MSCI semi-annual index review triggered $400 mln in outflows from Russia

Bottom line

On May 13, MSCI announced the results of the May 2019 Semi-Annual Index Review for the Global Equity Indices. All changes will be implemented as of the close of May 28, 2019, rather than June 3, as originally scheduled. As expected there were no inclusions and exclusions expected this time around, but in May 2020 the Index’ structure may undergo dramatic changes. We estimated over $400 mln in outflows of passive money from Russia due to inclusion of new countries into MSCI EM and downgrade of weight of some Russian issuers in the index due to contraction in free float as a result of previous corporate actions such as buyback, which, in turn, had an impact on certain shares and Russian market in general.

Global changes to MSCI EM

May 2019 Semi-Annual Index Review has led to some significant global changes: 8 Argentinian and 32 Saudi Arabian securities were added to MSCI EM at an aggregate weight of 0.3% and 2.6% respectively. Thirty Saudi Arabian securities will be added at half of their FIF-adjusted market capitalization, representing an aggregate weight of 1.42%. The second and final step of the inclusion will coincide with the August 2019 Quarterly Index Review. MSCI reclassified the MSCI Argentina Indexes from Frontier Markets to Emerging Markets in one step coinciding with Maty Index Review. Saudi Arabia inclusion will bring up to $40 bln in inflows from active investors this year, Argentina inclusion — $6–8 bln.

Twenty-six China A shares will be added to the MSCI EM at an aggregate weight 1.76%, a rise of 0.96%. All inclusions will bring up to $2.8 bln in inflows from passive investors.

Inclusions of new countries and instruments will result both in inflows and outflows from many countries. Total outflow mostly from Asia ($1.1 bln) and Russia will amount to $1.8 bln, according to our assessments. Russia’s weight is expected to drop by 0.2%, or $224 mln. Lower free-float of certain issuers that have launched buy-backs in 2018, such as Lukoil and MTS, or changes in ownership structure (Polyus Gold and Tatneft) will result in an outflow of additional $205 mln from Russia.

Our calculations are based on the assessment of passive capital in MSCI EM estimated at $112 bln. The figure reflects the funds under the management of Index ETFs linked to MSCI EM that surpasses the Index’ cap.

Passive capital flows in MSCI EM, $ mln

Source: MSCI Inc, ITI Capital

MSCI EM composition, %

Source: MSCI Inc, ITI Capital

Free-float changes — MSCI Russia

Source: MSCI Inc, ITI Capital

Lukoil

  • From September 2018 to April 2019, Lukoil bought back 30.8 mln of ordinary shares totalling 4.1% of the issuer's free-float (750 mln). Given that the current free-float factor for MSCI is 65%, we expected it to drop to 60% (MSCI rounds up to the closest 5), resulting in lower weight (18.4%, −1.3%) and outflow in $65 mln, just above average daily trading volume (ADTV). However according to MSCI official calculations, the free-float factor was lowered to 55% which implies that almost 70 mln shares were bought back, according to MSCI, leading to a drop in weight by 3,4%, or $175 mln in outflows, which was the reason for a recent sell-off

Tatneft

  • At the end of 2018, Svyazinvestneftekhim, owned by the government of Tatarstan, purchased 1.2% of Tatneft's ordinary shares, bringing its share in the company to 34.6%. The move reduces MSCI free-float factor to 65%, down from 70%
  • This is expected to lead to a drop in of the company’s weight from 8.7%, to 8.2%, and an outflow in $35 mln of passive capital, which is almost three times above ADTV

Polyus

  • In April 2019, major shareholder of Polyus Said Kerimov (a son of senator Suleiman Kerimov) sold 3.5% of the company's shares on LSE and MICEX. The sale will bring the free-float above 20% (25% under MSCI standards) and trigger an inflow in $15 of passive capital as a result of the weight’s growth to 1.3%. The inflow will exceed ADTV by over 2.5 times

MTS

  • In July 2018, MTS has launched a $30 bln buy-back programme effective for two years. As of today, MTS bought over 5% of shares, that is expected to lead to a drop in the free-float factor from the current 45% to 40%. However, this will not materially change neither the company’s weight, nor the outflow of passive capital

MSCI Russia: May Review brings no surprises — major changes seen in May 2020

  • On May 13, MSCI announced the results of the 2019 Semi-Annual Index Review for Global Equity Indices, including MSCI Russia Standard Index, triggering major market movements on May 14. Since Saudi Arabia and Argentina were added to the Index, all changes will be implemented as of the close of May 28, 2019, rather than June 3, as originally scheduled
  • There are 23 constituents in the Index now, 58% are from the O&G industry. On November 13, 2018 MSCI excluded HYDR from MSCI Russia. This is the most recent exclusion following Semi-Annual Index Review. The most recent inclusion (Polymetal) took place in November
  • Calculations that MSCI relies on when adding and excluding companies from the index were made in April 20 — April 30. During this period, the MOEX Russia Index little changed. Minimum market capitalization requirement for the MSCI is $ 3,200 mln, as it has been in recent years, and the free float-adjusted market capitalization is $ 1,600 mln

