MSCI's index review on June 11 brought the most significant and
eventful country reclassifications in recent years. Now it's time
to dive into what all those changes will mean for existing
The last time MSCI made a significant country reclassification
was in May 2010, when it upgraded Israel from emerging to developed
status (a year later in May 2011, it did yank Trinidad & Tobago
out of frontier-but that was an insignificant event to ETF
investors at the time).
In this year's review, four countries were either upgraded or
downgraded. Greece was demoted from developed to emerging, while
Morocco was demoted from emerging to frontier. Meanwhile, UAE and
Qatar were promoted to emerging from frontier.
I think Greece's demotion was not only expected but also
somewhat of a yawner. Greece's presence in the $41.6 billion
iShares MSCI EAFE Index Fund (NYSEArca:EFA) is currently less than
Even when Greece jumps into the $35 billion iShares MSCI
Emerging Markets Index Fund (NYSEArca:EEM), with Coca-Cola Hellenic
no longer a part of the MSCI Greece Index-the bottling giant
formerly made up close to one-third of Greece's entire
index-Greece's presence in EEM is likely to be miniscule.
The most significant changes will be felt in the frontier
landscape. Perhaps the most affected ETF will be the $224 million
iShares MSCI Frontier 100 Index Fund (NYSEArca:FM), which holds 100
of the largest, most liquid and investable companies from frontier
markets, per MSCI's classification framework.
Currently, Qatar makes up 18 percent of the fund and UAE makes
up 14 percent (a combined 32 percent). Of the 100 holdings in FM,
23 are currently from Qatar and UAE. This means that once the
changes are implemented, roughly one-fifth of the entire fund's
portfolio will be replaced with securities from other markets.
This may initially create uncertainty for investors in FM, but I
don't necessarily see this as a negative event. In fact, I touched
on this in a previous blog when FM first launched in September
2012, but the promotion of Qatar and UAE might actually provide
more regional diversification to a fund that's highly concentrated
in the Middle East region (more than 60 percent).
With 32 percent of the fund's weighting freed up, that weighting
will need to be reallocated to other securities from other markets,
potentially boosting exposure to other countries like Nigeria,
Pakistan, Kenya, Kazakhstan, Vietnam and Sri Lanka.
From a sector perspective, more than 50 percent of FM is also
currently allocated to financials. Of that 50 percent financial
exposure, more than 9 percent comes from Qatar and more than 10
percent comes from UAE. Without those countries, FM's financials
exposure could decrease to provide a more sector-diverse fund.
Of course, there's always the possibility that the exclusion of
Qatar and UAE might also boost the already-massive 26 percent
weighting in Kuwait. Currently, the index caps a single country to
50 percent, so Kuwait can potentially carry an even bigger hand in
the fund. It's not a certainty but a possibility that's good to be
Finally, let's not forget Morocco. The North African country was
also demoted to frontier, which means Moroccan companies should
eventually be eligible for inclusion into FM. While Morocco's
weighting in EEM is a measly 0.01 percent, Morocco should become a
bigger fish in a smaller pond in FM (I wouldn't be surprised to see
some Moroccan companies in FM in the coming year).
Important to note is that while MSCI announced the
reclassifications last week, the actual changes in the MSCI
Frontier Index for Qatar and UAE won't be implemented until May
2014, which will give investors and funds like FM nearly a full
year to prepare for the changes.
For Morocco and Greece, the changes will be implemented
sooner-currently scheduled for November 2013. That's why we'll
likely see changes in exposure to Morocco before Qatar and UAE in
Still, even after the MSCI reconstitution in FM, investors
wanting more Qatar and UAE exposure should still have plenty of
other ETF options. Qatar and UAE make up close to 70 percent of the
WisdomTree Middle East Dividend Fund (NYSEArca:GULF).
In the Market Vectors Gulf States Index ETF (NYSEArca:MES),
which tracks a Dow Jones Index, Qatar and UAE make up 56 percent,
while the PowerShares MENA Frontier Countries Portfolio
(NYSEArca:PMNA), which tracks a Nasdaq Index, allocates 53 percent
to the two gulf countries.
For those wondering about the $99 million Guggenheim Frontier
Markets ETF (NYSEArca:FRN), I haven't forgotten. There just isn't
much to say about that fund because this recent reclassification
has no effect on it.
FRN not only has zero exposure to Qatar and UAE-it tracks a BNY
Mellon index that's composed of depositary receipts anyway-more
than 70 percent of the fund consists of Chile, Colombia and Peru,
countries that are all classified as emerging by major index
providers like MSCI, FTSE and S&P.
At the end of the day, I don't think any of the recent
reclassifications came as a shock. MSCI has been very transparent
about its review process, and I think the outcome of this past
review was expected.
As for the coming changes in iShares' FM, I don't see the
eventual exclusion of Qatar and UAE as a negative development. In
fact, it may even enhance the fund's attractiveness from a regional
and sector-diversification perspective.
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