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iShares’ Frontier Switcheroo

In December, iShares filed for its first global frontier markets ETF—sort of. I was originally excited about the news, hoping for a frontier version of its blockbuster iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM - News).

But, as I blogged after the initial filing , it turned out the fund was planning to track an emerging-frontier hybrid index that included smaller emerging markets such as Colombia, Peru and the Philippines, as well as frontier markets, ex-Vietnam and Nigeria.

Now, just a few months later, iShares pulled a switcheroo with its filing, and will be launching a “pure” frontier markets fund after all.

The new fund will track the new MSCI Frontier Markets 100 Index , which consists of the 100 largest and most liquid companies from the broader MSCI Frontier Markets Index.

I’ve long been an advocate for the need of a global “pure” frontier markets ETF.

I’ve written before about the shortcomings of the Guggenheim Frontier Markets ETF (NYSEArca:FRN - News), which has over 70 percent of the fund weighted in Chile, Colombia, Egypt and Peru. Major index providers like MSCI, FTSE and S'P have all these countries classified as emerging, not frontier.

The only other filing for a “pure” global frontier markets fund is the Global X FTSE Frontier Markets ETF, which is planning to track the FTSE Frontier Markets Index.

Now the question remains, Who will launch first?

I wouldn’t put it past iShares to win this race. The ETF giant has really made a push into the niche fund space in recent months, with funds being rolled out as if they’re being mass-produced on an assembly line.

Of the 91 ETP launches we’ve seen so far in 2012, 39 have been from iShares, including many with catchy ETF ticker symbols.

It looks like iShares is looking to really dominate the industry in every space that it can. And there’s tremendous potential and investor interest in the frontier markets space.

So what will the new fund’s composition look like?

As provided by MSCI, as of April 9, 2012, here is the country breakdown for the MSCI Frontier Markets 100 Index.

Country

Weighting

Kuwait

31.83%

Qatar

15.92%

UAE

11.71%

Argentina

5.76%

Pakistan

4.89%

Nigeria

4.84%

Kazakhstan

4.65%

Bangladesh

4.01%

Oman

3.43%

Croatia

2.38%

Vietnam

2.17%

Kenya

1.74%

Sri Lanka

1.69%

Romania

1.27%

Jordan

1.03%

Mauritius

0.84%

Lebanon

0.82%

Estonia

0.36%

Lithuania

0.27%

Serbia

0.20%

Ukraine

0.17%

Source:MSCI

As you can see, Kuwait, Qatar and UAE carry large weightings in the index, almost 60 percent combined.

However, Qatar and UAE are currently on MSCI’s reclassification review list. Just in December, MSCI announced its decision to keep the two classified as “frontier” for now. But an upgrade to “emerging” status in the coming year or two is very possible.

Should that happen, Qatar and UAE would eventually get pulled from the index and fund, though that might not be such a terrible thing. In fact, that would leave an extra 26 percent to be reallocated to other frontier markets.

In such an event, Kuwait may become even heavier, but other countries like Nigeria, Pakistan, Kazakhstan, Bangladesh, Kenya and Vietnam should get a boost in weighting.

The big question is going to be about investability.

With liquidity still lacking in these smaller, less-developed markets, what will premiums and discounts look like? How efficiently will the creation and redemption mechanism run in illiquid and restricted markets?

Tracking error is another issue. According to its filing, iShares plans on using a “representative sampling” approach, which is another name for “optimizing its portfolio,” both of which mean the fund won’t have to replicate the index.

These are questions that would be interesting to address once the fund launches and its holdings become more transparent.

Still, to me, this upcoming iShares frontier fund has all the makings to potentially become the EEM of frontier markets. It seems the new fund still doesn’t have a ticker symbol picked out.

Can I suggest FFM?

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