In September 2017, FTSE reclassified Kuwait as a secondary emerging market (EM). This kicked off Kuwait’s journey towards ascending to EM status. In another step towards achieving full EM status, S&P Dow Jones announced that Kuwait’s stock market will be added to its Global Benchmark Indices with an EM classification, a move that would be effective this September. Finally, a potential upgrade to EM status by MSCI is in the cards and will cement Kuwait’s EM status.
The upgrade in status will lead to an improvement in market dynamics and the resulting passive inflows of $2.8 billion (Dh10.2bn) will undoubtedly be a boon, making it a highly anticipated event.
Analysts expect passive inflows of around $2.8bn in case of an MSCI EM upgrade, significantly higher than the $950 million or so of passive inflows from the FTSE EM upgrade. Foreign passive inflows usually hit the market around the implementation date, though, going by previous similar events, prepositioning by some active investors in the market happens before the upgrade announcement and implementation dates.
Additionally, on top of the $500bn or so of passive funds tracking the MSCI EM indices, they are used by actively managed funds with more than $1.5 trillion in assets, which could lead to sizable active inflows as well. Unlike the passive flows, which are more or less automatic, the magnitude of the active foreign flows will depend on the attractiveness of the Kuwaiti market and the companies in an EM context. As such, liquidity, valuation, earnings growth, transparency, corporate governance practices will all be factors that will affect which companies will attract active investors. It is this incentive that will help the market improve over time.
The impact of the MSCI upgrade process on the market so far this year has been easily felt, and could continue to affect the bourse in the period leading to the implementation and potentially beyond. The Kuwaiti market has traded in excess of $10.5bn in the first five months of the year, which is a 170 per cent increase over the same period last year. Net foreign flows grew significantly this year to $1bn. Even adjusted for the $300m or so of passive inflows triggered by the increase in the foreign ownership limit for the banks in March, this remains the highest net foreign inflow figure on record. On performance, Kuwait continues its strong performance year-to-date and the MSCI Kuwait index is up 24 per cent. This compares to 16 per cent and 12 per cent increases for the respective World and GCC Indices. We believe the anticipation of a positive announcement from MSCI regarding the upgrade is in part a driver for the outperformance of Kuwait this year, in addition to solid results from certain sectors such as banking.
Just to put things into context, the market has had a very good run since the FTSE EM upgrade announcement in September 2017, rising almost 34 per cent to date. It is important to keep that in mind when building expectations for future returns. Nonetheless, we still have a positive outlook on the Kuwaiti stock market over the medium-term, as we believe it offers investors the right mix of fundamental attractiveness and fund flow catalyst. We believe Kuwait is in a ‘sweet-spot’ from a macro perspective considering its comparatively low budget-breakeven level - one of the lowest in the GCC. This allows Kuwait to stay on course for executing its ambitious infrastructure-spending plan and maintain or potentially grow its sovereign wealth reserve.
Kuwait’s robust infrastructure spending plan is likely to result in notable GDP growth over the medium-term as per IMF forecasts. This is likely to have a multiplier effect resulting in earnings growth across multiple sectors especially the banks, which are very well represented in the market. Our fundamental case for Kuwait is strengthened by the funds flow angle. Following the FTSE flows, the attention now shifts to the potential MSCI upgrade. As mentioned earlier, this is a significant event and with the right ingredients can attract foreign flows that are more sizable than seen before.
From a structural perspective, we are also excited about the reforms that are taking place in Kuwait to open up the market further and employ global best practices when it comes to rules and regulations that govern the market. The reform process initiated by both Boursa Kuwait and the CMA is creating a more robust platform that allows improved access, transparency and accountability in the market. This will lead to a better functioning market and is at the heart of the push to upgrade Kuwait to EM status.
Husayn Shahrur, PhD and Wajih Al Boustany are respectively, managing director and assistant vice president, Mena Asset Management at NBK Capital, a member of The Gulf Bond and Sukuk Association