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June 27, 2013

Global Investment Alert: Bad News for Greece, Morocco; Good News for Qatar and UAE

Changes are coming for a number of indexes globally, according to MSCI. In its annual market classification review, it announced that Greece’s index, currently classed as a developed market, will be moving down to emerging markets, and Morocco’s index will be reclassified from an emerging market to a frontier market.

In addition, Qatar and the United Arab Emirates will see their indexes elevated from frontier markets to emerging markets, thanks to improvements each has made to its markets, and China A-shares will be under review for possible inclusion in the MSCI Emerging Markets Index.

The company also said that the MSCI Korea and MSCI Taiwan indices will remain under review for a potential reclassification to developed markets, while the situation in Egypt, according to the company, may result in the “launch [of] a public consultation on a potential exclusion of the MSCI Egypt Index from the MSCI Emerging Markets Index were the situation to worsen in the coming months.”

Greece is the first developed market country downgraded by MSCI to emerging market status. Market accessibility is a major factor in that decision, and MSCI said that Greece fails to meet the requirements in securities borrowing and lending facilities, short selling and transferability.  “Market participants have commented that in-kind transfer and off-exchange transaction-like facilities that were introduced in 2008 by the Greek authorities and the Athens Stock Exchange are so restrictive that they are, in practice, unusable. In addition, the long standing absence of well-established stock lending as well as short selling practices also make the Greek equity market incompatible with the standards of other developed equity markets,” according to MSCI.

There is also the issue of size, on which MSCI said the country has fallen short for the last two years. Greece’s stock index has lost 83% since 2007, and the country has been under review for downgrade since June of 2012 after MSCI criticized its market restrictions.

The downgrades of Greece and Morocco will take place in November, to coincide with the issuance of MSCI’s semiannual index review, while the upgrades on Qatar and the UAE will wait till the next annual review in May of 2014.

No immediate action is expected on China A-shares, with the company stating that “a large number of key obstacles in the areas of capital mobility, quota allocation and taxation continue to exist and substantial progress would need to be made in order to warrant an inclusion in the MSCI Emerging Markets Index.” “However, given the significant size of the China A-share market and the possibility of further regulatory reforms in the short term, MSCI believes that it is important to actively engage with the international investment community on this matter. The speed and magnitude of any hypothetical inclusion will be entirely dependent on the speed and magnitude of actual progress in the opening of the market and the resulting experience of international institutional investors,” according to MSCI.

Dimitris Melas, managing director of index research for MSCI, said that investors in developed markets will not see a significant change because of the Greek downgrade because “it already had such a tiny weight in the index that even for portfolios that replicate the MSCI index, the effect will be tiny.” Greece’s presence in the developed markets index amounted to about one basis point, and “removing that small allocation will not really register for most investors,” he said.

However, for advisors who look more at emerging markets, “the changes are likely to have a more noticeable impact,” Melas said. Greece’s very small weight in developed markets may not be noticeable in its absence, but in the emerging markets index, in which market cap tends to be lower, it will have a greater weight. “We are projecting that after the reclassification in November, Greece would probably have a weight of 0.3%—30 basis points—in emerging markets. That’s still small, tiny compared to China or Brazil, but it’s now beginning to be noticeable.”

The emerging markets index will also feel the effects of the addition of Qatar and the UAE, he said. Based on available data at the time of interview, he predicted that Qatar will have a weight of 0.45% and the UAE 0.4%. “In total, across the three, the total will be 1.2% weight,” said Melas. “This is now a noticeable, significant change for emerging market investors—those who follow the MSCI index will have a broader opportunity in addition to other countries classified today as emerging markets.”

Last but not least for advisors to remember is the effect on the frontier markets of the departure of Qatar and the UAE and the arrival of Morocco, “These changes will be noticeable,” Melas said.

The changes are announced well in advance of their taking effect, he said, not so much because of advisors who use ETFs and third-party vehicles, but more because of asset managers who invest directly. Such managers “may need to cover the market, set up custody arrangements, find local brokers, and so on. It’s not such a big issue for Greece, because it’s being downgraded to emerging, so it’s not too difficult for investors there. But for Qatar and the UAE, the process is to give a long lead time to make sure people are able to make necessary arrangements to invest in those markets.”

 

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