KSE one of the hottest markets in the world

It’s a country known as a haven for militant Islamic terrorism. And the government continues to engage in a dangerous game of nuclear brinksmanship with its neighbour. Yet Pakistan’s largest securities market, the Karachi stock exchange, enjoyed a 118 percent return in 2002—the best by far (Prague’s PX 50, up 38 percent, was second) of any index on the planet. And it wasn’t a one-year fluke: The KSE has trounced both the New York Stock Exchange and the S&P 500 over three and five years, reports Fortune.

Just what is driving this improbable bull run? Ironically, the answer may be linked to the country’s unstable political climate. In periods of crisis, says George Greig, an emerging-markets specialist at William Blair, investors concerned that the local currency under their mattress may lose its value often take their chances with the market.

Despite the capital influx from desperate investors, Pakistan’s KSE remains small. The 709 companies listed on the exchange have a combined market capitalization of just $9.5 billion. And much of the volume is concentrated in the hands of a few companies. On February 6, for example, more than 30 percent of the volume was attributed to just five stocks—12 percent alone in the exchange’s largest company, Hub Power Company. As a result, smaller securities often see massive swings in value. That day more than two dozen issues gained or lost at least 10 percent of their value.

Brave US investors willing to risk investing in the KSE face another barrier—lack of access. Tracking down a specialist in the Pakistani market proved a fool’s errand. No ADRs are offered on Pakistani stocks, and the only fund devoted to the country, Morgan Stanley’s Pakistan Investment fund, closed in 2001. “It’s not really even a country emerging-market investors pay attention to,” says Morningstar’s Bill Rocco. “It’s too small, too undeveloped, and too risky.”

Indeed, despite missing the boom last year, Franklin Templeton emerging-markets guru Mark Mobius feels justified that he pulled out in 1998. “Given the geopolitical situation, we think it’s still a bit early to invest in Pakistan.”

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