Some EM-exposed frontier funds ‘to keep QE focus’

The reclassification of the MSCI Qatar and UAE indices is expected to significantly decrease the pool of potential FM 100 Index constituents.

By Santhosh V Perumal/Business ReporterSome frontier market funds that are already exposed to small emerging markets will keep some exposure to Qatar and the UAE after their upgrades take effect, according to EFG Hermes.“We estimate that about $98mn and $95mn in passive funds will exit Qatar and the UAE, respectively,” EFG Hermes said in a report.Allocation changes are likely to occur around the effective date of the UAE and Qatar reclassification, which is expected to be effective on June 2, 2014, it added.On June 11, 2013, MSCI announced its decision to reclassify Qatar and the UAE indices from frontier markets (FM) to emerging markets (EM) coinciding with the May 2014 semi-annual index review.Currently the MSCI FM index (FM 100 index) includes 24 securities from Qatar and UAE, which represent a cumulative weight of 35% in the FM 100 Index.The reclassification of the MSCI Qatar and UAE indices is expected to significantly decrease the pool of potential FM 100 Index constituents. In addition, once the reclassification takes place, the FM 100 Index may exhibit high country concentration. Highlighting that the reclassification of Qatar and the UAE as EM members from June 2014 will shake up the composition of the FM index; EFG Hermes said Kuwait and Nigeria will together account for 44% of the index, leading to high country concentration.MSCI has therefore suggested changes to the methodology for the MSCI FM 100 Index, a subset of the MSCI FM Index that has additional investability requirements relating to liquidity and foreign room. EFG Hermes said very little passively-invested money tracks the MSCI FM index, but EPFR data suggests that around $540mn passively tracks the MSCI FM 100 index. EPFR Global provides fund flows and asset allocation data to financial institutions around the world.MSCI had said early this month that it would launch consultations on potential changes to the methodology for the index given the upcoming reclassification of UAE and Qatar, the results of which will be announced shortly after March 24, 2014.“The main change in our view would be a cap of 40% on the weight of the two largest countries in the index (Kuwait and Nigeria) and changing the parent index to MSCI FM Investable Markets Index,” EFG Hermes said.It said its understanding is that a 40%-cap would only apply to the MSCI FM 100 Index, and would therefore be of greater significance for the about $540mn in exchange traded funds that track that index.“We would not expect much broader impact on frontier market flows because only a small share of frontier dedicated AUM (assets under management) passively tracks the MSCI FM or MSCI FM 100 indices and that the anecdotal evidence suggests that actively-managed FM funds (about $4.9bn) do not track their benchmarks as closely as their EM-dedicated peers,” it said. Although Kuwait would see the largest net inflows; it said the 40% cap would be beneficial for other Middle East and North Africa countries such as Oman and Morocco, which would see passive flows of about $23mn and $15mn, respectively.