Some Thoughts on MSCI Reclassifications

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After markets closed last night, MSCI announced it will include China A-Shares in its Emerging Market index.  Below, we summarize its findings and give our predictions for future reclassifications.

WHAT WAS DECIDED

From MSCI:  [i]t will include 222 China A Large Cap shares in the MSCI Emerging Markets Index using a 2-step inclusion process. The first inclusion step would coincide with the May 2018 Semi-Annual Index Review followed by the second step which would take place as part of the August 2018 Quarterly Index review.  This will represent an approximately 0.73% increase in China’s overall share in MSCI EM to 28.55%, slightly higher than the 0.5% that was previously flagged.

MSCI also announced that it has launched a consultation on possible reclassification of Saudi Arabia from Standalone to Emerging Market status.  The decision will be announced in June 2018, and we think it will be reclassified then if the Saudi authorities stick to their economic reforms.   If implemented, MSCI estimates that Saudi Arabia would hold a 2.4% share in its EM index.  MSCI asked “Is the current level of opening of the Saudi Arabia equity market to foreign investors sufficient to warrant a reclassification of the MSCI Saudi Arabia Index to Emerging Markets?  Should MSCI give more time before the reclassification in order for market participants to fully absorb the changes that have been implemented in the market?”

MSCI delayed its decision on reclassifying Argentina from Frontier to Emerging.  Argentina currently has a 20.27% share in the Frontier index.  The decision will be announced in June 2018, and we think it will be reclassified then if President Macri sticks to his economic reforms.  MSCI noted that “Although the Argentinian equity market meets most of the accessibility criteria for Emerging Markets, the consistency and persistence of the relatively recent changes as measured in practice still remains to be assessed.”

MSCI delayed its decision on reclassifying Nigeria from Frontier to Standalone.  Nigeria currently has an 8.86% share in the Frontier index.  The decision will be announced in the November 2017 Semi-Annual Index Review, and we think it will be reclassified then if policymaking remains as opaque and unpredictable as it’s been this past year.  MSCI noted that “On April 21, 2017, the Central bank of Nigeria introduced a new FX trading window for investors and exporters that aimed to facilitate the repatriation of capital. To date, investors seem to be cautiously optimistic on the effectiveness of this new window but still require more time to test it further.”

Of note, MSCI did not include Korea in its reclassification plans for June 2018.  Note that MSCI announced in the June 2016 review that Korea would not be included in the June 2017 review for a reclassification to Developed Market status.  MSCI noted then that “the recent changes announced by the Financial Services Commission in South Korea will not take effect until 2017 and the investment frictions related to the lack of convertibility of the Korean Won and restrictions imposed by the local stock exchange on the use of exchange data for the creation of financial products remain unaddressed.”

 

CONCLUSIONS

The MSCI annual review is a good reminder that investors must continue to be discerning within Emerging and Frontier Markets.  Should funds be invested in countries with questionable track records?  Are countries undertaking significant reforms?  Can investors repatriate funds easily?  Bottom line:  China and Argentina are taking the right steps.  Nigeria?  Not so much.