For most investors, Pakistan is not an investment destination being considered in their investment process. But soon MSCI, the biggest index provider globally, may bring that to a sudden change. On June 14th, MSCI will announce its decision whether to upgrade Pakistan from the current frontier market classification to emerging market classification or not. In the case of a positive decision, emerging markets funds with an estimated 40x the capital of frontier funds will be forced to have a look at the 180 million population nation on the border between Asia and the Middle East.
Although Pakistan is an undiscovered market for most investors today, this has not always been the case. Between 1994 and 2008, Pakistan was part of the MSCI Emerging Markets Index. After the Balance of Payment crisis in 2008 the country was kicked out and in May 2009 it resurfaced in the MSCI Frontier Markets Index. For more than two years now, Pakistan has fulfilled all quantitative criteria (liquidity and number of investable companies for foreign investors). Currently there is a questionnaire circulating among global emerging market investors after which a decision will be taken.
Pakistan will be small if included in the emerging market index (the weight estimated to 0.2%) and hence a risk that investors simply feel there is no need to bother. The risk-reward however appears to be on the right side as equity markets today do not appear to have priced in Pakistan’s return to emerging markets – the Pakistani market trades at P/E 8.5x, a more than 50% discount to its Asian emerging market peers. During the last three years before exclusion from MSCI Emerging Markets, Pakistan traded at an average discount to similar countries of 25% and recall that this was in the midst of the War on Terror. At the end of 2015 this discount had widened to 56%. In fact this is the second highest discount to its peers (2011 ended at 59% discount) during the years outside MSCI Emerging Markets.
P/E-ratios MSCI EM Asia * vs MSCI Pakistan
Source: Bloomberg, Tundra calculations
* MSCI EM SE Asia is a non-weighted average of Indonesia, Malaysia, Thailand, India and the Philippines
Based on recent history, a MSCI Emerging Markets inclusion could act as a trigger for investors. The most recent example was in 2013 when United Arab Emirates (UAE) and Qatar were upgraded. During the twelve months following the decision to upgrade UAE and Qatar, UAE outperformed MSCI Frontier Markets Net index by 68% (USD) and MSCI Emerging Markets Net index by 87% (USD). Qatar outperformed the same indices by 23% (USD) and 43% (USD) respectively. UAE and Qatar peaked within 12 months of the announcement. Given that the Pakistani equity market is well supported by fundamentals it is not impossible that some investors will see an upgrade as a trigger for a revaluation and will act accordingly. The once unloved Pakistani market may hence all of a sudden be in for a new love affair with a new set of investors.
Author: Jon Scheiber - CEO Tundra Fonder
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