Investability

What Is Investability?

Investability refers to the ease and extent to which foreign investors can access and transact in a given financial market or specific securities within that market. It is a critical concept within international finance and market classification, as it evaluates the practical considerations for investment beyond mere economic size. High investability implies that a market has the necessary infrastructure, regulatory transparency, and operational efficiency to facilitate cross-border capital flows. Factors influencing investability include the openness of a country's capital markets, the ease of repatriating capital and profits, and the existence of robust investor protection measures. For asset managers and index providers, assessing investability is fundamental to determine which markets or securities are suitable for inclusion in global investment portfolios, directly impacting portfolio construction and ultimately, diversification.

History and Origin

The concept of investability gained significant prominence with the rise of global index providers and the increasing internationalization of investment portfolios in the late 20th century. As institutional investors sought to diversify globally, the need arose for standardized criteria to evaluate the accessibility and operational efficiency of different national markets. Organizations like MSCI (Morgan Stanley Capital International) became instrumental in formalizing these criteria through their market classification frameworks. MSCI, for instance, evaluates equity markets worldwide to classify them as developed markets, emerging markets, or frontier markets based on economic development, size, liquidity, and crucially, market accessibility and investability⁹.

Historically, debates around capital account liberalization, often influenced by institutions like the International Monetary Fund (IMF), have played a role in shaping market investability. While the IMF generally advocated for the benefits of open capital accounts, their stance evolved following various financial crises, leading to a more nuanced view on the timing and conditions for liberalization, acknowledging potential risks and the utility of capital controls in certain scenarios⁷, ⁸. The framework developed by major index providers has become a de facto standard, influencing billions of dollars in passive and active investments by categorizing markets based on these operational aspects.

Key Takeaways

• Investability refers to the practical ease and extent to which international investors can access and trade in a market or its securities.
• It encompasses various qualitative and quantitative factors, including market openness, regulatory efficiency, and operational ease.
• Major global index providers use investability criteria to classify markets, guiding global portfolio allocations.
• High investability generally indicates a mature and transparent financial environment conducive to foreign investment.

Interpreting Investability

Interpreting investability involves assessing a market's practical readiness for foreign capital. It's not merely about legal openness but also about the actual mechanisms in place for investors. For example, a country might legally permit foreign ownership of equities, but if its currency exchange rates are volatile or its settlement systems are inefficient, its investability will be low. Key considerations include the presence of clear and consistent market regulations, the depth of market liquidity, and the operational ease of trade execution and capital repatriation. Investors and analysts often look at a market's adherence to international standards and its history of stability in capital flows. A market with strong investability implies a reduced operational risk assessment for international participants.

Hypothetical Example

Consider "Country Alpha," an emerging economy seeking to attract more foreign direct investment and portfolio investment. Its government has recently enacted reforms aimed at enhancing its financial market's investability. Previously, foreign investors faced restrictions on capital repatriation, and the process for opening brokerage accounts was cumbersome. To improve investability, Country Alpha introduces a simplified online registration system for foreign investors, guarantees full capital repatriation after a six-month holding period, and implements real-time settlement for equity trades. These actions directly address operational hurdles and provide clearer guidelines for capital movement, making Country Alpha's financial markets more attractive and accessible to international investors.

Practical Applications

Investability is a core consideration in several areas of the financial world. Global asset managers rely heavily on investability assessments when making asset allocation decisions and constructing diversified global portfolios. For instance, the inclusion or exclusion of a country in a widely followed index, such as those maintained by MSCI, is significantly determined by its investability status⁶. A market's upgrade from frontier markets to emerging, or from emerging to developed, signals improved investability, which can lead to substantial inflows of foreign capital.

Regulatory bodies also consider investability. The U.S. Securities and Exchange Commission (SEC), through its Office of International Affairs, engages with foreign regulators to promote regulatory cooperation and high standards, which indirectly enhance the investability of global markets by fostering transparency and investor protection⁴, ⁵. Furthermore, national governments aiming to attract foreign capital often implement reforms to improve their market's investability, recognizing that a favorable regulatory framework and operational efficiency are key to securing international investment. The Federal Reserve Bank of San Francisco has published research highlighting how capital flows, influenced by market accessibility and stability, impact economies, particularly in emerging markets², ³.

Limitations and Criticisms

While investability is crucial, its assessment can be subjective and may not always capture the full picture of a market's attractiveness. Critics argue that relying heavily on metrics defined by index providers might overlook nuances or specific opportunities in markets that don't fit neatly into established categories. For example, a market might have limited market capitalization for large institutions but offer compelling growth prospects for niche investors.

Another limitation is that improvements in a country's stated investability, often driven by policy changes, do not guarantee sustained investor interest if underlying economic fundamentals or political stability are weak. Rapid liberalization of capital accounts without adequate domestic financial system safeguards has, in some historical instances, led to increased financial vulnerability, as evidenced by some emerging market crises where sudden capital flow reversals caused significant disruption¹. Even with a strong investability score, investors still face macroeconomic and geopolitical risks.

Investability vs. Market Accessibility

While closely related and often used interchangeably, "investability" and "market accessibility" have distinct nuances in the context of market classification frameworks.

Market accessibility is a prerequisite for investability; a market cannot be investable if it is not accessible. However, high accessibility does not automatically imply high investability. A market might be legally accessible but practically difficult to navigate due to low liquidity or inefficient trading infrastructure. Investability therefore builds upon market accessibility by considering the full operational lifecycle of an international investment strategy.

FAQs

Q: What makes a market "investable" for international investors?
A: A market is considered investable when it offers sufficient openness, operational efficiency, regulatory transparency, and investor protection to allow foreign investors to easily buy, sell, and repatriate their investments. This includes factors like the absence of capital controls and efficient trading mechanisms.

Q: Why is investability important for global index providers?
A: Global index providers, such as MSCI, use investability criteria to determine which countries and securities are eligible for inclusion in their global indices. This is crucial because many institutional investors track these indices, and a market's inclusion (or exclusion) significantly impacts global capital flows and portfolio construction.

Q: How do capital controls affect investability?
A: Capital controls, which are government restrictions on the movement of capital in and out of a country, generally reduce investability. They can limit the ability of foreign investors to bring money into a market or, more commonly, to repatriate profits and capital, thereby increasing perceived risk and operational complexity.

Q: Is investability a static concept?
A: No, investability is dynamic. Countries often undertake reforms to improve their financial market infrastructure, legal frameworks, and operational procedures to enhance their investability. Similarly, political or economic instability can lead to a decline in a market's investability.