As Pakistan celebrated its entry into the MSCI Emerging Market (EM) Index on May 15, 2017, Templeton Emerging Markets Group Executive Chairman Dr Joseph Mark Mobius — biggest foreign investor in the Pakistani capital market and considered by many as the all-time best investment guru after Warren Buffet — offered what then appeared to be a shocking comment: “Franklin Templeton Investments will continue to treat Pakistan as a frontier market (FM) as it was not ready to become EM,” he said.

The then managing director of the Pakistan Stock Exchange (PSX) Nadeem Naqvi dismissed Mobius’s statement, so did almost all stockbrokers, analysts and fund managers.

The excitement over the reclassification of the Pakistani stock index to the EM from the FM was built on the premise of an inflow of $300-500 million into the equity market from global players on June 1, 2017 when the MSCI reclassification was to become effective.

The anticipatory buying by local investors, mainly in the six companies that qualified for the main index, included those stocks that have the heaviest weight in the benchmark: United Bank, Habib Bank, Lucky Cement, Oil and Gas Development Company, MCB Bank and Engro Corporation. The KSE-100 Index propelled to an all-time high of 53,124 points on May 25, 2017.

But investors stared at the trading screen in disbelief as the benchmark plunged 862 points (1.67 per cent) on May 31. Instead of an inflow, the market witnessed $400m worth of foreign sell-off. The evil spell cast that day has lingered on and the market has continued to bleed from incessant foreign selling.

Foreigners have offloaded stocks for the last four years: $309m in 2015, $339m in 2016, $488m in 2017 and $227m in 2018 (to date). A major market player said that rising treasury yields and a stronger dollar had sapped demand for riskier assets, adding that the equity sell-off was not Pakistan-specific and could be seen in most emerging markets.

Pearl Securities Head of Research Rehan Khan observed that the foreign sell-off could be attributed to a number of factors, such as the rising US yields and attractiveness of stocks on Wall Street after tax cuts announced by President Trump. “As for local factors, the policy of holding the rupee at an unnaturally high value for a long period, worsening of the balance of payments and uncertain political conditions were to blame for foreign outflows,” he said.

Another stock watcher said that the weight of the Pakistan equity index in the EM had trimmed by half from initial 0.10pc, which had disillusioned foreigners. Spectrum Securities Head of Research Abdul Azeem observed it is no wonder that foreign investors have been re-evaluating their portfolio strategy considering the declining trajectory of the economy, high-risk categorisation and a negative outlook by rating agencies.

Despite persistent selling, foreign funds still hold $5.75 billion worth of Pakistani equities (Aug 3). While Franklin Templeton towers above the rest, those having a stake in the local market include Asia Frontier Capital, Black Rock Inc, Lazard Asset Management, Parametric Portfolio Associates, Charles Schwab Investment Management, HSBC Global, Bank of New York Mellon, HardingLovener, Capital Group and Schroeder.

A major fund manager affirmed that foreigners were opting to exit equities. He pointed out that internationally equity funds were anticipating a decline in their dependence on oil going forward as alternative sources of energy were catching up quickly. “A careful look at the pattern of foreign selling would reveal a major sell-off in refineries, oil and gas exploration companies and oil and gas marketing stocks,” he said, adding that it was the case globally.

He said foreigners had big stakes in oil and gas heavyweights and top-tier banks. Held over a long period and bought at cheap valuations, foreign investors were inclined to take profit in a falling market. Sometimes it triggers selling in other stocks as well, pulling down the entire market due to its domino effect.

Stocks in which local individuals and institutions were invested remained comparatively stable, such as those in textile, steel, cement and fast-moving consumer goods segments.

But unlike the past when foreign selling was dreaded because it precipitated a sell-off by local participants, foreigners are no longer able to set the direction of the market.

The market is now flush with liquidity and the appetite of local investors for fresh issues has not been satiated in the absence of new initial public offerings (IPOs). Only three companies have entered the capital market to mobilise funds this year. As many as 11 companies were positioned to launch IPOs till May 2017. But most of them put their plans on the hold fearing under-subscription in a declining market.

As a result, a great amount of liquidity has been chasing a tiny number of blue-chip stocks. That was the reason the sell-off by foreigners was successfully absorbed by local high net-worth individuals and institutions, including banks, companies, mutual funds and insurance companies.

Mutual funds, which have come to assume a commanding position among participants, were required by law to remain 70pc invested in the market in the case of equity funds. This also helped limit the stock market’s downside and avert a crash.

Published in Dawn, The Business and Finance Weekly, August 13th, 2018