These Mutual Funds Actually Beat The Index. And “The Market”

by Darwin on February 14, 2013

I usually deter investors from chasing hot mutual funds based on last year’s returns because they tend to have much higher costs and managers find it difficult to repeat the performance. In fact, most mutual fund, hedge fund and individual money manager outperformance in a given year is due solely to luck and not skill (eloquently outlined in Nassim Taleb’s Fooled by Randomness with data and logic).  However, this weekend I came across a piece on frontier markets mutual funds that have been routinely beating their index (if you can call it that) and the market at large due to the obscurity of their investments.  I wanted to independently verify how they do against common ETFs in the sector and I was shocked!

Frontier Markets Mutual Funds

Frontier Markets is the latest moniker one level past “emerging markets” that showed such great performance during the past bull market.  Now that many of the key emerging markets seem to have played themselves and in many cases, dissapoint (BRICs for instance), the last frontier of rapid growth may reside in these economies.  There are a few mutual funds in this space that have been beating both a broad index of frontier markets and the ETFs that seek to replicate those returns via a passive index.  Here are some 2012 results and then an analysis as to why:

Mutual Funds:

  • Frontaura Global Frontier Fund +18%
  • BankInvest New Emerging Markets Equities Fund +37%
  • Templeton Frontier Markets +24%
  • HSBC GIF Frontier Markets +24%

ETFs and the Index:

  •  Guggenheim Frontier Markets (FRN) +8.9%
  •  PowerShares MENA Frontier Countries (PMNA) +3.6%
  • MSCI Frontier Market Index +8.4%

Here’s Why Frontier Markets Mutual Funds Beat ETFs:

As I’ve said in the past (and have proven at my other site ETF Base, ETFs are usually a much better investment because managers can’t help themselves.  They over-trade, pay themselves a handsome fee and then lose to the index while generating higher tax liabilities for the mutual fund holders).  However, what differentiates frontier markets from larger equity mutual fund vs ETF debates is that there is so little intelligence on these small companies that there IS a asymmetry of information here. Markets are NOT as efficient as your typical S&P500 stock where all information regarding the company is known to all investors simultaneously.  Many of these companies have never even been visited by a fund manager.  There are a select few funds with feet on the ground that actually know what their doing to assess these companies.  Meanwhile, an ETF seeking to replicate frontier markets simply looks at a few of the larger companies in a few select countries, makes up a mix and calls it a representative ETF.

And an index?  Well, take the MSCI Frontier Markets Index for instance.  The largest holdings are from Kuwait (24%), Qatar (15%) and Nigeria (15%).  That’s practically an oil ETF!  This is not the mix of the mutual funds seeking out companies in countries like Kenya and others that are completely off the map in terms of press and oil output.

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Do You Have Other Mutual Funds You Prefer Over an Index or ETF?

Thoughts on Frontier Markets?

 

{ 4 comments… read them below or add one }

Brick By Brick Investing | Marvin February 14, 2013 at 12:09 pm

I personally like to invest in individual securities instead of the mutual funds or ETFs.

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Darwin February 14, 2013 at 9:43 pm

Most of these securities aren’t tradable on US indices; not ADRs. They’re small coffee, phone companies in Africa, etc.

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krantcents February 14, 2013 at 5:15 pm

I think you can always find exceptions to the rule! When you rely on managed funds, they usually beat the index for a number of years and then they don’t. Investing is longer term and you want to average a decent return for 30-40 years not just a 5 year period. Additionally, the funds that consistently beat the index usually have a little more risk.

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Darwin February 14, 2013 at 9:47 pm

In this case, it’s almost like private equity; they’re taking stakes in and trading companies that don’t really have much of a market. Hot money will chase it and eventually returns will peter out; now’s the time of invest in frontier markets probably; within 5-10 years, they’ll be like any other emerging market fund.

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