Frontier Market ETFs Poised To Become Riskier

May 16, 2017

MSCI's frontier market indices will see their biggest shakeup in three years next month. Starting in June, the index provider will begin classifying Pakistan as an emerging market, upgrading the country from its current frontier market status.

The move will have a significant effect on frontier market indices managed by MSCI and the $600 million iShares MSCI Frontier 100 (FM), the largest frontier ETF in the space.

The removal of Pakistan, which currently accounts for almost 11% of the MSCI Frontier Markets 100 Index and the ETF that tracks it, will be the most notable reclassification for the index since Qatar and UAE were upgraded from frontier markets to emerging markets in 2014. Prior to their reclassification, Qatar and UAE accounted for 28% of the index.

Top 10 Country Holdings For FM

Country Weighting (%)
Argentina 19.9
Kuwait 19.5
Pakistan 11.3
Vietnam 7.9
Morocco 6.0
Romania 5.3
Kenya 5.2
Nigeria 5.0
Bangladesh 4.0
Oman 3.3

 

FM To Become More Concentrated

The reclassification of Pakistan is good news for the country, and perhaps for investors willing to hold the single ETF that specifically targets the country, the $46 million Global X MSCI Pakistan ETF (PAK). MSCI noted that the size and liquidity of the Pakistani equity market has grown significantly in recent years, prompting the upgrade.

But for investors who want diversified index exposure to frontier markets―small, investable markets that don't meet the more stringent standards of emerging market classification―the MSCI move raises a potential issue.

Frontier markets are risky. Removing one of the largest and most liquid holdings in frontier markets will make the space more concentrated and even riskier.

Moreover, such reclassification may not stop with Pakistan. MSCI noted that it is considering upgrading Argentina, currently the largest component of FM at 20%, and removing Nigeria and its 5% position from the index also. Those decisions will come next month and likely be implemented in 2018.

In other words, depending on what MSCI does, more than a third of the stocks making up its frontier markets index today could be gone by next year.

 

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