On Wednesday, Argentina’s economy got some unequivocally great news in the form of a decision from the Morgan Stanley Capital International (MSCI): Argentina is now officially classified as an “emerging” market
This is big news because this seemingly arbitrary classification does more for real direct investment in the country than the IMF and the World Bank put together. It signals that the global investment community believes Argentina might be able to keep it together. Inclusion in the MSCI Emerging Market Index gives the green light for institutional money to invest in Argentine equities.
Have you ever bought shares of a mutual fund? In case you are a millennial who has spent all of your money on avocados and selfie sticks, allow me to explain. Many investors choose to purchase shares of a mutual fund rather than directly go out and buy stocks in a company or country’s bonds. The investor is then exposed to a much wider range of securities (aka stocks and bonds) than they would otherwise be. So in this example, you could have time free to work on your tech start up AND spend your lucrative investment gains on avocados.
Mutual funds, along with pension funds and other lower risk pooled capital are examples of institutional money. To protect passive investors like mutual fund shareholders, these funds have rules that limit the amount of risk and concentration that keep your money from being invested in, for example, the guy who manages the fund’s own startup or a crazy pyramid scheme in Egypt (see what I did there?). These rules might allow a small percentage to be invested in Emerging Markets but certainly is too practical for Frontier Markets.
Besides actively managed institutional funds, the investment world also comprises Exchange Traded Funds, or ETFs. Rather than spend money on administration costs and salaries of someone to actively choose where to invest based on a set of rules, these ETFs just track the movement of an index, automatically buying and selling shares in the companies included.
Over US $1.6 trillion tracks the MSCI Emerging Market Index. And now, some of that money is allowed to go to Argentina.
Emerging vs. Frontier
Frontier Markets is a nice way to say the only kind of investment you’re going to see is by what I term “cowboys and assholes”. Let me explain. When a country is called a “Frontier” it sends a message that practical people with reasonable expectations of things like transparency or rule of law need not apply. And so you’re left with investors willing to take big risks to potentially score a big win. Basically if you’re familiar with frontier world from the sweet 1973 film Westworld, or the lesser known cult show on HBO of the same name, you get investors to the tune of that guy in the black hat or that other sadistic piece of work:
Now I moved here and started a business while Argentina was a Frontier Market so take from that what you choose, but the point is that equity investors in frontier markets are by definition comfortable with a crazier, riskier operating environment and their access to capital is limited. We are definitely better served by more even keel institutional investors.
Equity vs. Debt
The key thing to take away from this is how different it is than the Argentine government – or even Argentine companies – going to the market and selling bonds. When a sovereign or a corporation sells bonds they create a debt that must be repaid, and penalties and conditions that legally fall into place if payments are not made. This how how the whole vulture funds/fuera buitres situation unfolded. Argentina borrowed money and then was unable to pay it back.
Equities are shares in companies – so there is nothing to pay back. Investors own shares in Argentine companies and thus are exposed to both gains and losses without recourse.
But I thought the economy was looking meh?
It certainly hasn’t been a good month for the ol’ peso. The MSCI decision though is based on market participants’ “confidence in the country’s ability to maintain current equity market accessibility condition … however it would review its reclassification decision were the Argentinian authorities to introduce any sort of market accessibility restrictions, such as capital or foreign exchange controls.” That is banker lingo for saying that the recent monetary volatility is not Argentina’s fault, and if Argentina maintains its present economic policy course than this is a risk that investors are willing to take.
So does this turn on an automatic tap of investment flowing into the economy?
No. The decision will take effect in May 2019 and be restricted to foreign listings of Argentine companies until the liquidity conditions on the Buenos Aires Stock Exchange improve. Again in plain English that means Argentine companies that are publicly listed in Buenos Aires and allow their shares to trade via mechanisms such as American Depository Receipts (ADRs). But this gives more companies in Argentina the incentive to become publicly listed, access capital, and grow.
The Merval, the Buenos Aires Stock Exchange, rose 7 percent on the news. And this year should see big players in the investment world of the likes of BlackRock nosing around the market doing some due diligence. Happy days.
If you’re having trouble sleeping and looking to catch some zzz’s, you can check out the methodology MSCI uses to pick emerging markets here.