In just a few days time, Poland will see its capital markets promoted to Developed Market status from Advanced Emerging by FTSE Russell, a leading index provider that is part of the London Stock Exchange Group (LSEG). The move marks the first time in around 10 years - since Israel - that a country has been upgrade in the same fashion.
While news of the upgrade had signalled to the market a long time in advance by the FTSE Russell – from September last year to allow industry participants to get ready it – the big question is what impact will the change have on Poland's equity and bond markets.
Some view it certainly a positive development, and let’s face it which country would not want to be promoted to the big boys league that includes the likes of France, Germany, Spain, Switzerland, the U.K and the U.S. among 23 other countries in the Developed FTSE country classification (as of March 2018).
Others have expressed certain doubts and reservations over how positive it will actually turn out to be. But whatever the case, Poland will shift from the ‘Advanced Emerging’ classification, which at the time of writing included 11 countries - from Brazil to the Czech Republic and Mexico to South Africa and Turkey.
Speaking at the London Stock Exchange in The City of London earlier this summer, Arkady Rzegocki, the Polish ambassador to the U.K., pointed out that: “According to World Bank analysts the Polish economy has now entered the 26th year of uninterrupted growth - the longest in Europe’s recent history. This speed of economic expansion outpaces even Japan or South Korea.”
Rzegocki, a former assistant professor at the Jagiellonian University in Krakow, describing Poland as a “unique success story” added: “We never had an economic crisis. Nor a banking crisis requiring bailouts - thanks to the strong banking supervision. Poland is the only economy where privatization did not produce oligarchs. Today, with the annual GDP growth rate at 4.6%, unemployment at 6%, low public debt at 54% and low inflation at 1.6%, we enjoy high quality of human capital, ever better infrastructure and stable macroeconomic, fiscal, and monetary policies.”
Journey To Developed Market Status
Looking back over the past decade and a half, it has been an interesting journey for Poland. When the FTSE Country classification was launched in 2004 the country was ‘Second Emerging’. Today, countries in this grouping include Chile, China, Egypt, Indonesia, Pakistan, Russia and the UAE.
By September 2006, Poland was added to the index providers ‘Watch List’ for possible reclassification from Secondary Emerging to Advanced Emerging market status (effective from September 2008).
Subsequently in September 2011, it was added to the Watch List for possible promotion from Advanced Emerging to Developed market status. Then last September, FTSE Russell confirmed the nation’s reclassification to Developed market status (effective this month).
Country Comparison: CEE Region & Russia
FTSE Index No. Inv. Mkt.
Classification Of Securities Cap ($m)
Austria Developed 28 61,694
Poland Developed* 38 70,965
Poland Advanced Emerging 42 71,355
Czech Rep. Advanced Emerging 6 10,523
Hungary Advanced Emerging 5 19,671
Russia Secondary Emerging 47 211,574
Source: FTSE Russell. As of March 30, 2018. *For Poland the figures provided for Developed status were a projection at the time. The nation’s FTSE GEIS Index weight will remain at around 0.138% (versus 0.120% for Austria). And, within the Advanced Emerging classification (0.020% for Czech Republic and 0.038% for Hungary).
Philip Lawlor, Managing Director of Global Markets Research at FTSE Russell, commenting at the recent co-hosted event at the London Stock Exchange near St Paul's cathedral with Warsaw Stock Exchange officials, said: “It’s underestimated just how big Poland is in context of the European economy. Looking at aggregated nominal GDP, the country is the seventh biggest economy biggest economy in Europe. It’s comparable to Sweden and significantly bigger than other economies like Austria, Portugal or Hungary.”
He added: “One can also observe that Poland - if comparing the delivery of gross national income (GNI) per capita as defined by the World Bank - the country has not only experienced a vastly superior growth rate trajectory, it now stands (in terms of the GNI category) at about 50% above the ‘upper middle’ category.”
With consumption, which represents the bulk of the economy and constituting over 60%, and growing at a healthy clip of around 3.5% to 4.00%. Lawlor, a former fund manager on the buy-side, said: “So, Poland is looking and feeling like a developed market. Over the longer term [look at the charts] it has persistently delivered faster and more secure growth than other emerging markets - and maintained this big growth premium.”
It is worth pointing out for Poland, that as well as attracting quite large fiscal transfer flows from Europe in recent years, the banking system was not exposed to the securitization debacle that unfolded in rest of the world.
