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MSCI Pakistan: Add A Little Green To Your Portfolio

Summary Developed and current emerging markets are not offerings returns as high as frontier markets. Pakistan’s economic outlook is improving, thanks to China’s investment, low oil prices and rate cuts. MSCI Pakistan is a decent bet for a frontier market exposure; it’s cheap on relative valuation. Developed equity markets continue to trend higher. It is hard to predict the end of the current bull market, but the returns would be limited going forward. S&P trades at a PE of 21.24 while NASDAQ composite is trading around 23 times the trailing earnings. European markets are also rising but the upside seems limited given high multiples. Emerging markets are witnessing a slowdown in growth. High return investments are not easily found in the above mentioned markets under current circumstances. However, there are alternatives for investors with a high risk-appetite: the frontier markets. Frontier markets are small to be classified under emerging markets but they often entail a higher return at a higher risk. One such frontier market is Pakistan, which has started to look attractive. Equity market of Pakistan is trading at a substantial discount and can bring considerable gains to investors. Detailed thesis follows: Status of Pakistan might be upgraded to an emerging market. Pakistan is up for consideration to be included in emerging markets. MSCI will review for a potential upgrade in June 2016. According to WSJ, Pakistan is liquid and deep enough to be considered as an emerging market. KSE 100 index is one of the best performing equity markets since the financial crisis of 2008. Note that Pakistan meets most of MSCI’s emerging market requirements. It is highly likely that Pakistan will be upgraded to the emerging market status. If that happens, the PE multiple of Pakistan’s equities will expand resulting in substantial gains for investors. KSE 100 is one of the best performing equity markets trading at a discount. In 2013, KSE 100 rose 37%, in dollar terms, topping S&P 500 and every other benchmark in Europe. It was the third best performing market in 2014 with a 31% return. The index is up ~19% during the trailing twelve months. Despite the run, the index trades at 8.3 times forward earnings, an 18% discount to MSCI’s frontier markets. Source : FT.com Source: Yahoo Finance, MSCI, AHL Research The charts depict that after a decent run, KSE 100 is still trading at quite a discount. Further, the expected benchmark rate is 8%, which is equal to the rate back in 2006. KSE was trading at 11.3x at that time. This indicates that the index is undervalued by more than 20%. According to AHL research, ” When the policy rate stood at almost at the same level in 2006 as today i.e. 8.5%, and the earnings growth also being in close vicinity as today i.e. 10%, the market PE stood at 11.3x then, compared to 8.3x today, showing a substantial 27% discount, which the KSE100 is currently trading at (barring all other factors i.e. level and risk of macros and the market between two different times).” See the following graph to witness the correlation of interest benchmarks to the KSE 100 index. (click to enlarge) Focus Equity Estimates and AHL Research The graph clearly mentions that KSE 100 is negatively correlated to the interest rates. As Government is pursuing aggressive rate cuts, PE multiple is expected to expand. To review, Pakistan’s equity market is trading at a substantial discount based on historical PE levels; it’s also cheap relative to comparable indexes and markets. The economy is in a turnaround mode; related indicators are positive. Economy is getting a boost from several developments. Falling oil prices are a big positive that are keeping a check on inflation. This, in turn, is allowing for rate cuts, which will give a boost to economic activity and the stock market. Pakistan is a net importer of oil; prices of oil are not expected to go up any time soon, think recent U.S.-Iran deal. Oil prices will continue to have a positive impact on the economy of Pakistan. As mentioned above, low interest will also boost the economy. Interest rates are cut by 1% to drop to 7%. The Government is pursuing aggressive rate cuts; they are down from 10% in November 2014 to 7%currently. Other favorable factors include pro-business government and favorable demographics; 54% of the population of Pakistan is under 25 years. The current Government is heavily investing in infrastructure; a $500 million Metro transport project is recently completed in twin cities, Islamabad and Rawalpindi. Other construction projects are expected to boost materials and construction industry. Elimination of circular debt by the Government bodes well for power producers. Further, consumer spending is increasing; 26% p.a. increase in spending was recorded (pdf) during 2010-2012 as compared to Asia’s 7.7% growth. Analysts’ expect the GDP to grow at 4.6% p.a. through 2019. Pakistan’s security forces’ operation against terrorism is proving to be fruitful. Number of civilian casualties has declined by 81% since 2013. Number of drone attacks by the U.S. in Pakistan has decreased 62% since 2013 indicating that terrorist element is being eliminated efficiently. (click to enlarge) (click to enlarge) Source : South Asia Terrorism Portal Regarding the stock market, it was among the best performing markets in 2013 and 2014. In 2013, the market performed better than 2014 as mentioned somewhere else in the report. The point is that investors’ sentiment is not