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PAKISTAN TO RETURN TO EMERGING MARKETS
JULY 2016
MSCI to upgrade Pakistan from Frontier Markets (FM)
to Emerging Markets (EM), effective May 2017.
improving liquidity in the Pakistani equity market have
allowed the country to meet the requirements for a
return to emerging market status, which will happen
next year. Although the announcement did not come as
a major surprise given the positive feedback to MSCI
from investors and the liquidity-driven nature of such
reclassifications, we believe that Pakistani stocks may
benefit from increased demand resulting from a move to
Pakistan, at 8.4% of the FM Index, will account for only
0.2% of the EM Index.
The upgrades creates a meaningful opportunity for
capital appreciation, as passive index followers add
exposure and active investors recognize the improving
market conditions and stability acknowledged by MSCI
in the reclassification.
a more benchmarked index.
Pakistan is a relatively large and liquid market
compared to other frontier countries, but will be
overshadowed by the major constituents of the Emerging
Markets Index. The country currently represents 8.4%
of the MSCI Frontier Markets Index, yet it will have
the smallest representation of any country in MSCI’s
Emerging Markets Index with a 0.2% weight. In Figure
1, we provide a list of companies MSCI indicates are
provisional Pakistan index constituents as it moves to
EM. Post-implementation, liquidity may tail off once
investors have gained needed exposure. This was the
case in Qatar, where liquidity fell to near 10-year lows
after joining the EM index, although other countries such
as Morocco have seen liquidity trend higher despite
having been downgraded from EM to FM in 2013.
MSCI announced on June 14 that it will be moving
Pakistan from its Frontier Markets Index to Emerging
Markets, to take effect in May 2017 during MSCI’s SemiAnnual Index Review. Emerging markets classification is
not new territory for Pakistan; the country was previously
a member of the index prior to being downgraded in 2008
following a period of market turmoil that halted trading
for months in the local Karachi exchange. Pakistan held
“standalone” status until markets began to function more
normally in 2009 at which time MSCI added the country
to the Frontier Markets Index. Since that time, Pakistan
has recovered to be one of the strongest performing
markets across frontier countries. Recent growth and
FIGURE 1
Provisional Pakistan Constituents for the MSCI Emerging Markets Index
Oil & Gas Development
Habib Bank
Market Cap
(USD)
Index
Family
Sector
Industry
Energy
Oil, Gas & Consumable Fuels
4,786
Large Cap
Financials
Banks
2,428
Large Cap
MCB Bank
Financials
Banks
2,147
Mid Cap
United Bank
Financials
Banks
1,823
Mid Cap
Lucky Cement
Materials
Construction Materials
1,765
Mid Cap
Engro Corporation
Materials
Chemicals
1,557
Mid Cap
Fauji Fertilizer Co
Materials
Chemicals
1,335
Mid Cap
Hub-Power Co
Utilities
Independent Power & Renewable Electricity Producers
1,153
Mid Cap
Pakistan State Oil Co
Energy
Oil, Gas & Consumable Fuels
942
Mid Cap
Source: MSCI. The securities mentioned should not be considered a recommendation to buy or sell individual securities. MSCI Copyright MSCI 2016. All
Rights Reserved. Unpublished. Proprietary to MSCI. As of 4/19/16.
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For institutional investor use only. Not to be reproduced or disseminated.
MSCI UPGRADE DECISION
2014. MSCI’s upgrade announcement created a material
return appreciation catalyst, as the Qatar and the UAE
returned 54% and 98%, respectively, from the time
that MSCI announced the upgrade to the time that the
upgrade was implemented.
We believe there is significant opportunity for
appreciation for Pakistan as it heads into its upgrade,
given the need for passive emerging market investors
to rebalance significant capital into this country.
As described in our 2015 paper “Transition Strategies
Around MSCI Reclassifications” there is evidence of
price appreciation in the period from announcement
date to implementation date for countries moving into
indexes with a higher percentage of assets owned by
index tracking strategies. There is also evidence of price
appreciation pre-implementation for countries being
“upgraded” to an index reflecting higher levels of
market development. Both are true in Pakistan’s
case, and Figure 2 shows that Pakistan has begun to
Pakistan was broadly expected to be upgraded, as it
meets almost all of MSCI’s emerging market criteria.
Ultimately liquidity tends to be an important driver
of MSCI’s decisions, and Pakistan’s relatively broad,
liquid profile was a meaningful consideration. In addition
to investor response to the proposed upgrade, there
was a subjective element that added uncertainty to
the upgrade: political risk. While this risk has been
limited since the peaceful transition of power to Prime
Minister Nawaz Sharif in 2013’s democratic elections,
and the current regime’s demonstration of strong support
for the private sector has further helped to improve
Pakistan’s standing.
