In June, major
international equity index provider MSCI confirmed Greece’s sojourn among the
ranks of “developed markets” would end later this year as it will become the
first-ever country to lose its “developed market” status in the MSCI universe.
Interestingly, Greece was classified as emerging when I started with the
Templeton Emerging Markets Group in 1987, and while the recent news might
conjure up images of a significant turn for the worse for the country’s
economic fortunes, MSCI’s explanation for Greece’s reclassification was
actually more mundane.
The division of
MSCI’s equity universe into separate “developed,” “emerging” and “frontier”
indexes was originally conceived in response to the arrival on the world scene
of countries in various stages of economic development. In order to be
classified as a developed market, a country’s gross national income (GNI) per
capita has to have been at least 25% higher than the World Bank’s threshold for
a country to be in a “high income” (i.e. developed) category for three
consecutive years. That would equate to US$15,600, given the World Bank
threshold stood at US$12,475 as of 2011, the latest year for which data are
available. Despite several years of wrenching recession, Greek per capita GNI
has been far in excess of this figure. Indeed, several emerging and frontier
markets would meet this criterion. Therefore, MSCI’s economic development
requirements for index inclusion were not the issue for Greece, but other
factors relating to the ability of international investors to easily enter and
operate in the market proved important.
*GDP figure represents rate of growth/contraction
The Greek
Tragedy
According to MSCI,
for an international equity index to fulfill its purpose, investors, including
passive “index” vehicles, must be able to buy and sell its component companies
with a degree of ease and confidence. To this end, MSCI has a number of
criteria including explicit requirements for market size and liquidity, and
somewhat more subjective targets, including a country’s openness to foreign
ownership, restrictions on foreign currency trading that might hamper repatriation
of funds and availability of mechanisms to facilitate trading. Greece has
failed both the MSCI size and accessibility tests for inclusion in the
developed index because of the Greek stock market collapse since 2007, and the
subsequent re-listing elsewhere of some key companies which left the Greek
market containing too few large and liquid stocks to allow major investors to
take adequate positions. In addition, the Greek stock exchange authorities have
failed to match developments in other markets in areas such as stock borrowing
and lending, short selling and transferability, making the Greek market
relatively difficult to do business in.
Despite Greece’s
problems, we still see potential long-term opportunities there. However, just
because Greece will become part of the emerging market universe again does not
necessarily mean we are rushing out to buy Greek stocks immediately. A key
aspect of our investment philosophy is that we are not constrained by
considerations of index weighting, and although we will pay attention to a
country’s macroeconomic fundamentals, our allocation decisions are based
primarily on individual companies’ long-term value and potential prospects. We
see some faint signs that Greece’s challenging economic ordeal might be reaching
a turning point, and we will look at the possibilities for investing. The key,
of course, is to find stocks that meet our value criteria.
A China
Addition?
While Greece’s
reclassification made headlines, perhaps the most striking MSCI announcement
did not involve an actual change, but one that may be on the horizon. China’s
domestic “A” share market probably won’t become part of an MSCI index any time
soon; however, the idea that it might become eligible at some point is
potentially of tremendous significance given the very large size of the market
compared to the internationally traded “B” and “H” share markets.
MSCI’s commentary on
the subject emphasized huge obstacles remaining to the “A” share market joining
the MSCI index family, notably the limitations of the “qualified foreign
investor” quota system as a means of providing access and a level playing field
for foreign investors, ongoing restrictions on foreign exchange trading and
uncertainty about taxation. Nevertheless, as investors we should be aware of,
and excited by, the prospect that a vast and dynamic market may eventually
become more available.
Movin’ on
Up
Meanwhile, South
Korea and Taiwan remain under MSCI review for promotion to developed market
status. In terms of economic development and market depth, we think both easily
qualify to upgrade, but idiosyncrasies in their foreign exchange markets and
stock identification systems worry large institutional investors, causing South
Korea and Taiwan to fail the market accessibility test. We feel that the South
Korean and Taiwanese economies are so intimately meshed with their emerging
neighbors that their presence in emerging market indexes currently makes good
sense.
In the Middle East,
the long-anticipated promotion of the Persian Gulf states Qatar and the United
Arab Emirates to emerging from frontier market status was confirmed, while
issues of accessibility led to Morocco’s reclassification to frontier status.
We should again
emphasize that these developments are not likely to lead to any major
short-term changes to the composition of our emerging and frontier market
portfolios. These shifting sands certainly keep things interesting, but the
MSCI class switches won’t take effect until 2014, and regardless, making sharp
turns isn’t generally our style. Still, we are definitely eager to see more
investor attention drawn to these dynamic markets.
