How Big An Effect Does Index Inclusion Have?
ETF inflows have continued to reach record highs in both developed and emerging markets, but ETFs into frontier markets remain small and very niche. We recently compiled a list of all the US-listed ETFs with frontier market exposure, and even the largest one, FM, which is based off MSCI’s Frontier Market 100 Index, has about $400 million USD in assets – compare that to SPY which has almost $200 billion USD in assets.
These ETFs are very transparent about the content of their indices, and MSCI will announce index additions and deletions on a quarterly basis. We were discussing an investment thesis based on these additions and deletions and wanted to test it – is there a material effect on a stock’s price when it is added to or deleted from a MSCI Frontier Market Index?
In large, developed market ETFs, these changes are telegraphed much in advance so there is not much opportunity to take advantage of it. However, our theory was that given the smaller size and niche nature of frontier markets, perhaps there would be more upside in a less efficient market. First, we needed to gather a sample of stocks to test our hypothesis.
Complete List of Additions and Deletions from MSCI Frontier Market Indices
We focused on MSCI’s Frontier Market Indices and got a full list of companies that were added or deleted to these indices in the past 2 years – since November 2014, comprising 8 review periods in total. Note that we did not look at small-caps given how small many of these frontier market stocks already were, and we did not focus exclusively on the MSCI Frontier Markets 100 Index. All of these additions/deletions came from frontier market country specific indices maintained by MSCI. They can be found at their website here.
Here is the complete list, 47 total reviews in all (20 additions, 27 deletions):
|Country||Security||Review Date||Added / Deleted|
|Argentina||Grupo Clarib B GDR||29-Feb-16||Added|
|Bahrain||Ahli United Bank (KW)||30-Nov-15||Added|
|Croatia||Ina Industrija Nafte||29-May-15||Deleted|
|Jordan||Al Eqbal for Investment||31-May-16||Added|
|Jordan||Jordan Islamic Bank||31-Aug-16||Added|
|Jordan||Jordan Phosphate Mines||31-May-16||Deleted|
|Jordan||Jordan Telecom Corp||30-Nov-15||Deleted|
|Kenya||Co-op bank of Kenya||31-May-16||Deleted|
|Mauritius||Rockcastle Global (ZA)||30-Nov-15||Added|
|Mauritius||State Bank of Mauritius||31-May-16||Deleted|
|Morocco||Ciments Du Maroc||29-May-15||Added|
|Nigeria||Flour Mills Nigeria||29-May-15||Deleted|
|Oman||HSBC Bank Oman||31-May-16||Deleted|
|Oman||Oman Cement Co||29-May-15||Deleted|
|Pakistan||Indus Motor Company||29-May-15||Added|
|Pakistan||Pakistan Tobacco Co||29-May-15||Deleted|
|Serbia||Aerodrom Nikola Tesla||29-May-15||Added|
|Serbia||Aik Banka AD||29-May-15||Deleted|
|Ukraine||Motor Sich (UX)||31-Aug-15||Deleted|
|Vietnam||Hoang Anh Gia Lai Agri||30-Nov-15||Added|
|Vietnam||Vietnam Dairy Product||31-Aug-16||Added|
|Vietnam||Petrovietnam Fert & Chem||29-May-15||Deleted|
|Vietnam||Hoang Anh Gia Lai Agri||31-May-16||Deleted|
Finding the Impact of Index Addition and Deletion
MSCI usually announces index changes two weeks before the announcement date. So by taking the price of a stock on the day before that announcement date, and comparing it to the price on the day of the actual index action date, we see how the stock has performed after an announcement has been made.
We also tracked the performance of that country’s broader market index to see how much the stock outperformed or under-performed the market in that time. If our theory was correct, stocks that were added to MSCI Frontier Market indices should outperform the broader local market and vice versa for stocks that were deleted.
Unfortunately, given the nature of frontier markets, it was hard to get historical pricing data for Argentina, Bahrain, and Mauritius, but we still had 41 index additions and deletions to test.
MSCI Frontier Market Index Additions Outperformed by 4.1% On Average
The 16 stocks that were added to a MSCI Frontier Market Index over the past two years managed to outperform their local index by 4.1% on average in the time from the index announcement date to the date the stock was officially included:
|Country||Security||Price Chg (%)||Index Chg (%)||Net Difference|
|Serbia||Aerodrom Nikola Tesla||6.8%||0.0%||6.9%|
|Bahrain||Ahli United Bank (KW)||2.9%||0.0%||2.9%|
|Morocco||Ciments Du Maroc||10.5%||-1.8%||12.2%|
|Jordan||Al Eqbal for Investment||12.5%||0.6%||11.9%|
|Vietnam||Hoang Anh Gia Lai Agri||1.6%||-5.0%||6.7%|
|Pakistan||Indus Motor Company||9.4%||1.7%||7.7%|
|Jordan||Jordan Islamic Bank||1.7%||-2.0%||3.7%|
|Vietnam||Vietnam Dairy Product||14.1%||4.1%||10.1%|
Here it is in graph form:
MSCI Frontier Market Index Deletions Under-performed by 2.4% On Average
Meanwhile, the 21 stocks that were deleted from a MSCI Frontier Market Index over the past two years managed to under-perform their local index by 2.4% on average over the same time period:
|Country||Security||Price Chg (%)||Index Chg (%)||Net Difference|
|Serbia||Aik Banka AD||-6.2%||0.0%||-6.2%|
|Kenya||Co-op bank of Kenya||-7.5%||-1.8%||-5.8%|
|Vietnam||Petrovietnam Fert & Chem||-2.7%||3.2%||-5.9%|
|Nigeria||Flour Mills Nigeria||-2.0%||-0.1%||-1.9%|
|Oman||HSBC Bank Oman||-8.0%||-2.3%||-5.7%|
|Vietnam||Hoang Anh Gia Lai Agri||5.2%||0.7%||4.5%|
|Croatia||Ina Industrija Nafte||1.4%||0.7%||0.7%|
|Jordan||Jordan Phosphate Mines||-21.9%||0.6%||-22.5%|
|Jordan||Jordan Telecom Corp||-3.1%||-1.7%||-1.4%|
|Ukraine||Motor Sich (UX)||-2.4%||-1.9%||-0.6%|
|Oman||Oman Cement Co||5.0%||1.2%||3.8%|
|Pakistan||Pakistan Tobacco Co||18.4%||1.7%||16.7%|
In graph form:
The sample size is small, but it seems our investment theory has some merit given how much better index additions performed and how much worse index deletions also did. Yes, the stocks will probably be higher beta to the broad market so you would expect a bigger loss if the broad market is selling off. However, in the additions the local markets were actually flat in the same time.
Intuitively it makes sense since liquidity is not great in these markets, so even if the buying/selling volumes from index managers is small, it will still have an impact on a stock.
Moving quickly after an announcement made is important to capitalize on this trade, but building a model to predict when a stock is about to be added or at risk of deletion from an index is even better.
To begin we would look at the liquidity restrictions that are one of the main drivers behind MSCI’s decisions to add and delete securities from their indices. That means a stock that has fallen on hard times and no longer meets market cap standards are at further risk of falling if MSCI pulls it from indices; likewise a new stock that has become much larger is a prime candidate for inclusion in the future.
This article was written by Investment Frontier