Index providers the new gatekeepers in investment capital

Kenya is getting reclassified and that means a lot of money is going to move around. PHOTO | SHUTTERSTOCK

Index gurus are at it again. Kenya is getting reclassified and that means a lot of money is going to move around.

FTSE Rusell’s positive review (about two weeks ago) is expected to potentially draw inflows of billions of dollars.

Passive funds tracking FTSE’s All-World and emerging markets indexes would now be forced to buy shilling-denominated shares and bonds.

For bonds, that’ll help lower borrowing costs and for equities, shore up the weak prices. Most importantly, fresh capital would help ease depreciation pressure on the shilling.

The index provider had acted on feedback from subscribers and other stakeholders who’d earlier expressed concern about reduced liquidity in the foreign exchange market.

But whatever the outcome, new inflows or not, the work of these index providers raises some questions: Ever wondered why China is classified as a secondary emerging market in the FTSE Russell Index but South Africa is classified as advanced emerging?

How does Jamaica end up with a higher weighting (5.77 percent) than Mauritius (2.17 percent) under S&P Global Frontier classification? Have they become the new gatekeepers of investment capital?

According to FTSE, about $16 trillion is currently benchmarked to its indexes. MSCI and S&P Global follow with over $13.5 trillion and $6 trillion respectively.

With all this capital, imagining global asset owners and managers, ETF providers and investment banks all benchmarking their investment performance and new products on index reviews, that’s a lot of power.

And the three majors are increasingly exercising this private authority as they steer capital via their index reviews.

Let’s put it this way; index providers are now more influential than fund managers. In a world where people buy funds that are tied to indexes, the people who determine what goes into those indexes have become the new gatekeepers.

Previously, active managers called the shots. Back to our Kenyan story; would the review reverse outflows and get us to black?

It’s complicated. Kenya has had several positive reviews in recent years. However, foreign investors’ net cash outflow from the equity market has continued to grow, totalling Sh119 billion as at March of 2023 in a period spanning six years.

In short, expected positive implications (due to positive feedback) do not always work. In the present circumstance, should the global economic picture not improve, it’s possible that expected inflows may not materialise.

Whether or not, market participants say previous sticking points such as repatriation delays are no longer issues, powerful exogenous forces may still keep inflows away.

Nonetheless, index providers are undoubtedly the new de facto gatekeepers, next to the World Bank and IMF. Thanks to the passive investment ecosystem, the three majors are the crucial intermediaries in the relationship between investors and countries.

Gone are the days when active managers would move markets in one direction or another. That said, I still wonder; if China – the world’s biggest emerging market – is not in your advanced emerging market index, doesn’t that make your benchmark defective or at least incomplete?

Mwanyasi is the MD Canaan Capital.