The Lima stock exchange fell 5.25% yesterday on news that the MSCI equity-index provider is considering reclassifying Peru as a “frontier market.”
The selloff of Peruvian stocks was prompted by a statement from the MSCI research and market-data company that it was reconsidering its classification of Peru as an “emerging market” because of low market liquidity. The MSCI emerging-market index was the first to track emerging-market equities and is closely followed by mutual funds, hedge funds and other investment firms worldwide.
If Peru were removed from MSCI’s emerging-market index, financial products which mimic the index or have bylaws which require investment in MSCI-defined “emerging markets” would be obligated to remove Peruvian equities from their portfolios.
“Currently only three securities from the MSCI Peru Equity Universe meet the relevant investability requirements applicable to Emerging Markets,” read MSCI’s press release. “MSCI proposes to apply the minimum size requirements of the Smaller Frontier Markets, and a minimum liquidity requirement of 5% Annualized Traded Value Ratio (ATVR) for the MSCI Peru Indexes.”
The annualized traded value ratio measures the total trade volume as a percentage of market capitalization. With a ratio below 5%, MSCI may consider Peru-listed stocks not to be easy enough to sell and convert into cash. Hence the classification would be an effective downgrade to “frontier market,” where the minimum annualized traded volume ratio is only 2.5%.
While the reclassification would not be a referendum on Peruvian stocks or the national economic performance, a confirmation of reclassifying Peru as “frontier” would trigger more sell-offs and remove significant foreign investment from the country.
Exchange-traded funds which follow MSCI’s emerging-market index manage a total of $1.7 trillion, while those following the frontier markets total only $14 billion.
Emerging markets defined by MSCI include each of the other three Pacific Alliance members as well as Brazil, China, India, Russia, South Africa, Egypt, Poland and Korea. Frontier markets include Argentina, Kenya, Nigeria, Vietnam, Pakistan and Kuwait.
Yesterday’s losses represent the largest single-day loss in over four years for Peru’s stock market, which has fallen over 50% from three years ago.
Peru’s central bank sold $108 million to slow the fall of the nuevo sol, which closed the day at 3.239 per dollar, a new six-year low.
MSCI will announce its decision on how to classify Peru on September 30.
MSCI FRONTIER MARKETS INDEX (MSCI)