strongly correlated to the security related issues. Drone attacks and terrorism related causalities were higher in 2013 compared to 2014 yet the market performance in 2013 was better than 2014. Now, the security situation is getting better. This will boost investors’ confidence and will help the stocks rally in 2015 and beyond. China’s $46 billion investment in Pakistan makes the bull case a no brainer. China is investing in Pakistan for an economic corridor. $46 billion in investment is expected. Most of the investment will be used for power and infrastructure related development. Financial services, materials and power companies will be the primary beneficiaries of the investment. According to Barrons, Beijing’s investment is expected to boost Pakistan’s GDP by over 15%. The investment will, in time, put an end to Pakistan’s electricity woes, another positive from a business perspective. 10GW capacity is expected to be added by 2018. The economic corridor will link China to the markets in Central Asia and South Asia. ‘If ‘One Belt, One Road’ is like a symphony involving and benefiting every country, then construction of the China-Pakistan Economic Corridor is the sweet melody of the symphony’s first movement.’ – Wang Yi , China’s foreign minister All in all, China’s investment bodes well for the economic growth of Pakistan and its capital markets. For further insight into China-Pakistan economic corridor, see this (pdf) report. There is a turnaround in analysts’ sentiment about Pakistan. David M. Darst, Chief investment strategist at Morgan Stanley, thinks that the rise of Pakistan is just a matter of time. He further points out that Pakistan is among the nine countries in Asia that will add another China in the next 35 years. Commenting on Pakistani stocks he said, “What is important is that the stocks in Pakistan are still very cheap compared to the markets in the industrialised world and they are performing better than many markets in terms of returns,” IMF thinks that Pakistan has succeeded in stabilizing its economy; growth of 4.3% is expected during 2015. World Bank expects expansion of 4.4% during the current year. Goldman Sachs has included Pakistan in “Next 11” list of economies, which will be a key source for economic growth in years to come. Pakistan is an overlooked reform story without reform valuations, says Renaissance Capital. According to CIA Factbook 2015, “Pakistan is one of the larger, more liquid frontier markets and has advantageous demographics. These factors make it an attractive investment destination for investors looking beyond traditional emerging markets, which have been demonstrating slowing growth.” To review, Pakistan’s outlook is getting positive. A rise of status from a frontier a market to an emerging market will be catalytic for the growth of the stock market. Economic growth supported by low oil prices, low interest rate environment and diminishing security problem will add to the capital market’s growth. More importantly, China’s investment in the country will steer Pakistan’s economy in an upward direction going forward. How to Invest? Investors can get exposure to this frontier market through MSCI Pakistan ETF (NYSEARCA: PAK ). This ETF is designed to represent the performance of broad Pakistan equity universe. The ETF offers access to the highly liquid equities in Pakistan. The ETF was launched in 2014. However, the equities in the ETF posted a CAGR of 18% during 2011-2015. The ETF trades at a forward PE of 8.79 making it a cheap proposition. The ETF also compares favorably to other alternatives. (click to enlarge) Source : MSCI Another important factor is the weightage of sectors. PAK ETF is concentrated among financials, materials and energy. See the chart below: (click to enlarge) Source : Global X Funds As mentioned above, financials, energy and materials will be the largest beneficiary of China’s investment in Pakistan. Consequently, this ETF will outperform the market due to dominant weightage of these sectors. Further, the current Government is also focused on infrastructure development, which is another bullish indicator for the ETF. For fiscal year 2015/2016, the government has increased infrastructure expenditure by 27% . Low oil prices will continue to support the energy sectors and the ETF’s growth Another, relatively low-risk/low-return alternative is to invest in MSCI Frontier 100 ETF (NYSEARCA: FM ). Pakistan makes up 10.6% of this ETF. Kuwait, Nigeria and Argentina are the three largest countries in this ETF. Bottom Line Developed and current emerging markets are not offerings returns as high as frontier markets. However, the returns from frontier markets come with added risks. These investments are only suitable for investors with high appetite for risk. Anyhow, Pakistan’s economy is in a recovery mode, thanks to China’s investment, pro-business government, falling oil prices and interest rate cuts. Equity market of Pakistan is an attractive investment option given that the market outperformed developed markets even with worse security and economic conditions. Now, as the economic and security situation is stabilizing, high gains will certainly follow. MSCI Pakistan ETF is looking good amid high concentration in financials, materials and energy. Further, the valuation is cheap as compared to emerging markets. All in all, we rate MSCI Pakistan ETF a buy with more than 30% upside; the valuation is based on historic correlation of interest rate benchmarks to the PE multiples of the market. Risks Low trading volumes and liquidity concerns attached to frontier markets Highly volatile political conditions Re-ignition of the terrorist elements Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

