MSCI has announced that it’s considering removing Nigeria from the MSCI Frontier Markets Index given restrictions on currency trading and the resulting deterioration of FX liquidity impacting investors’ ability to repatriate capital.

MSCI plans to announce its decision on or before April 29.

According to Daniel Salter, Head of Equity Strategy at Renaissance Capital, frontier equity investors are much more index agnostic than their emerging market peers – and frontier funds typically allocations typically differ significantly from the index (including off index allocations).

“However the fact is that investors who are currently underweight Nigeria would find themselves overweight if Nigeria was to be removed from the index,” he said.

“Equity investors already have at least $500m less in Nigeria than they "should" have if they were exactly tracking the index (and a billion less than the $1.5bn they might have if they were optimistic and "overweight" Nigeria). Now the remaining $500m is under threat too,” he added.

Salter said that the government prefers longer-term foreign direct investment rather than more volatile foreign portfolio investors.

“However we suspect it is tough to attract one without the other. We think the desire for a decent return on capital is a key motivator for both portfolio and direct investors. Nigeria's exclusion from bond indices and threatened exclusion from this key equity index, is because investors' ability to make that return is now jeopardised by currency restrictions,” he said.

He added that, bond or equity index inclusion helps makes portfolio investors “more sticky” as they tend to invest around the benchmark weighting of a country.

“Indeed - Nigeria still has $500m (NGN200bn) of equity investments in the country - because it is in this frontier index. Being excluded from such indexes creates a higher hurdle to attract future investments. Nigeria would have to become so attractive to foreign investors that they would make it an off-index investment,” he said.

According to Salter, the asset-weighted aggregate MSCI Frontier Markets benchmarked fund is currently underweight Nigeria (6.5% allocation vs 12.3% index weight using end-February data, the latest available): “If they were to sell their entire remaining holdings in Nigeria, this would account for $410m of foreign equity selling.”

He said that global frontier equity ETFs are still tiny, with just $570m of passive money benchmarked to MSCI, of which only $70m is in Nigeria.

“So, a potential of $480m to be sold, but given the illiquidity of naira foreign exchange markets, it is unlikely that this amount could be sold,” he explained.

“At the end of the day, in frontier markets, indices matter less. But a clearing exchange rate and ability to repatriate is vitally important, and equity investors (and bond market investors) will be unlikely to return to Nigeria in to a currency which is still vulnerable to weakening, and where the main policy option available to avoid weakening the currency is capital restrictions. This is particularly the case when emerging and frontier funds alike have been experiencing redemptions and may be required to return dollars to fund holders,” he said.