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Wed 20 Jun 2018 08:46 AM

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A $600bn decision looms for Saudis, Argentina on MSCI nod

The potential for the MSCI upgrade has made the market in Riyadh a magnet for foreign investors, making it the world's second-best performer this year

A $600bn decision looms for Saudis, Argentina on MSCI nod

Two nations divided by geography - and united by a history of financial protectionism - embarked on a journey toward more transparent markets three years ago.

Today, they’ll learn whether foreign investors are ready to embrace their tales of transformation.

As MSCI decides whether to promote Saudi Arabia and Argentina to emerging-market status, expanding the asset class by as much as $600 billion, it’s not just those nations that are on the edge.

An upgrade for either or both could boost sentiment after a selloff that erased $2.7 trillion from developing-nation equities since late January.

The announcement is due after 4:30 pm New York time on Wednesday.

MSCI's expected upgrade to see billions of infow to Saudi Arabia

Analysts believe that the move could lead to inflows of approximately $10 billion of passive inflows into the country.

“Both Saudi Arabia and Argentina are stories of reforms,” said Julian Mayo, a money manager at Fiera Capital UK Ltd. in London.

“On whether they’ll continue on that path, my answer is a cautious yes. The MSCI decision will be a guide to the investment opportunity, but to investors, the fundamentals of these economies and businesses are more important.”

Smaller developing nations, called frontier markets, vie for emerging-market status because it can mean billions of dollars of foreign-investment flows from index-tracking funds.

These so-called passive funds manage $384 billion in emerging markets, in addition to $1.1 trillion of actively managed funds, according to JPMorgan Chase & Co.

Decision day

“It’s not easy predicting MSCI decisions,” said Andrew Brudenell, a portfolio manager at Ashmore Group Plc in London.

Among many factors, he said: The index provider’s demands for market openness and regulation and the process by which it satisfies itself that policy changes won’t be rolled back.

Have Saudi Arabia and Argentina done enough to warrant an upgrade? Judging by stock-market performances, the Middle Eastern kingdom is on top.

This chart shows the size of the two stock markets relative to the $18 trillion emerging-market universe.

The potential for the MSCI upgrade has made the market in Riyadh a magnet for foreign investors, making it the world’s second-best performer this year.

By contrast, waning confidence in the economy, a currency slump and one of the world’s highest inflation rates is shrinking the Buenos Aires market.

Break with past

When Saudi Arabia opened what was then one of the world’s most restricted stock markets to foreigners three years ago, it received a muted reaction.

In a nation where women couldn’t drive and there were few investment opportunities beyond oil, investors didn’t see much of a long-term opportunity. That changed during the past year as Crown Prince Mohammed Bin Salman carried out a global charm offensive.

Modernising the Middle East’s biggest stock market and attracting foreign investors is part of his broader plan to shift the country’s economy away from oil, its main source of revenue. The proposed initial public offering of Saudi Aramco has also attracted the world’s attention.

For Argentina, which has relied on capital controls in the past and lost its emerging-market status nine years ago, it’s a question of re-establishing credibility.

President Mauricio Macri, who came into office in 2015, rolled back protectionist measures of his predecessor, Cristina Fernandez de Kirchner. He settled a 15-year debt battle with creditors, ended capital controls and eased foreigners’ access to the country’s markets.

But almost three years later, the economy is under stress, the peso is in free-fall and foreign investors are moving away from equities.

So what will happen?

Many money managers say Saudi Arabia is a shoo-in.

“The country has come such a tremendous way from about a decade ago,” said Asha Mehta, a Boston-based senior portfolio manager at Acadian Asset Management LLC, which oversees about $100 billion.

“The regulator within Saudi, the exchange and MSCI have been working almost in concert with each other to help bring this capital market to required levels of development.

"In some ways, Saudi’s local market meets these thresholds to a higher level than Argentina does.”

Given that the MSCI index is market-cap-weighted, the size of the Saudi market could entail fund inflows of $10 billion.

Foreigners are already net buyers of Saudi stocks, having poured in $3 billion this year through June 7, according to data from the stock exchange and compiled by Bloomberg.

The jury’s still out on Argentina’s reclassification. An investor survey by Bank of America found that while 56 percent of participants thought Argentina should get an upgrade, only 38 percent think it will actually get one.

At least three different Wall Street shops have assigned Argentina’s reclassification chances between 60 to 70 percent.

An upgrade could bring about $3.8 billion of inflows from index-tracking funds, according to JPMorgan Chase & Co. That could help prompt a 20 percent rally in Argentine stocks, according to Morgan Stanley.

It’s hard to argue that the deal Argentina struck with International Monetary Fund for a $50 billion credit line is anything but a vote of confidence, and that agreement alone could help sway MSCI to upgrade the nation. Yet a half-measure is also possible: MSCI could upgrade only the American depositary receipts of Argentine companies.

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