June 25, 2021 (MLN): Index provider MSCI has released the results of the 2021 Market Reclassification Review, where it has proposed to downgrade Pakistan to Frontier Markets (FM) from Emerging Markets (EM).
This comes in line with the market expectations as in the annual market reclassification review in Jun-21, there were increased chances of Pakistan being considered for a downgrade.
If MSCI decides to downgrade Pakistan from Emerging to Frontier, it will be in one step coinciding with the November 2021 Semi-Annual Index Review (SAIR). It also proposes to apply the minimum size requirements for Smaller FMs, and the minimum liquidity requirement for Average Liquidity markets (15% Annualized Traded Value Ratio or ATVR).
In this regard, MSCI will consult with market participants on this reclassification proposal until August 31, 2021, and will announce its decision by September 7, 2021.
MSCI has been artificially maintaining Pakistan’s stature in Emerging markets since the country has been no longer meeting EM standards for size & liquidity criteria for the last 19 months, according to a statement released by MSCI.
Therefore, it is now proposed to put Pakistan back to Frontier markets with a higher weight of 2.3% from the existing meager country weight of 0.02% in Emerging markets.
Moreover, Pakistan is likely to have a weight of 5.8% in the MSCI Frontier Market Index. Meanwhile, it is important to note that at the time of Pakistan’s upgrade to MSCI EM from FM in 2017, Pakistan’s weight in MSCI Frontier Markets 100 index was around 8.5%.
The MSCI EM index has three components from Pakistan, but the MSCI FM index is simulated to have four components, with an additional component being the OGDC.
The MSCI EM Small Cap Index has 13 components from Pakistan, while the MSCI FM Small Cap Index is simulated to have 19 components with the additional constituents being INDU, BAHL, ABOT, NBP, SYS, and PKGS.
According to market participants, the aforesaid development is expected to turn out beneficial for Pakistan Stock Exchange as Pakistan would now have a higher weight in FM and could attract more inflows than currently in EM.
Moreover, a small survey conducted by Topline Securities with foreign investors revealed mixed sentiments as 50% believe this development is positive, 25% believe it is likely to have mixed implications and 25% believe it is negative for Pakistan equities.
Commenting on the aforementioned development via series of tweets, Founder and Chief Investment Officer at Tundra Fonder, Mattias Martinsson said, “it would be a good move. At 2bps of MSCI EM it will continue to be ignored.”
He also highlighted shortcomings in the indexing process by stating that there is a structural flaw in the algorithm deciding country weights. As opposed to MSCI EM where 50% free float is required, in the FM index a mere 7.5% free float is required. Not a brilliant idea as it gives a higher weight to “zombie markets” with zero liquidity, he said.
He further said that it is ridiculous that Bangladesh with >150 musd a day has 1/3 of the weight of Kenya with 6 musd.
“There is a long row of markets where annual traded volume is far below 10% of mcp and whose weights are far too high vs what their equity markets offer,” he added.
Increasingly, Frontier markets funds are looking beyond the FM index. When straying outside the index they mainly look towards LMIC-countries (low- and lower-middle-income) like Indonesia, Philipines, Egypt, and Pakistan are the most common examples.
“MSCI really need to rethink their index process for Frontier Markets unless they want the benchmark to completely lose its relevance. Who wants to own a benchmark where the only thing in common is poor liquidity? And still, the ETF has USD 460m in assets,” he said.
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