Equity analysts are analysing the pros and cons of a possible upgradation, as the MSCI intends to restore the well-performing Pakistani equities emerging market (EM) status. "MSCI... will include the MSCI Pakistan Index in its 2016 Annual Market Classification Review for a potential reclassification to emerging markets," reads a stock filing Wednesday.
Then weighing 0.12 percent, Pakistan was downgraded from EM to frontier market (FM) category due to the imposition of "floor rule" by Karachi Stock Exchange (KSE) after 2008 stock market crisis. Enforced for an uncertain period, the infamous floor, the MSCI observed, had deteriorated investability conditions at the country's bourse. MSCI is reported to have reiterated that the international equity indices were constructed and managed with an objective of being fully investible from the perspective of international institutional investors.
Operating as a stand-alone index post removal till May 29, 2009, the MSCI Pakistan Index was reclassified as a component of the MSCI Frontier Markets Index in the 2009 Semi Annual Index Review. The ensuing years, up to 2014, saw Pakistan index consistently outperforming the frontier market index by 2.3x in terms of average annual returns. Since May 29 when MSCI's Semi Annual Index Review results for its equity indices took effect, there are 16 Pakistani stocks in the MSCI FM Index: HBL, MCB, NBP, UBL, ENGRO, FATIMA, FFC, KEL, HUBC, LUCK and INDU. Pakistan's cluster weighs in the FM and FM 100 indexes at 9.14 and 10.4 percent, respectively.
Excerpts from its Tuesday's Review results show that the MSCI lauded Pakistani equity market for a number of positives marked over the course of past 12 to 18 months. Improvements the MSCI underlined include the launch of Pakistan Unified Corporate Action, Reporting System (PUCARS) at KSE, restricting Negotiated Deal Market (NDM) and the development of an online complaint management system.
"Most accessibility criteria of the Pakistani equity market meet the MSCI Emerging Markets standards, except for some potential issues with the stability of the institutional framework," it observed. The Pakistani equity market has grown significantly with its liquidity also having improved greatly. "As a result, concerns about the potential for failing to meet size and liquidity criteria should there be a negative market event have receded," the MSCI is quoted to have said.
As researchers at Arif Habib Limited (AHL) described it, the significant development for the country's capital markets has made the market observers thinking whether or not the potential up-gradation would benefit Pakistani equities in terms of attracting foreign portfolio investment and strengthening bullish sentiments of the market. Topline analyst Muhammad Tahir Saeed said the reclassification would significantly reduce the number of constituents (companies) listed on MSCI Pakistan Index to six from 16. The country's share in MSCI EM would fall below one percent, he estimated. Saeed, however, noted that although Pakistan's weight in EM would be small, the number of mutual funds tracking EM was many times higher than those tracking frontier markets.
Quoting a CNBC report, the analyst said about $1.5 trillion in mutual funds, Exchange Traded Funds and other funds were benchmarked to the MSCI EM index. "Not only size of passive fund flows would increase, many large EM funds may return back to Pakistan," he viewed. Analysts at AHL research were more elaborate. Dominant in the MSCI EM index, they said, were economically strong countries having more vibrant capital markets. China's weight in the index is 25.3, South Korea 14.6, Taiwan 12.9, South Africa 7.4, Brazil 7.3, India 7.0 and others up to 32.5 percent.
"It would be like being a very small fish in a big pond," the analysts opined. They said the current size of EM index, having 833 constituents with market capitalisation of $4.03 trillion, was far higher than FM index which had 127 constituents of $92.8 billion market capital. "It apparently looks more favourable for Pakistan to be categorised in the higher category," the analysts viewed. However, they said, Pakistan's last 0.12 percent weight in the current EM category would cut its weight with its market capital standing at $4.8 billion compared to FM category's weight of over nine percent and $8.5 billion market capital.
"Understandably, the size of Pakistan cluster... should also yield the same results which is expected to attract only a handful of fund flows given the limited number of EM funds being launched compared to FM category funds," they said. The analysts cited five major factors which, they thought, contributed to changes in the foreign flows in a typical market when it's category is changed: free-float weight/size of the constituents, number of index trackers/ETFs in the category, active fund managers' alignment/tilt to weights according to their eco-political-institutional view of the constituents' market, number of constituents representing a market and number of new funds launch in a particular category given risks versus future growth potential.
In a statement, a KSE spokesman said the most significant potential benefits of the reclassification would be an increase in portfolio flows with greater participation of foreign institutional investors and index-tracking investors. "Very large institutional investors do not look at frontier markets but limit their investments in developed and emerging markets only," he said. Being in the EM Universe would put Pakistan on the radar screen of a very large global investor base, the spokesman said. At the same time, he said, the development would also significantly enhance Pakistan's profile for global fixed income investors who have over $1 trillion invested in emerging market debt.