Polish Equities: A ‘Big Opportunity’ Set?
Lawlor noted that around the time the U.K. was occupied by the referendum on continued EU membership and Brexit issues (mid 2016) there was dramatic inflection in relation to the performance of Polish equities. and, over a 12-month period from around this time Polish equities delivered some of the best returns anywhere.
He added: “Polish equities started trying to outperform emerging markets at the latter end of 2017, but continued to outperform the Developed market latter.”
With around 42 stocks from Polish companies in the FTSE Russell Developed market index – up from 38 constituents as it was under the Advance Emerging category, Lawlor thinks that the “universe of stocks to will expand” and there is certainly an opportunity here.
Added to that there could be scope for more listings, with potential for the London Stock Exchange to benefit. It already lists a number of Polish companies on its Main Market (Bank Pekao S.A. from 2000; Stock Spirits Group Plc from 2013; and International Personal Finance Plc from 2007 and Work Service S.A., which listed in 2016),
While there is a concentration among certain stocks – the top 10 Polish stocks account for c.65% of the main Polish index (WIG), there is a high overweight in financials relative to Europe as a whole.
How Does Poland Stack Up?
And, while from the 2013-2014 period onward Polish equities saw a “gradual, but fairly persistent de-rating” according to Lawlor pointing to the graphs, it now stands at a discount to both developed and emerging markets.
Lawlor said: “Now, this is something that many people will be looking at in terms of their screenings [i.e. on stocks]. Once you get big differentials...then market participants start to look at this an opportunity set.”
He added: “Poland is a market that has witnessed a big de-rating. And, it looks as though from the forecasts that the outlook relative to other markets is going to improve quite markedly.”
Turning to earnings per share (EPS) growth forecasts from the analysts, this year they have been below the peer group. That said, the profile is changing dramatically according to consensus forecasts over the next 2 years from IBES. This sees a tangible improvement in EPS growth being delivered in 2019, with it expected to “accelerate even more through 2020”, Lawlor stated.
Access To Polish Market
Filip Slipaczek, a British-born independent financial advisor of Polish heritage and a bespoke fund picker through his practice that avoids model portfolios and discretionary fund managers, noted an increasing appetite and preference for the firm’s clients to invest in individual countries.
The tripled-chartered Financial Planner, whose family practice has over 300 clients and assets under management (AUM) in excess of £50 million (c.$66 million), said: “Over the years clients have specifically requested a desire to invest in individual countries in Europe - and Poland in particular. Indeed, one particular client wanted a large exposure to Poland.”
He added: “This is best undertaken by recommending suitable FCA-regulated UK-domiciled funds. And, if you choose a mutual fund you know what is on the tin.” Generally speaking, Slipaczek does not recommend exchange traded funds (ETFs) in the space.
Funds that come to mind for access the Polish market include Perpetual Emerging European fund, which has around 14.5% overall holding of the fund in Polish equities.
The largest constituent holding (c.5.5%) in this fund being PZU Group (Powszechny Zakład Ubezpieczeń), a publicly traded insurance company founded in 1803, a component of the WIG20 index and one of the largest financial institutions in Poland. It is also one of the top insurance companies in the Central and Eastern Europe (CEE) region.
Another fund cited by Slipaczek is Jupiter Emerging European, which a 21.34% holding in Polish equities that includes a 3.41% holding in Poland’s largest bank, PKO Bank Polski.
Continuous Improvement...With Caveats
While Poland’s reclassification to Developed status is the fruit of continuous improvements in the country’s capital markets infrastructure, some market pundits are not entirely convinced the move will be positive - at least in the near term.
This is notwithstanding the fact that in FTSE Russell’s assessment of Poland, which spans 21 criteria of the market that canvassed opinion in the market (i.e. from brokers, custodian banks, etc), the nation’s World Bank GNI per capita rating was ranked as “High” (it had been “Upper Middle” back in 2013); Settlement for trades was T+2 in 2017 (versus T+3 between 2004 and 2015); and, all the other criteria received a “Pass.”
Within the Custody and Settlement area, for Custody (Omnibus and segregated account facilities available to international investors) had in the years 2013 and 2015 been labelled “Restricted”, and prior to that “Not Met” (in 2004 and 2011). Now they have passed the criteria.
