Arabian heights: What Saudi Arabia's upgrade means for investors

 
Katherine Denham
SAUDI-LEBANON-CHRISTIANITY-DIPLOMACY
The Saudi Crown Prince has been driving things forward, transforming this conservative country into a modern-day nation (Source: Getty)

It was a symbolic moment for Saudi Arabia last week when women could finally get behind the wheel.

Lifting this archaic driving ban was obviously a huge milestone for women’s rights, but it also speaks volumes about the direction of travel the country is heading in.

The Saudi Crown Prince, Mohammed bin Salman, has been driving things forward, transforming this conservative country into a modern-day nation through an extensive programme called the Saudi Vision 2030.

Read more: Saudi Arabia set for $90bn boost as women driving ban lifted

As it stands, the country depends on oil exports and government funding, but the Crown Prince wants to boost the country’s private sector and increase its use of renewable energy.

These game-changing reforms are also being felt in Saudi Arabia’s stock market, in the wake of a string of improvements to regulation and operational requirements.

On the back of these positive changes, index provider MSCI announced it will include Saudi Arabia in its emerging markets benchmark for the first time – following in the footsteps of the FTSE, which promoted the country to emerging market status in March.

It’s a move that has been widely anticipated. Indeed, Tilney’s Ben Seager-Scott says it has really been a question of when, rather than if, the kingdom will achieve this status.

“While there is little argument that Saudi Arabia meets the requirements in terms of economic development, the main hurdle to date has been the restricted access to its markets, which is a requirement of index inclusion,” he says.

According to MSCI managing director Sebastien Lieblich, international investors have been impressed by the speed of change in the accessibility of the Saudi Arabian equity market, as well as the level of commitment from the Capital Market Authority and the Saudi Stock Exchange (Tadawul).

The change, which comes into effect next year, means index-tracking funds will automatically invest in the 32 Saudi Arabian stocks.These companies will comprise about 2.6 per cent of the index, offering slightly more diversity to emerging market investors.

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Asset managers, of course, don’t want to miss out on the action, and last month’s MSCI announcement was a green light for companies to launch their own Saudi investment products. Invesco, for example, has now launched Europe’s first exchange-traded fund which tracks the Saudi market, available on the London Stock Exchange.

Invesco’s Chris Mellor thinks that Saudi Arabia is in the early stages of an exciting transformation, with the country’s reforms encouraging major domestic companies to expand across borders and into global markets.

Such flows should hopefully help the economy diversify away from being almost entirely dependent on oil and the fluctuations that come with it

The MSCI inclusion is obviously good news for the economy, which has largely been fueled by domestic investors. Darius McDermott from FundCalibre says the move serves as recognition that the country is no longer a “frontier” market, but has now entered emerging territory – giving it more credibility, and raising its profile.

It also means billions of dollars from overseas investors will now flow into Saudi companies. Indeed, Seager-Scott points to the bulk of passive funds that will be mechanically required to invest in these stocks, as well as the increasing interest from foreign investors. “Such flows should hopefully help the economy diversify away from being almost entirely dependent on oil and the fluctuations that come with it,” he says.

But what does this mean for investors? Saudi is the largest economy in the Middle East, so for many investors, this presents fresh stock-picking opportunities in an interesting market. The returns look appealing too, with the MSCI Saudi Arabia index scooping up 32 per cent for investors over the past year.

As the country pushes for increased privatisation, the scope for investment opportunities will only get bigger, while foreign capital could help make the market far more liquid.

Significant inflows can rapidly turn to outflows if investors take fright, which would be a big negative factor for the economy

However, it is worth pointing out that when Saudi Arabia does join its emerging market peers (which include the likes of India, China, Brazil, and newly added Argentina), the exposure to this new market is tiny at just 2.6 per cent. By comparison, Seager-Scott says the benchmark’s two largest companies, Tencent and Alibaba, make up more than nine per cent of the MSCI Emerging Market index. Saudi’s inclusion is therefore unlikely to have a major impact on the performance of passive portfolios.

The new addition doesn’t come without risks – the biggest being that the Saudi economy is still heavily influenced by movements in the price of oil.

Meanwhile, foreign investors are likely to demand much greater transparency than may have historically been the case, says Seager-Scott. He warns that significant inflows can rapidly turn to outflows if investors take fright, which would be a big negative factor for the economy.

Read more: City watchdog defends controversial rules to clear way for Aramco listing

Most of the recent developments seem to be paving the way for the initial public offering of state-owned Saudi Aramco. The government is expected to sell a small stake in the company next year, which could expand the country’s weighting on the MSCI Emerging Market index.

We are only at the start of Saudi’s dramatic reforms, so while these changes look set to shift the country in the right direction, they are likely to bring bouts of uncertainty that will cause market wobbles over the course of the next few years.

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