PAK: Your Ticket To The Hidden Gem In Emerging Or Frontier Markets

Investors look for exposure to the frontier markets to diversify their portfolios, but have shied from investing in Pakistan. Although Pakistan attracts a lot of negative news, its economy is improving while the local stock market remains one of the top performing in the world. Pakistani stocks can be a great diversification tool for U.S. investors as they offer zero correlation with the S&P-500. The recently launched Global X MSCI Pakistan ETF gives U.S. investors exposure to this market. Investors look for exposure to the frontier markets to diversify their portfolios, given some of these markets have demonstrated little to no correlation with the S&P-500, but most steer clear of Pakistan. In the media, the country’s name is often followed by Osama bin Laden, Taliban, sectarian violence, protests and blackouts. However, Pakistan has also been making significant progress on the economic front and may very well be, in the words of Renaissance Capital’s chief economist Charlie Robertson, “the best, undiscovered investment opportunity in emerging or frontier markets.” Pakistan was created back in 1947 following its partition with India. But unlike its bigger neighbor, the political setup in Pakistan has been far from stable, thanks to corrupt politicians and frequent military takeovers. However, democracy has been taking hold following the departure of the last military ruler Pervez Musharraf in the 2008 general elections. In 2013, for the first time in its turbulent history, a civilian government successfully completed its term in office and transferred power to another. Those elections paved the way for the pro-business politician Nawaz Sharif to form a government. Sharif immediately moved to stabilize the economy, bolster public finances, lift foreign reserves and increase infrastructure spending. Although there is significant room for improvement, so far, the Pakistani government’s performance has been impressive, which was also acknowledged by the IMF. Besides, the country has received positive commentary from Moody’s and Standard & Poor’s. The two rating agencies have recently upgraded Pakistan’s credit rating. Betting on Pakistan’s future is its strongest ally China which has planned to inject $46 billion into South Asia’s second leading economy. China’s confidence stems partly from Pakistan’s latest, and perhaps its biggest, military offensive against the local militants. The country’s security situation, which has been one of the biggest concerns for foreign investors, has improved dramatically. Last year, Pakistan witnessed the lowest number of civilian casualties in terrorist attacks over the last seven years, and the number has improved considerably this year. Meanwhile, Pakistan’s economic growth has improved from 3.7% in 2013 to 4.1% in 2014. The economy currently appears to be posting its strongest growth since the global financial crisis while inflation has been slowing down over the last twelve months, dropping to their lowest level since 2013 of 2.1% in April due in part to the slump in oil prices. The foreign exchange reserves on the other hand, have climbed to their highest level ever of $18.2 billion. Meanwhile, the Sharif government has been doubling down on the construction and infrastructure sector. This has led to a construction boom which is driving the economic growth. As per data from Bloomberg, in the last fiscal year, the nation’s cement stocks have climbed by 57%, outperforming the benchmark index by three times. For the current fiscal year, the government has raised infrastructure spending by 27% to Rs 1.5 trillion/$14.74 billion, which will play an important part in fueling the country’s growth. As per IMF’s projections, growth is expected to tick up to 4.5% in the current fiscal year beginning July 1. With improving economic outlook, Pakistan’s stock markets have rallied. The Karachi Stock Exchange, the nation’s biggest and most liquid market, has generated one of the highest returns in the world over the last five years. During this period, the KSE 100 index has climbed by a whopping 200%. For the fiscal year ending June, the benchmark KSE-100 index has climbed by 14.9%, becoming one of the top performing markets of the world, despite declines coming from oil and gas, tobacco, telecom and banking sectors. Despite the rally, Pakistani stocks are still priced at a discount to their MSCI frontier market peers Bangladesh, Sri Lanka, and Vietnam. A great way for U.S. based investors to gain direct exposure to Pakistani stock markets is through the recently launched Global X MSCI Pakistan ETF (NYSEARCA: PAK ) – the only ETF that is tracking this frontier market. This can be a good diversification tool, since Pakistani stocks showed zero correlation with the S&P-500 last year. The $2.3 million fund, which charges just 0.88%, gives investors exposure to 33 of Pakistan’s leading companies, most of which operate in the financial, energy and materials sector. The fund’s top holdings include two of the country’s largest banks – MCB Bank and Habib Bank-as well as the top E&P company OGDCL, leading chemical fertilizer producer Fauji Fertilizer and the biggest producer and exporter of cement Lucky Cement. These five companies, which give Global X MSCI Pakistan ETF exposure to four diverse sectors, represent 44% of the fund. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.