Candidates for de-listing in November 2019

  • Transneft pref has the lowest weight in the index (0.59%), it was 0.61% at the beginning of the year. Transneft is the most likely candidate for de-listing, it survived the six-month review in November 2018 and is likely to do it again in May 2019. Free-float capitalization is the company’s weakest point. It stands at $1,202 mln, just $130 mln above the minimum requirement (11%). Transneft exclusion may trigger an outflow in $30–35 mln, that is 10 times as large as the ADTV in USD

Candidates for inclusion in May 2020

  • In May, three companies will be added to the index, one will be excluded (25 in total, 27 was the maximum). Inclusion of Yandex (possibly in 2020 February quarterly review) will be the key driver of volatility in the MSCI Russia Standard Index. Other companies (FGC and RusHydro) may be included too, but they have to significantly increase free-float capitalization. This is likely to happen by November 2020, rather than by May 2020

1. Yandex (YNDX RX) may be the strongest candidate for inclusion, but the company has low local liquidity. Yandex free-float adjusted cap is $11 642 mln, seven times as large the minimum cap requirement (FF-adjusted MSCI cap). Total market capitalization at the time of calculations was $12,127 mln, which is 3.8 times as more than the MSCI Russia minimum market cap requirement. The minimum local liquidity level of 12-month ATVR now stands at 13.5%, which is 1.5-2% lower than the minimum requirement of 15%. According to the 3-month ATVR, ATVR was way below 15% until Q42018. Since Q42018 this indicator has increased significantly and, therefore, if it does not drop to that level by the end of the year, there are chances that the company will be included in the index during quarterly review in February 2020.

According to MSCI, liquidity is measured on the last trading day of December for a quarterly Index review in February. Hence, Yandex should keep high liquidity till the year’s end. If the company is added to MSCI Russia, its weight will be about 4.5%, the inflow of passive capital may exceed $220 mln and almost $1 bln from active, which with respect to passive flow is 30 times above the current 30-day ADTV on the MICEX and 2-3 times above the current 30-day ADTV on the NYSE.

Yandex — quarterly liquidity ratio of ATVR MSCI

Source: MSCI Inc, ITI Capital

2. Rostelecom (RTKM RX) is the second most promising candidate for inclusion. It meets minimum market capitalization requirement (>$342 mln) but does not meet the free-float adjusted market cap (<$25 mln). The minimum local liquidity level of 12-month ATVR now stands at 47%, which is above the minimum requirement of 15%. If included, the weight will be 0.7%, while the inflow of passive capital will be $35 mln, 10–15 times above the current liquidity. Therefore, the share price may go up by 15%.

Due to low capitalization and high free-float (39%) Rostelecom meets the 12-month MSCI ATVR, even with the current low liquidity. However, the company's liquidity has recently been dropping and, as we see in May 2019, the average Q219 AVTR is approaching the minimum of 15%. If the current trend continues and the AVTR drops below the MSCI minimum of 15%, then Rostelecom will again have to keep higher liquidity over the next 12 months, which will significantly reduce the chances of inclusion in May 2020.

Rostelecom — quarterly liquidity ratio of ATVR MSCI

Source: MSCI Inc, ITI Capital

3. Rusal (RUAL RX) is the third most promising candidate for inclusion, but not earlier than May 2020.

Rusal’s FF-adjusted cap was $ 1 050 mln, which is 33% ($549 mln) lower than the minimum requirement (MSCI FF-adjusted cap). Total market capitalization at the time of calculations was $6 180 mln, twice that of the MSCI Russia minimum market cap requirement. The company’s liquidity increased significantly in the first quarter, but according to the MSCI rules, the company will not be added to the Index unless it maintains it on the proper level over 12 months, as is the case with Yandex. Therefore, Rusal must maintain a high liquidity till the year’s end. If included, the weight will be 0.5%, while the inflow of passive capital will be $30 mln, 10–15 times above the current liquidity. Therefore, the share price may go up by over 10%.

What is MSCI and why it matters?

  • The MSCI Indices are globally recognized benchmarks, against which some $14 trln in investors' assets are tracked
  • MSCI (Morgan Stanley Capital International) financial indices are among the most recognized global indicators
  • They are ideally suited for hedge funds, ETFs, investment vehicles; reflect the macroeconomic climate; more solid as compared to «proprietary» indices of exchanges
  • When Index Review changes take effect, the weight’s drop/growth leads to an outflow/inflow of capital from passive funds amounting to $6–7 mln every time the weight changes by 0.1%
  • Daily trading volume may be up to 10 times the average 30-day trading turnover

Искандер Луцко
16.05.2019