|18 June, 2018

Saudi shares-index upgrade likely to 'turbocharge' private sector growth

Investors are expected to pump billions into the Saudi bourse, known as the Tadawul, if the Kingdom is included in the key MCSI-emerging markets index in 2019.

A Saudi trader observes the stock market on monitors at Falcom stock exchange agency in Riyadh, Saudi Arabia February 7, 2018.

A Saudi trader observes the stock market on monitors at Falcom stock exchange agency in Riyadh, Saudi Arabia February 7, 2018.

REUTERS/Faisal Al Nasser

Saudi Arabia - Investors are expected to pump billions into the Saudi bourse, known as the Tadawul, if the Kingdom is included in the key MCSI-emerging markets index in 2019. The decision is expected on Wednesday.

Analysts interviewed by Arab News gave a unanimous thumbs up to KSA’s widely anticipated inclusion that will see huge US “trackers” run by the likes of BlackRock and Vanguard, sign off on multi-billion dollar cheques on behalf of investors in their pension, insurance and savings funds in North America and elsewhere.

There is about $2 trillion in global emerging (EM) market funds, according to EFG-Hermes in Cairo, a huge pool of capital that could be tapped for future IPOs, with state-owned Saudi Aramco a prime target when it floats in what is expected be the world’s biggest listing of all time.

The macro-story is important, too.

“The positive narrative around reforms being pushed by Crown Prince Mohammed bin Salman makes for a compelling backdrop,” said Charles Robinson, global chief economist at London-based Renaissance Capital.

One of the main advantages of inclusion in the index is that it would herald “a more efficient allocation of capital” in that foreign cash would find its way to those Saudi Arabian-listed companies that offer the best prospects, said Robinson.

Currently, 95 percent of Tadawul investors are made up of smaller retail or private shareholders. But Robinson added: “You would hope that there would be an increasingly professional approach in the Saudi stock market by professional investors who are going to influence the price/earnings ratios of the better companies, pushing up their share prices, allowing them to raise more capital and therefore enabling them to become bigger companies in the future.”

Those doing less well, which currently might be attractive to retail investors, could end up getting less cash, he suggested.

The inclusion of Saudi Arabia in the MSCI EM index may help to “turbocharge” the Vision 2030 plan that aims to reduce the Kingdom’s reliance on oil, and boost the private sector, he added.

In turn, this would pave the way for greater employment of Saudi nationals, especially young people who make up a large proportion of the potential and actual workforce.

Hootan Yazhari, head of Middle East and global frontier markets research at Bank of America Merrill Lynch, told Arab News:

“Global Emerging Market fund managers will effectively be forced to have a view on Saudi Arabia, especially as it will be a material part of the MSCI index (more than 2.6 percent weighting). Therefore, Saudi Arabia’s profile and awareness among fund managers globally will increase,” he said.

Others were equally enthusiastic. Mohammed Al-Hajj, Middle East equities strategist at EFG-Hermes, told Arab News that an upgrade to emerging market status meant that from 2019 Saudi Arabia would be part of global emerging market (GEM) benchmarks followed by GEM investors which he expected would lead to inflows of $30 billion-$45 billion into the Kingdom by the end of 2019 (excluding Aramco).

He said: “Ownership of Saudi businesses by foreign financial institutions is only 1.8 percent of total (Tadawul) market value versus an emerging market (EM) average of 17 percent, as such we see big potential for inflows into the country,” said Al-Hajj.

Importantly, analysts said MSCI inclusion would make the Kingdom a more sophisticated market as seasoned investors exerted greater influence on its corporates. KSA companies would be increasingly compared to international peers by investors, it was suggested, making management teams more likely to focus on improving strategy, efficiency and overall performance as they seek to compete for capital. “Accountability to shareholders will increase,” said Al-Hajj.

EFG-Hermes has highlighted the appeal of KSA-listed banks and petrochemical companies, tipping Samba, Kayan, SABB, SABIC and Al-Rajhi.

Hajj saw scope for about $10 billion of inflows to the market from passive MSCI EM index trackers and a similar amount from active managers. “With FTSE having elected to include the country in its EM benchmark in 2019, this necessitates another $6 billion of passive flows taking potential total inflows close to $30 billion.


“We see these flows providing tail winds to the market and supporting the country’s FX position,” he said.

Foreign ownership limits in KSA have been capped at 49 percent, and a few companies are fully closed to foreign investors, but the Tadawul embarked on a modernization and reform program in 2015 to make the market more transparent and accountable.

Historically, Saudi Arabian shares have traded at a premium to the average for emerging markets, but with excitement building ahead of MSCI’s decision this week, there are some concerns that stock values have become a bit too toppy.

Bloomberg said in a report that the buying had pushed the capitalization of Riyadh’s market beyond that of South Africa in dollar terms for the first time in 11 months.

“As the gains pile up, Saudi stocks have become increasingly more expensive than the group the country is poised to join,” claimed the report.

As markets anticipated an MSCI upgrade, “valuations have gone so much ahead of fundamentals,’’ Aarthi Chandrasekaran, vice president at Shuaa Capital, said in an interview with Bloomberg TV.

“I’m sure there will be a cool-off period post the decision announcement, when valuations will start catching up more with reality on the ground.’’

Another analyst cited by Bloomberg advised investors to be more selective and go for ‘bottom-up’ names.

There are, of course, disadvantages to being included in the index. In the good times, capital flows would pour in, but in less benign periods, outflows were possible, depressing market values, damaging sentiment and knocking balance sheets.

Timothy Ash at Blue Bay Asset Management in London told Arab News: “It’s a story about managing success: Portfolio managers, for a variety of reasons, could decide they don’t like the KSA story any more and they can leave … look at Argentina.”

Al-Hajj said: “What we have seen in previous upgrades is that multiples expand, making markets expensive on a fundamentals basis, which could make it prone to weakness (short-term) in the post-implementation period (after May 2019).

“In addition, once a market is part of EM indices it will be more prone to EM outflows and risk-off periods that lead to EM weakness.”

He also said: “However, the benefits far outweigh the negatives in our view. As the inclusion will increase the institutional share in the Saudi market, and offer companies access to funds during capital raising by Saudi companies (new listings) in the future.”
The MSCI proposal, which was laid out in a document published in February, is to implement the potential reclassification in two steps in May and August 2019.

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