Over the past three years, the MSCI Frontier Market Index has undergone a radical shake-up: three of the largest constituents (Pakistan, Qatar and the United Arab Emirates) have been promoted to emerging markets status, while two other prominent constituents (Argentina and Nigeria) may also soon be out of the index.
It would be too much to ask from fund managers to demand from them to reflect these changes in their funds instantly. In fact, all frontier market equity funds for sale in Europe now have sizeable allocations outside the frontier markets index.
The Schroder ISF Frontier Markets Equity fund, for example, holds companies listed in Pakistan, Egypt, the United Arab Emirates and Saudi Arabia, none of which are represented in its benchmark MSCI frontier market index. If MSCI decides to promote Argentina (which has a 19% weighting in the fund) to emerging market status as well later this week, well over half of the exposure of the fund will be outside frontier markets.
Wouldn’t this be a problem for investors, not least since the fund charges a 15% performance fee based on its relative performance versus the MSCI Frontier Markets Index? After all, the make-up of the fund does not anymore reflect the current frontier market universe.
Not necessarily, believes Alvaro Martin Sauto, head of funds-of-funds at the Spanish bank Bankia, who is invested in the fund. “The fund still gives us exposure to frontier markets, and if they are still trying to beat that index with a high tracking error that is fine for me,” he says.
In practice, frontier market fund managers already have sizeable allocations to emerging markets, but most have so far failed to change the description on the tin
“We also own the Templeton Global Bond Fund, which uses a global benchmark but has a strong bias to emerging markets. We don’t find that a problem either, as long as the manager does a good job.”
Martin Sauto’s flexibility is partly driven by his understanding that it has become almost impossible to run a pure play frontier markets fund, especially when it’s the size of the Schroders one. With assets of almost $1.5bn (€1.34bn), it’s the largest frontier market equity fund for sale in Europe. The frontier market index has a total market cap of only $116bn.
“It’s difficult to keep seeing frontier markets as a differentiated asset class, with so many countries being promoted to EM status,” the Spaniard concludes.
Ignore the index
Andrew Brudenell, manager of the Ashmore Emerging Markets Frontier Equity Fund, has tacitly accepted that large chunks of his fund are now part of the EM index rather than the frontier index, and he doesn’t see it as a problem either, yet.
“We don’t invest in an index. Instead, we aim to provide our clients with an allocation to companies they otherwise would not have exposure to,” he says.