Is MSCI breaking itself apart?
MSCI completed its classification review and in many respects has cemented its path to unwinding Frontier Markets as MSCI defines the world. Argentina is going to be upgraded to the EM index and Kuwait will likely follow next year. This means that in a relatively short time span, Pakistan, United Arab Emirates, Qatar, Argentina, Kuwait will all be in the EM index. Since 2014, over 62% of the MSCI FM Index has shifted over to EM[1].
This can seem alarming, and alarmists have suggested that this will result in a precipitous drop in AUM that is centered around Frontier Markets. We believe that any investment strategy that is rigid enough to only invest in Frontier or only in Emerging Markets as it is prescriptively defined by MSCI is bound for failure. Any coherent strategy should encompass a theme around risk tolerance and global growth and should envelop parts of emerging markets and parts of Frontier Markets. Investment Frontier itself covers countries that are defined as Emerging Markets (Pakistan, Saudi Arabia) and countries that are defined as Frontier Markets (Bangladesh, Vietnam) and countries that are neither (Myanmar, Iraq). In fact, in the universe cover, 29 countries are not even covered in either index. Additionally, there are many countries not covered by Shalifay or MSCI, these countries represent 10.7% of the world’s population and 2.9% of the world’s GDP output which is $2.3 trillion.
Our perspective on these changes is that they are inevitable and consistent with our general worldview. Countries will over time get more developed, wealthier, and safer which will result in upgrades to their MSCI Classification. Where we do think MSCI has failed repeatedly is in advancing countries from EM to developed status. There is no cogent perspective that justifies Chile, Poland, Czech Republic, Qatar, South Korea, Malaysia, and Taiwan as Emerging Markets. These countries collectively have a population of 256mm and a GDP of 4.5 trillion, giving them a nominal GDP per capita of 17,500. Portugal, Spain, Israel, and Italy are somehow developed but these countries are not. This overly prescriptive definition of ‘developed’ will lead to problems over time. Particularly as you compare the EM countries mentioned with what each of these developed countries were like at the time of the index’s creation. If the measures are not relative and are absolute, which is what MSCI always suggests then it is problematic with what appears to be a heavy Western European bias.
The changes within Frontier Markets is exactly what we would hope and expect. Frontier markets ought to move on, over time. The remaining countries within Frontier Markets still represent 12% of the world’s population and 3% of the world’s economic output. We would like to see MSCI also become looser with its Frontier standards so as to allow promising countries into its Frontier Market index, countries such as Rwanda, Georgia, Tanzania, Uganda, Nepal, Myanmar, and Laos.
Our answer then, to the original question is no, MSCI Classification exercises are an annual occurrence and the changes were predictable and well-rationed. There are certainly major improvements to be made, but they are not generally in the determination of whether a country is EM or FM. We think the challenge for our readers is to ensure that none of their advisors or investment managers are operating a strategy that is explicitly Frontier Markets or Emerging Markets.
