(Adds graphic in bullets)
* Pakistan trades at discount to India and other EMs
* Improved economic, political climate underpins GDP rally
* UAE rallied 98 pct ahead of inclusion in MSCI EM index
* Small weighting means some managers may ignore Pakistan
* GRAPHIC-Pakistan's performance vs other EMs:
By Claire Milhench
LONDON, Sept 5 A stock market boom and five
percent economic growth are helping Pakistan to find favour
among international investors and its re-entry next year into a
widely used emerging equity index could cement the rally.
For years Pakistan has traded at a chunky discount to its
neighbour India and other emerging peers, hampered by a
reputation for economic chaos and security issues. But Karachi
, currently designated a "frontier" market, is now less
than a year off re-joining MSCI's emerging market index.
Pakistan was ejected from the index in 2008 after the local
exchange imposed a price floor to halt a downward spiral and
trading was practically suspended for five months. When it
rejoins, passive or index-tracking funds could pump in a net
$125 million, according to calculations by Renaissance Capital.
Another $550 million may come from active managers, assuming
their Pakistan allocations are on a par with its expected 0.2
percent weight in the index.
In anticipation of these flows, Pakistani stocks have
already rallied 14 percent in dollar terms this year,
outperforming most other frontier markets and beating the 13
percent emerging market average.
Asha Mehta, manager of Acadian's Frontier Markets Equity
Fund, said the UAE and Qatar had returned 98 percent and 54
percent respectively from the time that MSCI annnouced their
upgrades in June 2013 until implementation in May 2014.
"Pakistan has strong earnings growth so when investors
become more familiar with the fundamentals, it is reasonable to
think there will be significant appreciation," Mehta said.
But the tailwind from index entry is only part of the story.
Michael Levy, manager of the Baring Frontier Markets Fund,
linked Pakistan's promotion to the big league to efforts to
create an environment for companies to deliver strong earnings
growth, which should outlast any short-term fillip.
New-found political stability, the completion of a
three-year IMF programme, privatisations and a $46
billion agreement with China for an economic corridor mean
economic growth is expected to reach around 5 percent in the
fiscal year to June 2017.
Earnings per share (EPS), a key profitability indicator, are
expected to grow by 14.7 percent over the next 12 months,
according to consensus estimates, Levy said. But the bourse
trades around 10 times forward earnings, versus an emerging
markets' average of 14 and around 17 for India.
"There are a lot of companies with good earnings growth
prospects that are cheaply valued," he said, citing positive
earnings surprises this year from Lucky Cement and
United Bank, both of which have been tapped by MSCI for
inclusion in the emerging index.
Pakistan offers similar opportunities to most emerging or
frontier economies, with cement demand growing by 15-20 percent
per annum. Less than a tenth of the population has a bank
account, meaning financial stocks also have potential.
This has already lured managers such as Will Ballard, head
of emerging markets and Asia-Pacific equities at Aviva
Investors, who highlighted dividend yields of around 5 percent -
well above India's 1.7 percent, according to Thomson Reuters
A third of Karachi's freefloat market capitalisation is now
held by foreign investors, but stumbling blocks
remain. Many companies are not well analysed and security
concerns still deter some managers from visiting Pakistan.
Liquidity is also an issue for bigger funds, with average
daily trading volumes at around $106 million, according to
RenCap, compared with some $2.6 billion in India.
While these volumes are good for a frontier market, larger
emerging market fund managers said they would find it difficult
to build positions.
Also, Pakistan's weighting in the emerging markets index
will be small enough for some funds to ignore it, while the
country already features in the biggest EM index tracker -
Vanguard's $57.5 billion Emerging Markets Stock Index Fund and
exchange-traded fund (ETF).
However, active frontier market funds, which according to
RenCap hold around $570 million worth of Pakistani shares, could
stay invested even after the move to the emerging markets
category. Baring's Levy, for instance, does not intend to sell
solely on the basis of the upgrade.
Also, Pakistan, in contrast to many frontier markets, is an
oil importer so frontier funds will be reluctant to sell, says
Hasnain Malik, head of frontier markets strategy at Exotix
Ross Teverson, who runs an emerging equity fund at Jupiter,
said Pakistan would see more measured inflows than the UAE and
Qatar, where cash flooded in before their index upgrades.
"We will see a more gradual waking up to the opportunity in
Pakistan," he said. "But it has been neglected for a long time,
and therein lies the opportunity."
(Reporting by Claire Milhench; Editing by Gareth Jones)