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Of MSCI and Men: Kuwait "pain trade" for another year

  • Kuwait and Iceland are moving up, Peru down in the latest MSCI annual country classification review

  • Kuwait is scheduled for upgrade to EM (nine stocks, 50bps weight) if two conditions are met

  • It means the pollution of the Kuwait investment case with heavy index-related inflows continues for a few more quarters

Of MSCI and Men: Kuwait "pain trade" for another year
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
26 June 2019
Published by

For MSCI, Kuwait and Iceland are moving up, Peru down

Index provider MSCI, the effective determinant of sizeable equity market inflows and outflows which are totally disconnected from country and stock fundamentals, released its annual country classification review last night.  

Kuwait is moving from FM to EM (nine stocks, 50bp weight) as expected, which likely means that the "pain trade" of owning the larger Kuwait stocks which, fundamentally, look unappealing relative to FM and small EM peers but which continue to rally on index-related inflows, persists for another few quarters. 

More surprisingly, Iceland is potentially moving from Standalone to FM (two stocks, Marel in food and Arion in banks, 3.5% weight, below Lebanon and above Mauritius) and Peru (40bp weight in EM) is potentially moving from EM to FM (because it may fall below the minimum requirement of three eligible stocks). 

No mention was made of a potential downgrade from EM to FM of Pakistan (for the same reason as Peru), which was more surprising than the absence of a mention of a potential upgrade of Vietnam from FM to EM (where restrictive foreign ownership limits are one of a number of market access obstacles).

Kuwait "pain trade"

Kuwait is scheduled for an upgrade to EM in June 2020, with nine stocks and a 50bp weight, if two conditions are met by November 2019 (omnibus account structures and same NIN cross trades made available for international investors). 

This upgrade is in line with expectations. It means that the pollution of the Kuwait investment case with heavy index-related inflows continues for another few quarters. This "pain trade" has been ongoing since the months prior to the September 2018 upgrade of Kuwait by FTSE to its Secondary Emerging index. 

Fundamentally, we are not enthusiastic about Kuwait top-down, apart from in globally very bearish scenarios where its US$ currency peg and extremely low sovereign risk make it a safe haven. In all other low or moderate global growth scenarios, we still regard Kuwait as too politically dysfunctional (driven by persistent clashes between a Cabinet appointed by the Emir and a populist and fragmented Parliament) and with too deep a sovereign wealth pocket (over US$350k per citizen) to implement austerity in times of low oil prices or project spend in times of high oil prices. 

At over 2x trailing book, MSCI Kuwait is on over a 35% premium to the last 5-year median. The largest stock, National Bank of Kuwait, is on trailing PB of 2x for merely 12% ROE. 

Among Kuwait's nine standard EM constituents there are some which screen well for value (e.g. meeting at least two of the following trailing metrics of PB below 1.5x, PE below 15x and DY above 3%): Agility in logistics, Burgan Bank, Gulf Bank and Zain in telecom. Kuwait stocks which are eligible for the EM small-cap index and which screen well for value include Humansoft in education, Kipco and NIG in conglomerates, Mezzan in consumer and Imtiaz in real estate.

But even in the GCC there are plenty of stocks with cheaper valuations (e.g. in Dubai and Oman) or higher secular growth prospects (e.g. in small-cap Saudi). And other regions in broader FM and small EM offer a much more supportive top-down context (e.g. Asian markets such as Bangladesh, Indonesia, Pakistan, Philippines and Vietnam).

Yet, assuming US$500bn of passive assets are benchmarked to MSCI EM (i.e. a quarter of all assets benchmarked to MSCI EM) implies inflows of US$2.5bn into Kuwait's nine standard EM constituents. The average daily value of these stocks is US$60m, which implies passive inflows equivalent to about two months of trading in these stocks. (This crude calculation assumes no prior positioning in anticipation of this upgrade, no outflows from small FM-benchmarked funds and zero weight for actively managed EM funds).

This annual MSCI review determines whether a country stock market merits membership of the Developed, Emerging or Frontier market indices or should sit as a Standalone. This is a separate exercise from the quarterly review of stock level index weights within those indices.