Small Fish In A Big Pond
This September, Poland leaves the FTSE Emerging All Cap Index, where its weight (as of March 2018, had been 1.33%), and join the FTSE Developed All Cap Index, where its weight has been projected to be around 0.154%. That is a no small shift.
Marcin Szortyka, Head of the equity team at NN Investment Partners (NN IP), an asset manager headquartered in The Hague, who is based in Warsaw and manages around €1 billion (c.$1.17 billion) in local equities in Poland, commenting on whether FTSE Russell’s upgrade to Poland will act as “a catalyst” for investment, said: “Fundamentally we do not view it this way. We do not think that this upgrade development will shift investors’ focus on Poland within EM’s.”
He added: “I would say that at present that Poland is an Emerging Market (EM). And, it is preferably better to be a larger constituent in the EM’s than be a tiny share in the Developed one [market].” Furthermore, he noted that even at this stage in the emerging markets Poland is “kind of on the sidelines.”
“There are not that many tech companies and the main index [WIG20] are mainly comprised of banks, utilities, oil and gas. So, let us call it heavy and legacy sectors.” Further, he contended that even right now “Poland is not in the focus of investors within EM’s.” So, certainly a contrast in views and food for thought.
Szortyka also contended that he did not think that the upgrade will mean that investors will have an incentive to add Poland to their portfolios at this stage. And, the general view in Poland - at least among fund managers - he pointed out is that the upgrade [FTSE Russell] was “not exciting from a flow perspective...or viewed as being overly positive.”
Szortyka went as far as saying of the upgrade: “It is regarded as a threat. And, if one looks at the history of the capital markets of Israel when the country was upgraded similarly back in 2010 from emerging, the net balance of flows were negative for the market.”
Poland Trading At A Discount
While concurring that Poland is trading at a discount in relation to its history and especially towards the developed markets, Szortyka added a caveat in that: “As a house we do feel this is partially justified given the fact that this year we are not likely to see any earnings growth.”
“So, I would not say the improvement or upgrade to developed market status would be a catalyst. It should be coming, if you like, from the earnings side [of companies]. And, we are expecting earnings growth – having started in the first quarter (Q1) this year - to show more visibility in 2019 - with perhaps 10%-15% growth in net income next year.”
In terms of the flows perspective, NNIP’s Szortyka indicated during a telephone interview that they would “look more positively” on matters when Poland has a second or third pillar reform on the pensions front front. “This might boost some flows and interest, but other than that not,” he added.
Fixed-Income Market & International Interest
An interesting thing on the fixed-income side is that there is significant demand for Polish bonds being seen, in contrasts to equities that have been trading at a discount. On this, Szortyka noted: “The yields [on bonds] are supported both by strong economic growth with low inflation and by demand. But it is a kind of a strange situation where you have a strong fixed-income market and a rather weak equity market.”
In terms of international interest in the Polish market, he stated: “Looking at the positioning of international investors, they are ‘underweight’ Poland. [And], they have always been underweight because the money flows and earnings growth are key factors.”
He added: “The earnings growth evaporated after a super 2017 when we saw about 20% earnings growth. By contrast 2018 has been rather sluggish in terms of the dynamic. So, what we would expect is growing interest of foreign investors only after they have confirmation that the Polish market is coming to the earnings growth track. So maybe next year we will see some investor appetite.
And, given the structure of the index [WIG], being comprised mainly the banking stocks, it will be these that will move the market because of their high percentage share in the index.
Valuations Are Cheap
Outside the top tier of stocks, valuations for small and medium-sized enterprises (SME’s), especially on the very low caps have fallen quite substantially of late. The Price/Earnings (P/E) ratio is close now to 8 or 9, and as a rule of thumb anything under the 10-mark is cheap.
“The valuations are cheap. We are seeing more tender offers than IPOs. In 2017, for example there were 27 IPOs and 56 tender offers to delist companies from the exchange,” Szortyka remarked. “So, from a long-term strategic point of view for investors these levels appear to be kind of a ‘value play’. Not surprisingly the number of tender offers for companies was up 50% year-on-year (YoY) in 2017.”
Of course, foreign investors will also have to factor in the exchange rate in their investing decisions and strategy. The Polish Zloty year-to-date by mid-July 2018 had depreciated by c.7%-8% against the US dollar by and some 5% against the Euro. But whatever else there is likely to be some volatility in the market as funds reposition their portfolios around the upgrade to Poland becoming effective.
