Alaskan Quant Fund Sees Profit in Frontier Markets Near Upgrades

(Bloomberg) -- It's time to pay attention to Kuwait's stock market, according to Alaska-based quantitative fund McKinley Capital Management.

McKinley sees opportunities in developing strategies for its clients, such as Alaska's $60 billion state investment pool, to access markets which represent a disproportionately small slice of equity indexes relative to their share of the global economy -- and Kuwait is one of those. Those gauges will, the thinking goes, become deeper and more liquid as they enter global benchmarks or get upgraded to new ones.

“We're loaded to the gills in Kuwait,” said Robert A. Gillam, McKinley's chief executive officer, in a recent phone interview. Stocks from that country currently comprise about 22 percent of the MSCI Frontier Markets Index, the highest weighting of any country. McKinley is investing to benefit from the incoming money flows in such markets, Gillam said.

“The bet is these countries' index weights will approach their economic power,” Gillam said.

Index compiler MSCI Inc. is consulting clients on whether to upgrade Kuwait to join the emerging-market club. The country has already attained that status in a rival index compiled by FTSE Russell.

Read more about the seismic shifts UBS sees coming from index companies

The strategy isn't a new one. Hedge funds and traders often ramp up purchases of stocks prior to their actual inclusion in indexes, planning to sell them to passive investors once the addition is made. Announcements that individual stocks or particular country assets will be included in benchmarks frequently boost the price.

“You tend to have a bit of a sell-off” after the actual inclusion, Gillam said.

Still, there are some lasting positive benefits. McKinley expects to see greater market liquidity as a result of index inclusion, and also longer holding periods for markets which have historically had a disproportionate share of retail investors. The fund manager has invested in Chinese domestic listings including Ping An Insurance (Group) Company of China and Kweichow Moutai Co. Ltd. in anticipation of a flood of new investment from passive funds with mandates to track MSCI's benchmarks.

“Those are the ones that get the most flows,” Gillam said, referring to the Chinese stocks. “I'd expect to see some pretty strong movement in those.” The interview was conducted before MSCI announced Friday that it was raising China A-shares' inclusion level to 20 percent from 5 percent.

The fund manager's preferred bets are fast-growing companies with accelerating revenue and profit increases, especially when they can be bought cheaply. One example is Xinyi Glass Holdings Ltd, a Hong Kong-based supplier of products to the automobile, construction and household sectors, which trades on a multiple of 8.3 times next year's estimated earnings, Gillam said. That compares with a figure of 11.5 for the full MSCI China Index.

To contact the reporter on this story: Gregor Stuart Hunter in Hong Kong at ghunter21@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Joanna Ossinger, Adam Haigh

©2019 Bloomberg L.P.