than tripled in recent years, but this year has shed more than half its value as investors flee rampant inflation and a sagging currency.

…Frontier markets offer opportunities to participate in some of the world’s fastest-growing economies. Parts of Africa, Central and Eastern Europe and the Middle East have been clocking growth of about 6% or more in recent years.

That trend is largely projected to continue through at least 2009, far outpacing developed-economy growth of about 1.3%.

Yet, frontier economies are some of the most volatile financial markets around. Kenya’s stock market, rocked by political strife, lost more than 11% in just 10 days earlier this year.

Romania, which nearly quintupled in the four-year run-up to its recent inclusion in the European Union, has fallen more than 37% in the past year.

…Many frontier markets are already richly priced. Bangladeshi companies tracked by S&P traded in May at 33 times trailing earnings, more than three times the level of 2004. Bulgaria, at a single-digit price-earnings ratio earlier this decade, today trades near 40. And Vietnam, though it has crumbled, still trades near 37.

Frontier markets also are illiquid, meaning investors can have trouble building a position without moving the share price, and can struggle to exit a stock amid chaos. On a recent Wednesday on the West African regional stock exchange in Abidjan, Cote d’Ivoire, only about half the 39 listed companies traded in just 113 total transactions.

The S&P Emerging Middle East & Africa fund, managed by State Street Global, tracks the S&P/Citigroup BMI Middle East and Africa Index. However, “in many cases we can’t acquire some companies in the index,” says Jim Ross, a senior managing director at State Street. “Some shares are virtually uninvestable” because they are so illiquid.

Meanwhile, industry breadth can be narrow, with heavy dependence on banking, locally traded units of global consumer companies and various infrastructure sectors. S&P’s Africa 40 Index is heavily devoted to banks, half of them Nigerian. Banks dominate Merrill Lynch’s Frontier Index as well, comprising 39% of the index.

Some frontier-market economies are riding high commodity prices — particularly many African markets, where oil is fueling growth in places like Nigeria and Ghana. If oil prices crack, they will suffer. Other markets are exporters of agricultural products, and a retreat in food prices would hurt them.

Perhaps the best argument for frontier markets is that they perform so differently.

…Not all frontier funds are created equal, however.

While the T. Rowe fund is up strongly on the year, S&P’s fund is flat. And where T. Rowe’s fund invests heavily in the United Arab Emirates, Egypt, Qatar and Oman, the S&P fund has the bulk of its assets in substantially more-developed markets like South Africa and Israel.

Moreover, because the S&P fund tracks a passive index, its fees are 0.6%. T. Rowe’s fund is actively managed and charges annual fees of 1.92%.”