Saudi stock market rumoured to be opening to foreign investors

16/02/2015 05:28 AST

Until now only investors from the Gulf Cooperation Council (GCC) enjoyed access to the Tadawul, the Saudi stock market. Recent adjustments opened the door to foreign investors by creating “swap agreements” allowing access to certain Saudi stocks, albeit under very restrictive conditions. If the road map suggested last summer becomes a reality, a significant opening up of the market to foreign direct investment might take place as early as April 2015.

The excitement in the investment community is understandable. The Saudi stock market has a capitalization close to half a trillion USD, around half of the total GCC market. It provides access to major firms in energy, finance and real estate that dominate the region and could expand internationally. The market is also deep and liquid: retail investors account for 80 per cent of daily turnover. It has also witnessed intense activity in the IPO market, with some successful large operation in 2014, particularly if compared to the rest of the region.

Furthermore, some sectors, like banking, present cheap valuations. Construction names might also receive substantial interest, in particular firms able to tap into the government’s infrastructure and housing spending plans in the next few years.

These factors have prompted enthusiasm in the investment community. Some experts expect that by 2017 Saudi Arabia might become part of the MSCI emerging market index, attracting large inflows of funds - initial estimates suggest $40 billion to start with - from investors that cannot participate now in the Saudi market.

At the same time, the possibility of these adjustments in the global allocation of assets has sparked fears in other markets - Kuwait, Dubai, Bahrain - which are concerned about rapid outflows towards Saudi destabilizing local markets. These fears are not groundless.

There are two important benchmarks that influence asset allocation in large investors. The first one is determined by the MSCI index. Stock investors often use MSCI indices as a benchmark to track their performance. Funds start by acquiring a portfolio composed of the constituents of the MSCI and then tweaking the allocation to improve the performance of the MSCI and generate additional returns. The inclusion of a country in the benchmark forces many international funds to invest in that country to replicate the performance of the new benchmark. Saudi Arabia, along with Kuwait, Bahrain, Jordan, Oman, Lebanon and Palestine in the Middle East and 17 other countries constitute the “MSCI frontier markets” index, the group of “less developed” stock markets. When countries reach a certain level of development, they are promoted to a higher group, the “MSCI emerging markets”. The number of institutions linking their investments to this benchmark is drastically larger, and therefore, being included in this category increases inflows into the country. As an example, stock market returns in Qatar and Dubai rose 55 per cent and 119 per cent in the 12 months following the announcement of their promotion from frontier market to emerging market.

CPI Financial