Looking for Tactical Solutions in 2020? Take a Look at Kuwait | KUW8
A side effect of the rise of
ETFs and index-based investment is that index providers have become the new
king makers when it comes to including a company or even a whole country into
one of their major benchmarks. In 2019, this was the case for Kuwait. The country
was reclassified as an emerging market by the big three, MSCI, FTSE and S&P.
This already had a positive impact on the Kuwait's equity market, but the
final implementation phase is still to take place in May 2020. In this report
we discuss the key aspects that investors should be aware of, if they wish to
consider taking a tactical position in the country’s equity market.
What Reclassification Means for Countries
The decision to reclassify a
country’s classification is not taken lightly. Index companies rely on rigorous, data driven processes, as they are well aware of the potential cash
flows such a decision might trigger and the implications for stock prices in
the affected markets. After all, the last decade has seen the rise of index-based
investing, with global assets exceeding USD 5 trillion. But reclassifications
are inevitable as countries develop and their financial markets become more
open. The Middle East has experienced two reclassifications in recent years.
First Saudi Arabi and now Kuwait have been upgraded to emerging market status
by the big three index providers MSCI, FTSE and S&P. While Saudi Arabia has
already experienced the final stages of that process this year, Kuwait will go
through the final, and for tactical investors potentially most relevant,
implementation phase in May 2020. This analysis focuses on the prospect of
Kuwait’s equity market going into 2020.
Figure 1 shows a summary of key
metrics relevant to the upgrade decision. The first two lines show the expected
weight of Kuwait in the respective EM indices of each index provider as well as
the dates when the decision will actually be implemented. The implementation
date is something that tactical investors should be cognisant of, as this is
the time when investment managers who track the respective EM indices will
rebalance their portfolios. It might not happen precisely on that date as each
portfolio manager will have his/her own strategy on how to conduct the rebalance
without impacting market prices and without being caught out by tactical
investors who try to take advantage of these rebalances. However, they usually will
not want to deviate too much from this date as they would otherwise risk
incurring tracking error against the index.
Figure 1. Key Metrics Relating to Kuwait's Reclassification to Emerging Market Across Index Providers
Source: FTSE Russell, MSCI, S&P, KMEFIC, HANetf; Past performance is no indicator of future performance.
* Expected flows based on estimates before
implementation started. For FTSE, best estimates of realized flows, as measured
by Bursa Kuwait, seem to have matched expected flows. For S&P, realised
data has not yet been collected. For illustrative purposes only.
Marked in green, we see the
actual expected asset flows from passive investors. These estimates are based
on the size of total assets tracking an index providers EM benchmarks,
multiplied by the weight of Kuwait in those indices. MSCI is the most widely
tracked EM equity benchmark and hence attracts the largest passive flows.
Interestingly, based on a research report from Goldman Sachs, it is expected
that active investors might add an additional $7.5 billion in the context of
this upgrade. If we put the total number of $10 billion in relation to the
investable market capitalisation of the MSCI Kuwait index, we see that it
equals 32% of the country’s equity market. This is quite a staggering number.
Even if this is not done on a single date but spread over weeks or months, we
expect it to create meaningful upside pressure on affected stocks.
Learning from Experience - Saudi Arabia: A Case Study
Moving on from the technicalities
of the index implementation process, we decided to take a look at a similar
historical reclassification decision and see if we can identify any patterns
that can help us estimate how the final implementation phase for Kuwait might
play out in terms of equity market performance. Fortunately, there was another
country from the same geographical region that went through the same process
just a year prior, namely Saudi Arabia. Figure 2. shows Saudi Arabia’s equity
market performance during the MSCI reclassification process relative to the
performance of the broader MSCI Frontier Market Index. We have circled the two
most interesting observations. Notably, Saudi Arabi outperforms the Frontier
index during the period January to June of 2018 and 2019. In both years, June
was the date when MSCI took the upgrade and implementation decision, while
January is often a time when investors position for the new year ahead. While
there are of course many factors impacting investors’ investment decisions, it
seems plausible that investors might have positioned themselves for the
respective MSCI events at the beginning of each year (both events including
dates were announced in advance), thereby creating positive pressure on Saudi
Figure 2. Case Study Saudi Arabia. Equity Market Performance During MSCI Upgrade
Source: FTSE Russell, MSCI, Bloomberg; Past performance is no indicator of future performance.
Next, we want to look a bit
closer at investors’ asset flows into Saudi Arabia during the mentioned
timeline. We do this by looking at asset flows into respective Saudi ETFs.
Figure 3. shows the aggregate value of all globally available Saudi ETFs.
Figure 3. Case Study Saudi Arabia. ETF Flows During MSCI Upgrade
Source: FTSE Russell, MSCI, Bloomberg.
We can clearly see that assets
started to rise drastically from $350 million in January 2019 to $3 billion by
end of May just before the MSCI implementation. It seems that investors indeed
tried to position themselves ahead of the implementation phase. Assets in
Kuwait ETFs currently stand at $90 million. It is possible that we might see a
proportionate rise during Q1/Q2 2020 in light of the expected MSCI
implementation in May, which could positively support stock prices in that
region and create an interesting tactical opportunity for investors.
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Watch our 90 second explainer video on KUW8 here.
Article Date: 15th November 2019.