MSCI-related flows: repeat-cycle for passive funds, more pain for some FM funds
The MSCI announcement on 8 April is a surprise and important, in the short-term, but in no way changes the long-term picture.
(1) Kuwait stocks earmarked for inclusion in the EM index (the original decision to upgrade in May 2020 was taken in June 2019) likely suffer a temporary outflow of funds positioned for that upgrade (indeed at the time of writing, the stock market has hit a intra-day, 5% limit-down circuit-breaker); and
(2) Countries whose weights in the FM (Vietnam, and potentially Iceland) and FEM (Philippines, Peru, Vietnam, Colombia) indices may have increased substantially will have to wait another six months.
The combined effect is likely to add to the pain felt so far this year by FM funds, many but not all of whom we sense were positioned in Kuwait mainly because of this inclusion. A market that has been so tricky for FM managers given its very large size in their benchmark index and its complete dominance by index-related flows (related to FTSE EM, first, and MSCI EM, second) over the past two years is delivering one last sting in its tail.
Kuwait investment case: very cheap equities, resilient sovereign, but structural weaknesses
Overall, Kuwait is not one of our preferred markets in a region, the GCC, which we do not regard as a safe haven in these times (at least, until oil price recovers).
In a time of Covid-19 economic disruption and the oil price war, Kuwait's top-down strengths are its deep sovereign reserves, which make for minimal FX rate risk and firepower for fiscal stimulus. Although recent warnings from the IMF and downgrades by sovereign credit rating agencies are a reminder that there are limits to this.
In any more normal era, Kuwait's weaknesses are too great a dependence on welfare provision by the state (which blunts citizen incentives, drives reliance on expatriate labour, constrains the ability to implement austerity in periods of weaker oil revenue, and crowds out growth of the private sector) and a political system (a hybrid of absolute monarchy and parliamentary democracy) where obstructionism blocks the efficient execution of non-oil diversification project spending, structural reform, and, potentially, could cause a problematic succession.
Kuwait stock screen for liquidity, value, performance