ETFs investing in frontier countries could become a riskier bet after index provider MSCI upgrades one of its largest constituent countries.
Pakistan, which represents more than 11% of the MSCI Frontier Markets 100 Index, is being upgraded to an emerging market.
The move in June leaves large frontier market index weights like 19.9% in Argentina and 19.5% in Kuwait. The new third spot will be Vietnam - currently at 7.9%.
The country switch will be the largest country shake-up of the index since 2014 when Qatar and the United Arab Emirates were re-classified as emerging markets.
Positive or negative change?
The news will most likely be positive for investors in the $46 million Global X MSCI Pakistan ETF (PAK) and for investors whose emerging markets ETF is about to become even more diversified at a country level.
For investors in the $600 million iShares MSCI Frontier 100 ETF (FM), the largest US-listed ETF in this space, the removal of Pakistan could have a significant impact, however, making the underlying index more concentrated and less liquid.
Despite potential concerns, the underlying index has attracted more than $32 million since 1 January, according to TrackInsight data.
PAK is up 6.2% year to date and 27.5% over one year in USD terms. In comparison, the broader FM fund has raced past year to date with 17.9% returns, but has slipped short of Pakistan’s performance in one year at 17.8%.
Watch out for more switches in frontier markets
Further changes might be coming to the frontier markets index, as the provider is considering upgrading the index’s largest constituent, Argentina, as well as Nigeria, which holds 5%. If the provider decides to upgrade these countries, the changes will be made in 2018.
One other US-listed fund to consider in this asset class is the $15 million Global X Next Emerging & Frontier ETF (EMFM), which costs 0.56% in fees.
Frontier markets have not beaten emerging markets’ performance recently.
The iShares MSCI Emerging Markets ETF (EEM) is on an even keel with FM year to date at 17.8% returns but has soared to 31.5% returns over one year. The asset class has surged in inflows and returns since the election of Donald Trump, thanks to a lack of strong reactions to the President's policy proposals, stabilising commodity prices and a weakening dollar.