The economic and political climates in Pakistan have improved greatly since the financial meltdown in 2008. So justifiably there is euphoria in certain business sectors that they will receive a much deserved promotion from Frontier to Emerging Market status. That could happen on June 14, when MSCI releases the results of its annual market classification review. However, a promotion could actually work to Pakistan’s detriment. Currently, in the MSCI Frontier Index they have an 8.82% slice of the pie, but with the upgrade they would probably get much less. After all, they will be up against powerhouses like China, India, South Korea and Taiwan. So, managers that benchmark their portfolios against either the MSCI EM or FM index would have to rebalance them, which could result in a large outflow from Pakistan thereby causing volatility in their markets.
Maybe I am taking a contrarian view, that if they are bumped up they should fold their hands and say no thank you, if that is allowed. It’s not that I don’t wish them well—I most certainly do, but I would like them to continue on the economic and political track they have embarked upon. They are receiving the correct attention, especially now that they are the focus of a single country ETF, Global X MSCI Pakistan ETF (PAK). In fact, this fund has performed remarkably well with a year-to-date return of 12%.
The KSE100, the benchmark index of the Karachi stock exchange, has performed as well with a year-to-date return of 13%. In fact, if an investor had bought the ETF at its low on February 24, 2016 they would have racked up nearly a 20% gain. I am not saying that the KSE would suffer in the long run if Pakistan did join the MSCI EM index, but without a doubt the realignment in portfolios will cause a certain amount of volatility in the short term. What I would do is to wait and see what the report on June 14 brings. If there is no upgrade there may be a selloff because of investor confidence, but that could present a rare buying opportunity.
I would look to a few stocks in particular. My first choice is Lucky Cement (LUKC:KA), which is the largest cement manufacturer in Pakistan and is a component of the KSE100. With the recent deal signed with the Chinese for an infrastructure buildout, this is one stock that could benefit greatly. Another recommendation is Pakistan’s largest bank, Habib Bank (HBL). And lastly, Engro Corporation (ENGH), which is a Pakistan domiciled multinational primarily involved in fertilizers, but they also have a power generation business which they intend to boost in order to solve the energy crisis in Pakistan. Prime Minister Nawas Sharif has committed to ending the power outages in two years, and so Engro is well positioned to capitalize on this business opportunity.
I hate to rain on anyone’s parade, because most of the news coming out of Pakistan recently is positive and I do hope it continues. But I would be remiss if I didn’t remind foreign investors of the 2008 meltdown when the Pakistan Stock Exchange froze the markets and no investor was allowed to liquidate their positons. A lot of money was lost, and even though I have been assured that investor protections have been strengthened, it would be wrong for me not to note that fact.
Peter Kohli, CEO of emerging market specialist DMS Funds.