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Life After MSCI

23 June 2011
MSCI has kept the door ajar for both Qatar and the UAE, but EFG-Hermes and Citibank analysts disagree whether either market will be elevated come December. Meanwhile, emerging market funds are already swirling around. The MSCI left the door open for UAE and Qatar to allow them entry into the exclusive emerging markets club. The influential index provider that is used by many funds and investors as a benchmark, said that while both countries did not make the cut this time, they will extend their review till December.

"The 2011 review period for the potential reclassification of the MSCI Qatar Index and the MSCI UAE Index from Frontier Market to Emerging Market status has been extended to December 2011 in order to give additional time for market participants to assess the impact of the recent positive changes implemented in these two markets," the MSCI statement noted.

EFG-Hermes, the Egyptian bank, thinks it is 'unusual' for MSCI to extend the review process to the end of the year.

"This move will give market participants more time to assess recent changes, as well as give regulators and stock exchanges more time to address the remaining concerns held by international institutional investors," notes EFG-Hermes in a note to client.

MSCI's gesture is a signal that the markets on the right track and close to reaching their EM status target - "but will they arrive?" asks EFG-Hermes rhetorically.

Major issues remain in both markets.

"Firstly, Qatar needs to increase foreign ownership limits (FOLs). We believe that there are still concerns within the government over the impact of foreign inflows and, more importantly, we suspect that increasing the FOL for Industries Qatar ( IQ ) is a politically sensitive issue. The fact that MSCI singled out IQ as being effectively uninvestable for foreign investors confirms our view that it is considered a key investment opportunity for EM investors," says EFG.

The second risk is the process for handling failed trades, which is a cause for concern.

While EFG believes it is too early to conclude that both markets will gain entry in the December review, and is not "bullish", although the Egyptian bank analysts thinks the UAE has a greater chance to make the cut then Qatar.

Wall Street giant Citibank, however, can not disagree more, suggesting that MSCI's unusual move suggests that promotion is highly likely to occur in December.

"In our view most market participants were not expecting an upgrade by MSCI at this review, and as such the extension of the review to December and potential positive outcome then should be viewed positively by the markets," says Citibank analyst Andrew Howell in a note. Some EM investors may interpret this as a signal that it is once again time to re-engage with MENA equities in anticipation of their joining the EM index."

EFG thinks that emerging markets will remain on the sidelines, as there is little appetite to venture beyond the emerging markets and into frontier market territory, given the lack of global risk appetite. "This strongly

limits off-benchmark investments in the MENA region, in our opinion. We see no reason for this to change in the short term, leaving local investors as the key drivers of MENA markets. This also suggests that trading volumes are likely to remain muted.

However, EFG concedes that emerging market investors are positioned to react swiftly in the event that Qatar and/or the UAE are upgraded to emerging market status.

But some emerging market investors are already swirling around looking for opportunities. Religare Capital markets, an emerging market focused investment banking and institutional securities business, has launched its first report on the MENA region.

"Our model portfolio and top picks portfolio trade 8x PE12 and 1.2x PB12 with a 5.3% dividend yield, a significant discount to MSCI EM and World indices and offer good earnings growth as MENA countries ramp up spending and economic diversification efforts even as stimulus fades elsewhere," Religare tells its clients in a note.

Religare Recommendation

Top picks

Religaire has picked Emaar (Dubai), Mobily (Saudi Arabia), Samba (Saudi

Arabia), Commercial International Bank (Egypt), First Gulf Bank (Abu Dhabi)

and Commercial Bank of Qatar (Qatar), which it believes offer 25-30%

upside potential on an 18 month view in addition to a dividend yield of 5.3%.

Foreign participation sweet spot

Foreign investment is at structural lows given the depth and breadth of these markets. "We believe that in 3-4 years time the region could make up 10% of the main MSCI EM index (less than 1% currently) and are significantly more transparent and well-covered than other frontier markets," notes Religare.

Faster spending

Job creation is a key concern for all regional governments and additional spending programs have been announced to aid this. This spending will continue even if oil prices pull back significantly and will help drive consumer demand and SME growth.

Top country picks

Religare believes Saudi market will steadily rerate, "potentially to bubble levels as the government looks to guarantee social stability."

Meanwhile, a bottoming out in the UAE property market and improved credit condition will see a strong rally in its equity markets.

Religare also like Qatari banks with their high dividends and cheap valuations.

Egypt to recover into 2012

"We maintain our positive stance on the Egyptian economy and view EGP devaluation as unlikely," says Religare. "Some sectors (real estate) will take longer than others (banks, chemicals) to recover."

Kuwait and Bahrain out of favour

Religare see "no reason" to invest in Kuwait given the political malaise and simmering sectarian tensions. The emerging market bank also suggests shunning Bahrain given the political unrest.

Bahrain's' two major selling points were its position as a recreation hub for Saudis and the solid framework it provided for financial institutions. "While the former may become increasingly important as the government aligns further with Saudi Arabia, we find it difficult to have much faith in the stickiness of banking assets and business with Dubai having achieved critical mass as a regional financial hub and only a short hop away for relocation with good, mature facilities," says Religare.

© alifarabia.com 2011