A little-known decision with potentially far-reaching consequences for investors will be announced on 20 June 2017: the results of MSCI’s annual market classification review.
Every June, decisions are taken that directly affect all investors globally: one of the world’s leading providers of financial market indices (or benchmarks), MSCI, announces the results of its annual review of market classifications.
With trillions of dollars of investors’ capital tied to the indices it produces, these indices define the investment universe for many funds. Which means these MSCI reviews can have far-reaching implications for both passive and active investors.
For passive managers, the results will mean adding or removing any reclassified securities/regions, whereas active managers may also want to add to or readjust portfolios given their benchmark may have changed.
What’s up for discussion this year?
This year, the MSCI has identified three major regional equity markets that could potentially be reclassified.
Mainland China – to enter the Emerging Markets indices. This reclassification would have the most impact for investors, given the size of the mainland Chinese equity markets. MSCI has considered this in the past several annual reviews, but the reclassification has previously not gained enough support given market structure and accessibility concerns.
However, several initiatives have been launched to address these issues, and with MSCI having watered down the number of stocks eligible and limited the amount to be included, we think this could be the year onshore Chinese stocks begin to join the wider emerging markets indices.
Argentina – to enter the Emerging Markets indices. Argentina was excluded from the wider emerging markets indices in 2009 due to market access issues. Since capital controls were lifted in December 2015, it has made good progress towards re-joining. However, only stocks that meet the liquidity requirements can join the emerging markets index, meaning some stocks will remain in the frontier markets indices.
Nigeria – to exit the Frontier Markets indices. This reclassification would have the least impact for most investors. Frontier markets remain a very small proportion of global investors’ portfolios. However, this could be quite damaging for the Nigerian equity market’s reputation as the MSCI’s decision to consider a reclassification “reflects a continuous deterioration in market accessibility”.
What do we expect and how does it affect Nutmeg portfolios?
MSCI works in tandem with investors globally to form a conclusion through a consultation process, to ensure that investors’ views are taken into consideration and the practicalities of new stocks entering the investment universe are fully considered.
The decisions are always difficult to predict, and MSCI typically adopts a cautious approach due to the potential magnitude of the impact of its decisions.
The decisions regarding Nigeria and Argentina will be less significant for investors, however should they go ahead, we’d add a small amount of Argentina exposure to our managed portfolios over the next 12 months (as part of our emerging market weighting).
The China decision remains of most interest to investors, not least because it starts the process for full inclusion of onshore China shares. This is critical, because the onshore market is large – estimated at US$7 trillion – and full inclusion would mark a significant change in the geographical representation of emerging markets, vastly increasing the China component.
That said, the process to full inclusion is likely to be a long one, and the initial decision, if taken, would have a much smaller impact on Nutmeg portfolios (with only a small amount of onshore Chinese equity being added over the next 12 months).
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.