‘Game changer’: Saudi Arabia opens doors to US$580B market
‘It’s an absolute game changer in ... the Middle East’
In a country where cinemas are banned and single men and women are not allowed to mingle, Saudi citizens often turn to the highs and lows of the local stock market for their entertainment.
Fortunes are won and lost on hot tips and rumours as mostly-local retail investors, trading as much as US$2 billion a day collectively, virtually have the run of one of the world’s largest emerging markets.
But on Monday major institutional investors will be crashing the Saudi citizens’ party as the country partially opens its doors to international institutional funds.
At US$583 billion, the Saudi Tadawul index has a bigger market cap than either the Russian or the Mexican trading boards and it would be the seventh-largest emerging market in the world if it were part of the MSCI Emerging Market Index.
Until now, international investors could only own Saudi stocks indirectly through the onerous share-swap method, which came at high cost. The new rules take a leaf from China’s Qualified Investor Program, allowing qualified foreign investors with assets of at least US$5 billion and a track record to directly own stocks.
“There is a strategic interest in being in Saudi,” said James Reeve, London-based economist at SAMBA, one of Saudi Arabia’s largest banks. “People see it as a big and important market as the country has a lot of assets in terms of natural resources.”
But don’t expect a gold rush come Monday. International investors will likely bide their time before dipping their toes into the world’s largest untapped financial market.
“I don’t think there will be a big bang opening with lots of investors and lots of trade — there will be some,” said Arindam Das, Middle East North Africa head of HSBC Securities Services, noting that investor interest is high and that HSBC plans to invest directly in the market. “But that does not in any way undermine the potential implications of this development — it’s an absolute game changer in the history of the Middle East capital markets.”
As the world’s largest crude oil exporter, with international reserves worth an estimated US$700 billion, an affluent, mostly young, population of 29 million, investors have long eyed Saudi Arabia’s investment prospects.
The country has also bulked up its non-oil economy, channelling as much as US$1 trillion of its petrodollars into the infrastructure, education, health-care, retail and real estate sectors over the past five years, fuelling corporate growth.
Indeed, international investors will be surprised to find almost no direct oil exposure in the market. The only real oil exposure is via petrochemicals stocks such as the Fortune 500 company Saudi Basic Industries Corp. (SABIC), which are a derivative play on oil, said Charles Robertson, chief economist at London-based Renaissance Capital, which advises clients on investing in emerging and frontier markets.
“(Investing in petrochemicals) is not, we think, the best way to play Saudi,” said Robertson. “We have a structural preference for sectors that offer exposure to infrastructure, services and consumer demand, as we view these are playing into themes that are locally driven, and where the demand is massive.”
As many as 165 companies across 15 sectors are open to foreign investment, with liquidity spread across the board and not just a handful of large companies — differentiating it from frontier markets that struggle with trading volumes.
The big prize for the Saudi regulators is attracting institutional capital such as insurance companies, pension funds and mutual funds to help raise corporate governance standards.
“Foreign investors are likely to bring a longer-term investment horizon than the local retail investors; we also see their involvement as potentially reducing volatility,” Bank of America Merrill Lynch said in a recent report.
In terms of size, liquidity, corporate disclosure and regulatory enforcement the Saudi market is comparable to emerging markets, said Hasnain Malik, managing director, head of frontier markets strategy at Dubai-based Exotix Partners LLP.
But he warned that institutional investors will need to see the qualified investor program work in practice, “sufficient headroom below foreign-ownership limits and funding of trades (settlement) similar to that seen elsewhere before fully supporting this upgrade.”
Aon PLC, which provides risk-management services, believes the risk of terrorism and political violence are “high” in Saudi Arabia, while the absence of democracy and a mixed record on corporate transparency could also dampen investor interest.
Another potential setback for the market came this week when index provider MSCI said it will seek advice from international investors before including the Saudi index in its main MSCI emerging markets index, retreating from an earlier comment that the Tadawul could enter the main index as early as next year.
“That may push it back by one more year,” says HSBC’s Das, noting that inclusion in the MSCI would see as much as US$24 billion flow into the Saudi market.
Canadian retail investors may find it hard to play the new market.
Most of the big Canadian banks, including Royal Bank of Canada, Bank of Montreal, Bank of Nova Scotia and Toronto-Dominion Bank, are not currently offering Saudi-exposed funds, while asset manager BlackRock Inc., which had expressed an interest in creating a Saudi ETF, said it had nothing to share at this point. U.K.based Genesis Emerging Markets Fund and Barings MENA Fund offer Saudi exposure, while a number of Middle East boutique funds can provide investment options.
Most asset managers are advising investors to wait. The Saudi market has already rallied about 14 per cent in the run-up to the relaxed rules, compared with MSCI EM’s 5.6 per cent jump year to date.
Bank of America Merrill Lynch, which has an “underweight stance” on the market, says it is calling for “caution and reliance on stock picking to generate superior returns.”
With current valuations not particularly compelling, and sustained low oil prices translating into weaker corporate earnings, investor interest may be subdued initially, said SAMBA’s Reeve.
“I think it will be more of a trickle than a flood.”