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An MSCI Frontier ETF Finally Arrives

Last week (9/13/12), BlackRock rolled out the first ETF tracking frontier markets based on the MSCI country classification system.  The iShares MSCI Frontier 100 Index Fund (NYSEARCA:FM) follows an index consisting of the 100 largest securities within the MSCI Frontier Markets universe.

iShares Dow Jones US Home Const. (ETF) (NYSEARCA:ITB)

The 20 frontier markets that are currently included in the MSCI designation are Argentina, Bangladesh, Croatia, Estonia, Jordan, Kazakhstan, Kenya, Kuwait, Lebanon, Mauritius, Nigeria, Oman, Pakistan, Qatar, Romania, Serbia, Sri Lanka, Ukraine, the United Arab Emirates, and Vietnam.  The largest country representations in the underlying index include Kuwait 30.8%, Qatar 15.8%, UAE 11.9%, Nigeria 10.6%, Pakistan 4.8%, Kazakhstan 4.1%, and Argentina 3.4%.

FM is holding 97 securities, with the largest allocations going to National Bank of Kuwait 8.0%, Mobile Telecommunications Co. 6.7%, BlackRock FDS III 4.2%, Kuwait Finance House 3.9%, Nigerian Breweries PLC 3.7%, and Kazmunaigas Explora-GDR Regs 3.6%.  Current sector breakdown has Financials at 56.5%, Telecommunications 15.0%, Energy 9.5%, Industrials 8.5%, and Consumer Staples 5.2%.

The new ETF has an expense ratio of 0.79%, and interested investors can find additional information in the press release, overview page, fact sheet (pdf), and prospectus (pdf).

Analysis/Opinion: The MSCI methodology of identifying countries as developed, emerging, or frontier is the most popular country classification system.  The iShares MSCI EAFE Index Fund (ETF) (NYSEARCA:EFA) for international developed markets has been available for more than eleven years, and iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) has been trading since 2003.  Why then did investors have to wait until now for an MSCI frontier market ETF?

The reason it wasn’t available sooner boils down to concerns about liquidity and tracking error.  By definition, the frontier markets consist of some of the smallest countries with the least accessible markets.  In order to address the inherent liquidity concerns, the MSCI Frontier Markets 100 Index (pdf) was invented less than six months ago (4/11/12), consisting of the largest and most liquid frontier stocks.  Claymore/BNY Mellon Frontier Markets ETF (NYSEARCA:FRN) addressed this concern by using the BNY Mellon definition, which requires US-listed ADRs and includes Chile, Colombia, and Egypt – countries defined as “emerging” in the MSCI classification scheme.

Even so, FM will usually not invest in all 100 stocks in the underlying index.  It uses a representative sampling approach, and its third largest holding is currently a money market fund.  BlackRock has stated that it expects FM “to have higher tracking error than is typical for similar index ETFs.”  Additionally, FM is far from a diversified offering with more than half of its assets in Financials and nearly a third allocated to Kuwait.  According to the ETF Field Guide, all other frontier market ETFs target less comprehensive subsets.

Due to their significant differences, there will be times when FM delivers the best performance and times when FRN is the clear winner.  Still, for investors seeking the missing piece of the MSCI global equity puzzle, FM is the best solution.

This article was originally written by Ron Rowland, and posted on Invest With An Edge.

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