MOROCCO: Falling down again

MoroccoCould relegation to a frontier market be a blessing in disguise for Morocco’s stock exchange? Orlando Crowcroft reports.

Few were surprised when Morocco’s stock exchange was downgraded to frontier market status by listings body MSCI earlier this year. The Casablanca-based bourse had struggled on the emerging market index, failed to meet liquidity requirements and seen its weighting in the index tumble from 50 basis points in 2008 to just eight in 2013.

The fall reflected an ever-decreasing ratio of investable stocks in Morocco. These accounted for just 15% of the market’s free float in 2013, significantly lower than even some frontier markets, according to an HSBC report.

At first glance – and especially given those numbers – the MSCI downgrade appears to be bad news for the Casablanca bourse. The MSCI Emerging Markets index tracks some $1.4 trillion of global funds, while the MSCI frontier index attracts just a fraction of that, $2.7 billion. 

Morocco no longer rubs shoulders with the likes of China and Brazil but with a less-impressive line-up including Bangladesh, Kuwait and Bahrain. 

But experts say the downgrade might, paradoxically, increase Morocco’s visibility. The Casablanca exchange made up a very small part of MSCI’s emerging market index, and emerging fund managers tended to ignore the country. On the frontier market index, Morocco has a weighting of 4.7%.

“Although the assets of global emerging market funds far exceeds those of frontier funds, having a piece of a small pie is better than having no portion of a larger pie. We actually view this as positive for Morocco,” says Sherif Salem, a portfolio manager at Invest AD.

Investors might also consider that the MSCI EM index only covered Morocco’s top three companies – Maroc Telecom, Attijariwafa Bank and real estate firm Douja Prom Addoha – leaving out a large number of mid-cap companies that could be interesting to fund managers in a frontier context. “It’s a question of whether it is better being a big fish in a small pond,” says Sebastien Lieblich, executive director in the index department at MSCI. 

“We went from an index with three names on it to one with eight or nine names, so the index is much more representative of the opportunities there. 

“The frontier index applies less stringent construction requirements than EM.”

It may be too early to tell if these expectations will turn out to be accurate, but there are some cases where a country did well after a downgrade. After Greece became the first country to be downgraded from a developed to an emerging market by MSCI in 2013 – its stock index had fallen 90% since 2007 – it ended the year on a high at more than 1,200 points. 

Indeed, Salem of Invest AD expects Morocco’s 4.7% weighting on the frontier index to jump to 7% in May, when the frontier index is rebalanced to account for the exit of UAE and Qatar, which were upgraded to emerging markets.

However, critics warn that an increased weighting on the frontier index does not necessarily lead to increased investor attention or fund flows. 

In particular, passive money flows on the emerging market index far outweigh those on the frontier index. Morocco may have a larger share of the frontier market pie, but that pie is a cupcake and not a gateau. 

That said, interest in frontier markets among active fund managers is increasing, especially against a backdrop of economic uncertainty in developed markets. Fund managers who do not slavishly follow MSCI indices often like to invest in frontier markets because their fundamental are easy to read – even if access can be limited. “Frontier economies are at the early stage of development and are expected to grow faster than emerging and developed economies,” says Edward Evans, client portfolio manager on the emerging market equities team at Schroders. 

“This is significant from an investment perspective since capital market liberalisation in combination with economic expansion can act as a key driver to long-term market returns.”

Evans mentions a number of attributes that are attractive to investors, including favourable demographics, low labour costs and natural resource deposits. Equally, frontier markets’ strong organic growth drivers are less reliant on the developed world than their emerging peers and should continue to insulate frontiers from the still uncertain global macro backdrop. 

“Correlations between frontier markets, emerging markets and developed markets remain low and should continue to attract investors looking to diversify their portfolios given an uncertain global backdrop,” says Evans.

The question remains, though, whether Morocco ticks the right boxes when it comes to the benefits of frontier markets. Its declining free float, cited by HSBC, shows no signs of abatement, and active managers may in the long term decide to shun Casablanca at a time when other frontiers are doing more to open their doors to foreign investment. One problem is that the Casablanca bourse has historically been dominated by a domestic pool of money – including pension funds and insurance companies – which have limitations on how much money they can invest abroad. 

Captive assets like these can inflate equity valuations, making them less appealing to foreign speculators – this is one of the reasons foreign participation has always tended to be low in Morocco, even when it was part of the MSCI emerging market index.

Evans says: “We were not invested in Morocco when it was in the MSCI EM index and we have not invested in the market post the reclassification. The market will likely continue to be driven by domestic liquidity, unless structural reform takes place.”

With a decline in passive money prompted by the MSCI downgrade and active managers waiting for structural reform, the future remains uncertain for the Casablanca exchange. It tends to be market upgrades – such as the UAE and Qatar – that lead to reforms, downgrades on the other hand tend to increase malaise. 

Maybe macroeconomic factors will determine whether the Morocco exchange returns to growth. Invest AD’s Salem believes the country’s close ties with Europe had a negative affect during the eurozone debt crisis, but the slow recovery under way on the continent supports reasons for a pick-up in growth.

“Additionally Morocco’s increasing ties with francophone Africa is an interesting development that will add to the attractiveness and uniqueness of Moroccan companies as Morocco becomes a hub for trade within north-west Africa and between north-west Africa and the developed world,” he says.

©2014 funds europe

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