When they wish to invest, fund managers across the globe look at the Morgan Stanley Composite Index.

Since the index is widely recognised as the leading provider of investment decision support tools worldwide, capital markets must conform to its standards.

Pakistan was part of the MSCI Emerging Market (EM) Index from 1994 to 2007. But during the stock market crash of 2008, panicked regulators and stockbrokers decided to close the exit door for foreign investors. In effect, it trapped foreign portfolio investors in the country.

When the dust finally settled, beleaguered foreign funds marched out of Pakistan and MSCI demoted the Pakistan MSCI Index from ‘Emerging Market’ to ‘Frontier Market (FM)’. The country’s equity market thus lost its access to the trillions of dollars that EM fund managers track.

“We may initially see foreigners test the waters with investments of under $100m”, ponders a veteran stockbroker

The FM market, on the other hand is a club of smaller markets with just a few billion dollars to invest that barely manages to draw the interest of foreign funds.

With the market’s improving fundamentals over the last few years and repeated reassurances by the regulators, independent teams of brokerages, local funds and big corporations, that such an act of restraining the free flow of foreign funds would never again be repeated; the MSCI last year finally announced that it would consider taking Pakistan back in the EM fold. The announcement came in the wee hours of last Tuesday.

The reclassification from FM to EM will be effective from June 1. In the weeks ahead of the MSCI announcement, investors already started to accumulate stocks of companies that they expected to be a part of MSCI EM.

According to the May 15 semi-annual review of the MSCI, six companies qualified for the ‘main index’. Those include United Bank, Habib Bank, Lucky Cement, Oil and Gas Development Company, MCB Bank and Engro Corporation. Two surprise additions to the original qualified stocks included D.G. Khan Cement and Thal Ltd.

Another 27 listed companies qualified for the inclusion in the MSCI EM ‘small cap Index’.

The investor’s excitement over the entry into the MSCI EM has been built on the premise that there shall be heavy foreign inflows of funds from global investors.

According to several Pakistani brokerages, aggregate funds tracking the MSCI EM at the moment amounts to around $1.5 trillion. In contrast, global funds that are tracking the MSCI FM are believed to be just about $18 billion.

Based on specifications, each country in the MSCI EM is allocated weightage. Pakistan has received a weight of 0.14pc, which pales in the face of China, which has the highest weight of 27pc and India with a weight of 8.45pc. But then again, those are infinitely larger markets than the Pakistan Stock Exchange.

Most Pakistani market strategists and local fund managers have drummed up expected inflows of $300-$500 million into the Pakistani equity market from global players who invest through EM index funds.

Is such an amount of foreign portfolio about to enter Pakistan? Mr Nasim Beg, vice chairman of MCB — Arif Habib Savings, in answer to that query, replied: “There are two aspects to it. There are international funds, which are mandated to follow the MSCI Index. Termed as ‘passive funds’, they can invest in Pakistan market according to its weight.

“On the other hand there are ‘active funds’ which try to create value more than the MSCI Index. It is upon them to either invest or ignore any of the markets. Pakistan may still be out of their radius”.

Brokerage Topline Securities has calculated that out of the $14tr — $17tr that track the MSCI EM, about $350bn, equal to 20-25pc of the aggregate are ‘passive funds’, from which Pakistan according to its 0.14pc weightage, be able to pull in $450m.

In anticipation of heavy buying by ‘passive funds’, local market participants both institutional investors and individuals, began to build up positions.

They took the cue from the reaction seen in the Dubai and Qatar equity markets, which had rallied 90pc and 46pc, respectively, between the MSCI inclusion announcement on June 11, 2013 and the actual inclusion on June 1, 2014. But investor behaviour in the local market has been surprisingly different.

Since the announcement of the MSCI decision on May 15, the Pakistan stock market benchmark KSE-100 index has plunged by over 2pc as investors decided to sell-off their holdings and book profit.

Most market watchers admit that the foreign inflows of expected $300m — $450m are not likely to flood-in post inclusion (June 1).

Foreign investors have been persistent ‘net sellers’ of Pakistani stocks in the last three years. They sold-off equity worth $315m and $339m in 2015 and 2016, respectively.

In the four months of the current year to April, foreign outflows have amounted to $210m. These actions worry local investors who wonder if the tide of foreign flows will really turn with the entry of Pakistan in the MSCI Emerging Market index.

Published in Dawn, The Business and Finance Weekly, May 22nd, 2017