Frontier Market Focus: Kuwait

the next MSCI Emerging Markets Upgrade?

By Hamlin Lovell, NordicInvestor

Kuwait is socially more liberal than Saudi Arabia, but less so than the nearby island of Bahrain, which is where residents of Kuwait looking for a real party time spend their weekends and their dinars.

Investors in Kuwait’s equity markets could also have reason to celebrate, if it follows Argentina and Saudi Arabia in being upgraded from frontier market to emerging market status by MSCI.  Argentina’s departure from the MSCI Frontier index, will leave Kuwait as the largest member of that index – but maybe not for long. MSCI said on June 20^th, 2018, that it would consider upgrading Kuwait from Frontier Market, to Emerging Market status in 2019, as part of the 2018 Annual Market Classification Review.

MSCI’s criteria for determining membership of frontier, emerging, and developed market equity indices are only partly based on economic development.  Kuwait is one of the world’s wealthiest countries, with a GDP per capita of USD 70,000 (ranking close to Norway, Switzerland and Luxembourg) and South Korea – which is a very developed economy – is classified as an emerging market rather than a developed market.  MSCI’s other two criteria are size and liquidity requirements, and market accessibility criteria.

Kuwait has been trying to make its equity market seem more attractive to investors – and to companies wishing to do initial public offerings. The premier market index contains 16 companies, which need to report in Arabic and English, and satisfy minimum levels of market capitalisation (144 million Kuwaiti dinars or $481 million) and daily liquidity (90,000 dinars). The modernisation process has been underway for some years. In 2016, the Kuwaiti Stock Exchange partnered with Thomson Reuters to provide financial data, including balance sheets, cash flow statements and financial ratios, and data on trading volumes, which had been patchy before.

FTSE Russell has already upgraded Kuwait, from “Unclassified” to “Secondary Emerging market status”, in two stages: with a 50% weighting in September 2018, and the next 50% weighting in December 2018. Weightings in the FTSE Russell index are based on stocks’ investible market capitalisation, so those with lower free floats will get smaller weights.

Liquidity in GCC exchanges

Most equity markets in the Gulf and Middle East are classified as frontier markets by MSCI: Morocco, Tunisia, Bahrain, Jordan, Lebanon, Oman and Palestine are all in this category. Kuwait would be the fourth MENA region country to join MSCI EM (after UAE, Qatar, and Saudi Arabia), but this status could be reversed if decent liquidity is not sustained.  For instance, Morocco was downgraded from emerging to frontier markets in November 2013, and Jordan in November 2008.

There is some scepticism about whether upgrades do much more than lead to a one-off boost to the persistent problem of low liquidity in the Gulf exchanges. Marmore Mena Intelligence observes that the elevation of UAE and Qatar to MSCI EM status generated a surge in liquidity in the year of inclusion, but did not result in any permanent uplift. Marmore’s MR Raghu argues that “Factors like large scale government ownership of companies, restrictions on foreign ownership, legal and administrative problems, information asymmetry have all contributed to very low participation in equity markets leading to low trading volumes and hence low liquidity levels”. Time will tell if the Kuwaiti experience turns out to be any different.

An MSCI upgrade can be significant, given the trillions of dollars tracking MSCI indices. However, Kuwait is only anticipated to have a weighting of around 0.5% in the MSCI EM Index, in the event of any upgrade.

The Kuwaiti equity market

The Kuwaiti market, which began life in the 1980s, has not been a great performer recently. Since 2010, it has basically travelled sideways, in a narrow range between 5,000 and 8,000, as shown below. The stock-market has unsurprisingly shown a strong correlation with the oil price, as oil makes up 60% of Kuwait’s GDP. The market peaked in mid 2014, and troughed in early 2016, matching the roller coaster ride of oil prices.

The total Kuwaiti stock-market capitalisation of USD 90 billion is clearly tiny, though the economy is also not huge, with GDP estimated at 170 billion USD in 2017.

The MSCI Kuwait index is highly concentrated, with only eight constituents (National Bank of Kuwait, the Kuwait Finance House, Mobile Telecom Co., Agility, Boubyan Banking, Mabanee Co SAKC, Burgan Bank and Kuwait Project Co Holdings), though they do represent 85% of Kuwaiti market capitalisation. 

The KSE has a reasonable spread of sectors: banks, consumer services, basic materials, consumer goods, financial services, healthcare, technology, telecommunications, insurance, real estate, industrials and oil and gas. The Kuwaiti Government has a long-term goal of diversifying the economy away from dependence on oil. Indeed, the world’s first sovereign wealth fund, the Kuwaiti Investment Fund, was set up in 1961 with one objective being to reduce dependence on oil. This vision is one factor intended to drive the IPO calendar.

In total, there are 156 listed companies and the number has declined in recent years as some firms have been taken private. Kuwait wants to reverse this trend with IPOs. For instance, the Kuwait Stock Exchange plans an IPO in early 2019.

Dividend yields on the KSE are relatively high, averaging 3.84% with some sectors offering much higher yields: banks average 4.51%, consumer services 4.89%, telecoms 5.8%, financial services 6.06% and basic materials 9.65%, according to Gulfbase. These dividend yields are attractive versus local cash interest rates of 3%.

ETFs

Frontier markets ETFs : the iShares MSCI Frontier 100 ETF [ticker:FM] and the Invesco Frontier Markets ETF [ticker:FRN] have 19% and 17% in Kuwait, respectively, while the WisdomTree Middle East Dividend Fund [ticker:GULF] has 13% in Kuwait. We are not aware of any pure play Kuwait equity ETF.

Verdict

For now, Kuwait’s market offers attractive dividend yields, but would appear to be of most interest to investors who expect oil prices to stay high or go higher. Over the coming years, it is worth watching how IPOs change the composition of the market to see if more idiosyncratic opportunities arise.