Morgan Stanley Capital International (MSCI) in its market classification review has put Pakistan in Emerging Market index (EM) from frontier market index (FM). To recall, Pakistan was part of MSCI EM Index during 1994-2007 but was removed in Dec 2008 due to imposition of price floor and in May 2009, Pakistan was shifted from standalone country index to Frontier Market Index.
Pakistan's re-entry into EM index is a strong bullish event for the stock market. Through this note, we are highlighting the potential impact of this event on Pakistan's stock market so that our clients can take an informed decision about their portfolio allocations.
i) Improved visibility and lower risk: Pakistan's graduation to a higher and more sophisticated index reflects well on market's risk and stability. Emerging market countries are assessed on a more stringent criteria and Pakistan's entry into this club will bring its perceived risk premium down in front of foreign investors. Also, the emerging market index is followed by a much larger number of investors and has several times more funds than frontier market participants.
ii) Strong re-rating case: Pakistan's reclassification from MSCI Frontier Market to Emerging Market could trigger a significant re-rating of the Pakistan Stock Exchange (PSX). Our market is trading at a Price/Earnings ratio (PEx) of 8.5x for FY17 which is a 40% discount to MSCI EM PE of 14.1x. This discount is likely to attract foreign investors to Pakistan. A similar trend was witnessed in case of recent MSCI EM updates of UAE and Oatar, where investors average returns were 21% and 18% in the first and second year of the upgrade as foreign investors rushed to buy cheaper markets.
iii) Sizable Foreign inflow: Although Pakistan's weight in EM will be small, but funds tracking EM (approx. USD1.4-1.7 trillions) are much larger than funds tracking FM (approx. USD17-20 billions). Our back of the envelope calculations suggests gross inflow of USD400-500mn by EM passive funds. However, there will also be an outflow from FM funds, which will lead to lower net inflows. Overall reclassification is expected to attract sizable net foreign inflows of around USD300-400mn of passive foreign flows based on the simulated weight of 0.19% in the MSCI EM Index. Furthermore, active funds, if they buy into the "Pakistan macro story" can invest significantly more than the benchmark weight of 0.19%.
We feel overall improvement in macro-economic indicators like (falling inflation & DR, strengthening FX reserves & exchange rate, healthy current account outlook) and materialization of multi-billion dollar China Pakistan Economic Corridor (CPEC) should complement this decision. All these should lay the foundation for improving investors confidence, forming a strong case of market re-rating.
On the other hand, relative asset classes have little to offer as boom cycle for commodities has seemingly come to an end while local fixed income instruments yield are losing vigor with monetary easing.
On these grounds we recommend investors to increase allocation in equities i.e. ABL Stock Fund and ABL Islamic Stock Fund in order to capture the expected rally in the market following MSCI's announcement. Overall, we expect 15%-20% return from the market over a period of one year. Investors looking for a more moderate allocation can opt for different asset allocation plans under ABL Financial Planning Fund and ABL Islamic Financial Planning Fund.
This publication is for informational purposes only and nothing here in should be construed as a solicitation, recommendation or an offer to buy or sell any fund. All Investments in mutual funds are subject to market risks. These may go up or down based on market conditions. Past performance is not necessarily indicative of future results. Please read the offering document to understand the investment policies and the risk involved including risk disclosures for special features.
