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With Changes Afoot, Future’s Murky for Frontier ETF


The iShares MSCI Frontier 100 ETF (FM) has had a banner year thus far, particularly when measured against comparable, diversified emerging markets ETFs. Here is the proof: FM is up 15.1% year-to-date while the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) are down 5.8% and 6.9%, respectively.

One of the primary drivers behind FM’s out-performance of rival emerging markets funds is the ETF’s Middle East exposure. Kuwait, Qatar and the United Arab Emirates are the ETF’s three largest country weights, combining for 59% of the fund’s weight. Equity markets in those countries have surged this year, helped in large part by financial services and real estate shares. Some Middle East countries tend to peg their currencies to the U.S. dollar. Consequently, their currencies have held up while many other emerging market currencies faltered. [Middle East Exposure Supports Frontier Market ETFs]

However, FM is going to look a lot different in the second quarter of next year. That is when Qatar and UAE join the MSCI Emerging Markets Index. The index provider announced that promotion earlier this year. While Kuwait will remain as part of FM’s index, the ETF may not offer a sequel to this year’s returns when Qatar and UAE leave. [ Frontier ETFs Leave Emerging Markets in the Dust ]

“The two upgraded countries are the biggest drivers of 2013′s surge. Stocks from the U.A.E. and Qatar rose 47% and 22%, respectively, through August, and together drove about 55% of the iShares ETF’s return for the period,” reports Brendan Conway for Barron’s.

While Kuwait’s weight in FM will likely rise after a bit after Qatar and UAE leave, so will volatile Nigeria’s. Perhaps Pakistan’s presence in FM will increase as well and Morocco will join the fund’s fray because MSCI demoted the North African country to frontier from emerging status this year. Nigeria and Pakistan currently combine for 16.5% of FM’s weight. Other top country exposures include Argentina, Oman and Vietnam.

Upon joining the MSCI Emerging Markets Index, Qatar and UAE will be dwarfed on a percentage basis by the index’s primary engines such as China, South Korea and Brazil. Investors looking to keep some exposure to the Middle East after Qatar and UAE depart FM can consider the high-yielding WisdomTree Middle East Dividend Fund (GULF).

Although GULF is small with $21.8 million in assets under management, the ETF has a 30-day SEC yield of 5.39% and it allocates a combined 73.3% of it weight to Qatar, UAE and Kuwait in that order.

WisdomTree Middle East Dividend Fund

ETF Trends editorial team contributed to this post. Tom Lydon’s clients own shares of EEM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.