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Investment insight: frontier funds face uncertain future

Investment insight: frontier funds face uncertain future

Our head of cross-border investment research, Dr. Nisha Long, delves into the potential shake-up which could see frontier investors rethinking their exposure to the fast-growing sector.

Pakistan will be reclassified by MSCI on June 14 and will leap from a frontier to an emerging market as part of its semi-annual review. It may not be the only nation making this upwards leap.

Both Argentina and Nigeria could also find themselves moving into the realms of emerging markets following further decision-making in June 2017. So, what does this mean for the MSCI Frontier Market index as we know and investors allocating here?

In simple terms, these three nations account for one-third of the entire frontier market index at present – Pakistan is 9.05%, Nigeria accounts for 7.5% and Argentina amounts to a whopping 17.8% of those on the cusp of being considered developing nations.

As they move upwards, there are no markets of comparable size to add to the index, which means risk will rise as investors are dedicated frontier managers are forced into less developed and less liquid alternatives.

This is particularly true if a manager has stringent requirements over investing solely in countries listed on the MSCI index.

In short, as a frontier market investor, you face losing three of its largest and most liquid members which makes the investment case harder for even those who are willing to take on risk.

Historical lessons

The last time the index was affected this way was back in 2014 when UAE and Qatar were reclassified from FM into EM. The market cap of the index halved as soon as these countries were removed from the index which dented overall performance and had an impact on liquidity.

The main worry lies with investors in passive products which track the MSCI Frontier Market index, as they will be forced into new areas and see performance impacted.

This means active managers in this space must be closely watched for those able to weather the change and also those with flexible remits which mean they won’t have to relinquish Pakistan immediately, if at all.

However, frontier market investing is becoming blurred, and this is even before any reclassifications coming from the MSCI. Manager’s active in the Equity – Frontier Markets sector still have large holdings in Qatar as well as the UAE despite their update.

Even with the exclusion of Pakistan from the FM index, it is unlikely managers will offload country holdings en masse.

The blended approach is faring well for performance and this type of investment only becomes an issue if, as an investor, you think you are investing in FM when you are actually invested in a blended portfolio of EM and FMs.

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