The country has a long history of political volatility
and its market remains susceptible to event-related
selloffs. The recent period of relative calm has helped to
stabilize the market, but Pakistan remains a market that
is highly influenced by political events both at home and
throughout the region.
outperform both the EM and FM Indexes since May.
Index-transition considerations aside, the country’s
structural growth story as well as its discount relative
to emerging markets today are additional reasons to
expect potential price appreciation. Specifically, Pakistan
currently trades at a P/E multiple of 10.1x earnings; a
discount to both the Frontier Markets Index (10.5x) and
Emerging Markets (14.3x).
WHAT HISTORY SHOWS
There are only two precedents of countries being
upgraded from frontier to emerging market status:
Qatar and the UAE which were upgraded together in
FIGURE 2
¢ EM
¢ FM
¢ Pakistan
YTD Performance: Pakistan, EM and FM Indexes
RETURNS (%)
20
15
10
5
0
-5
-10
-15
Jan-16
Feb-16
Mar-16
Apr-16
May-16
Jun-16
Index Source: MSCI Copyright MSCI 2016. All Rights Reserved. Unpublished. Proprietary to MSCI.
For illustrative purposes only. It is not possible to invest directly in any index. Every Investment program has the opportunity for losses as well as profits. Past
results are not indicative of future results.
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For institutional investor use only. Not to be reproduced or disseminated.
FIGURE 3
¢ MSCI Emerging Markets
¢ MSCI Frontier Markets
Qatar, UAE and Index Performance
RETURNS (%)
¢ MSCI Qatar
¢ MSCI United Arab Emirates
120
90
60
30
0
-30
-60
Pre-Announcement
01/01/13 - 06/11/13
Pre-Implementation
06/12/13 - 05/31/14
Post-Implementation
06/01/14 - 06/23/16
Index Source: MSCI Copyright MSCI 2016. All Rights Reserved. Unpublished. Proprietary to MSCI.
For illustrative purposes only. It is not possible to invest directly in any index. Every Investment program has the opportunity for losses as well as profits. Past
results are not indicative of future results.
While UAE and Qatar enjoyed significant rallies in the
period between announcement and implementation of the
re-classification, the countries retreated after the upgrade.
As shown in Figure 3, UAE and Qatar have declined
approximately 40% in the two years following their upgrade
to EM. Liquidity has also tailed off, with trading volumes
for the first five months of 2016 less than half of those
registered in the first five months of 2014 leading up to the
reclassification. There have been many potential drivers
for the selling in the UAE and Qatar including governance
concerns at the corporate and country level, their relatively
low weight in emerging markets, the drop in oil prices, and
sensitivity to emerging markets.
Vietnam, and there may be an improving liquidity profiles
in other countries with improving fundamentals, including
Argentina and Romania.
In Acadian’s frontier market portfolios, our policy is to
largely follow the S&P Frontier index, so we will continue
to actively invest unless S&P also upgrades the country.
Pakistan is on the S&P watchlist, and we expect an
announcement in late August. Should S&P also upgrade, we
would halt further buying of Pakistani securities in our FM
portfolios upon implementation. Existing positions would
be sold in a transaction-cost sensitive manner rather than
being forced out of the portfolio in a single day.
CONCLUSION
FRONTIER PORTFOLIO IMPACT
As Pakistan moves from frontier to emerging market
status, MSCI’s Frontier Markets Index will lose a
relatively large and liquid market; however, we anticipate
improving liquidity from other Asian markets, as well
as Romania and Argentina, will fill this gap as these
markets mature and evolve. While impacts to emerging
market investors may be minor given Pakistan’s small
share of the Emerging Markets Index, the reclassification
may present an opportunity stemming from increased
benchmarking demand. The recent experience of UAE
and Qatar gaining emerging market status showed
a pattern of price appreciation leading into the
implementation date. From the perspective of Acadian’s
Frontier Markets strategy, our overweight to Pakistan
leaves our portfolios in position to benefit from potential
market-wide price appreciation that may occur leading
into the implementation date.
Our Frontier Market strategy has a significant over-weight
in Pakistan and hence if further appreciation occurs, we
expect to be well-positioned. Further, existing frontier
assets may rotate into other regions as their weights
are increased in the reformulated index, boosting the
opportunity for price appreciation across frontier countries.
The Karachi Stock Exchange is a fairly liquid market,
so the upgrade of the country next year will represents a
loss of asset class liquidity for frontier markets. However,
our portfolios are attuned to the low liquidity nature of
this asset class and will be able to rebalance our 17%
Pakistan portfolio exposure across other frontier countries.
Further, we believe there are other sources of liquidity to
offset the impact this upgrade. For example, other Asian
markets are similarly liquid, including Bangladesh and
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