MSCI held a webinar on “Exploring Frontier Markets” this week which took a look at their two main frontier markets indices: the MSCI Frontier Markets Index and the MSCI Frontier Markets 100 Index. While we’re glad to have institutional interest in Frontier Markets, here are 5 points to keep in mind when using their index as a proxy for Frontier Market performance:
1. The “Frontier Markets Index” includes some of the richest countries in the world:
The index includes countries such as Qatar, Kuwait and the UAE. On a GDP per Capita basis, Qatar is the richest country in the world with Kuwait and the UAE in the top 10. For frontier market investors looking to capitalize on countries in the beginning stages of growth cycles, these are not your usual suspects. In fact, while MSCI’s Market Classification Framework includes “economic development” as one of its three main criteria, this only applies to defining developed markets. For both Frontier and Emerging markets, there is no economic development requirement at all.
2. The “Frontier Markets Index” is actually more of a “Middle East & Nigeria” Index:
As of April 2013, the index is heavily weighted for Middle Eastern countries with Kuwait (24.35%), Qatar (14.96%), and the UAE (11.58%) taking over 50% of the weighting by themselves, and Nigeria taking another 14.4% weighting. That means these 4 countries manage to make up 65% of the index despite there being 25 countries represented in total.
Argentina is the lone representative from the Americas with a weighting of less than 5%. Africa is represented by four countries (Nigeria, Kenya, Mauritius and Tunisia) and together have around a 20% weighting. Asia also has 4 representatives (Pakistan, Vietnam, Bangladesh, and Sri Lanka) but has under 10% of the weighting. This means that the usual Frontier Markets markets investors focus on, Africa and Asia, are actually the minority in this index.
3. Their Frontier Markets Index returned less AND was less risky than their Emerging Markets Index:
From its inception in May 2002 to April 2013:
- MSCI Frontier Markets Index Annualized Return: 9.87%
- MSCI Emerging Markets Index Annualized Return: 13%
- MSCI Frontier Markets Index Annualized Std Dev: 20.38%
- MSCI Emerging Markets Index Annualized Std Dev: 24.07%
Frontier markets are usually volatile and not guaranteed to outperform, so it wasn’t too surprising to see the EM index beating the Frontier Markets. However, the volatility/risk in their Frontier Market Index is also lower than the EM Index, a surprise at first glance since we expect them to inherently be more risky. However, it’s not as big a surprise due to points #1 and #2 with the large weightings in rich, developed countries.
4. Liquidity is measured using Annualized Traded Value Ratio (ATVR)
What is ATVR you ask? It is the main number used to quantify and filter markets depending on how liquid they are. ATVR is calculated as the median value of shares traded everyday in relation to the market capitalization of the stock. You can see the exact calculations here, but it basically measures the percentage of total share value that get traded every year.
The minimum requirement to qualify for the Frontier Markets Index is an ATVR of 2.5%, although this is considered a “very low” level. “Low” liquidity frontier markets have an ATVR level of at least 5%, while the average ATVR for frontier markets is 15%. As a comparison, the Emerging Markets index has a minimum ATVR of 15%, while to qualify as a Developed market requires an ATVR of at least 20%.
5. The MSCI Frontier Markets 100 Index Overweights the Middle East and Financials
The MSCI Frontier Markets 100 Index was created to lower tracking error and increase investability when compared to the parent MSCI Frontier Markets Index. They do this by filtering out companies with an ATVR below 10% and those with restrictive Foreign Ownership Limits, then taking the largest 100 companies.
These changes mean weightings for Kuwait (+5%), Qatar (+2%), and the UAE (+1%) are even higher since they are the most liquid countries included in this index. In fact of the Top 10 Constituents, 8 of the companies are from these three countries.
When looking at sector weights, Financials (+2%) and Telecoms (+2%) are the main beneficiaries. This is not a surprise since they are the largest sectors represented worth about 65% of the total weighting.
Creating a Frontier Market index is an arduous proccess given the illiquid and scattered candidate markets that could be included. While we’re glad that MSCI has gone to the trouble of creating an index focused on Frontier Markets, it’s reliance on a core group of Middle Eastern countries distorts the global performance of frontier markets, and makes for a poor index to compare your true frontier-focused portfolio to.