With structural and economic reform in full swing in the MENA region, equities Saudi Arabia are capturing the imagination of Emerging Market (EM) investors, according to a co-authored 2018 white paper titled “Emerging Market Equities: Index Upgrades and the Middle East”, from Emirates NBD Asset Management (Dubai) and Jupiter Asset Management (London).
Ross Teverson, Head of Strategy – Emerging Markets at Jupiter Asset Management, said:
“EMs had a strong run in 2017, and this outlook remains positive. This year, only 1% of the MSCI Emerging Markets Index by country weighting have a fiscal deficit likely to be over 3% of GDP. There are plenty of stocks that offer compelling long-term return potential, especially within travel and tourism, financials, and technology.”
The paper further argues that while EM indices are skewed towards large-cap companies and have high concentrations in certain countries and sectors, the opportunity for investors lies in building a portfolio that covers small- and mid-caps.
In 2018, the anticipation of the now-confirmed MSCI upgrade for Saudi Arabia has driven the Tadawul All Shares Index (TASI) up 15% YTD, in stark contrast to the MSCI EM Index itself, which is down 2% for the year.
Salman Bajwa, Senior Executive Officer at Emirates NBD Asset Management, commented:
“With a raft of socio-economic changes taking place in the Kingdom of Saudi Arabia – from women driving to the opening of the first cinemas – we are seeing a huge opportunity for EM investors in 2018-19.”
“While the country has been able to plug forex leakage with the issuance of US dollar-denominated debt, a great deal more can be achieved through its stock market, especially after inclusion on the FTSE Russell and MSCI EM indices.”
The Tadawul All-Share Index is up by double digits year-to-date, and NBD’s Saudi Arabia Equity Fund has exceeded 18% returns, as investors have become increasingly bullish on the Kingdom. Pre-upgrade, smart fund managers from the US, UK, and Asia have already dipped into the Saudi market, with foreign inflows passing $3 billion by May 2018, which is equivalent to all inflows to the UAE and Qatar for the whole of 2014, when they were upgraded.
“A number of sectors in Saudi Arabia may seem attractive at first glance, but investors should be selective and avoid blindly following indices. Additionally, economic reforms such as the introduction of VAT and the removal of fuel subsidies may initially inhibit growth. However, top sector targets including healthcare, consumer, and insurance are set to benefit from both structural reforms and the Kingdom’s initial EM index weightings.”
Plugging the money drain
By allowing women to drive, the local workforce rapidly increases in number, harnessing untapped potential and raising productivity.
It will, moreover, go some way to stemming leakage of the country’s forex reserves through remittances by expatriate workers. The Saudi Arabian Monetary Authority (SAMA) has reported that remittances have fallen from a peak of $42 billion in 2015 to $38 billion in 2017.
The Kingdom boasts considerable forex reserves which, at $506 billion, making them the 4th largest globally. However, they have declined – from$ 750 billion in 2014 – in the wake of an oil price slump that reached a low of $30/barrel in 2016.
As forex reserves have declined, the Kingdom has been able to plug this gap with the issuance of US dollar-denominated debt.
While the sovereign could easily issue up to $100 billion in foreign debt, maintaining a debt to GDP ratio of 25% and retaining an A1 credit rating, a great deal more can be achieved through its stock market.
Making Tadawul attractive
Investors must be guided by international indices, and that is now the case, with FTSE Russell, and MSCI all confirming Saudi Arabia’s status as an EM index constituent. Tadawul is making sweeping structural and technical changes to stimulate foreign inflows, including the introduction of the T+2 settlement cycle, a new custody model and clearing mechanisms aligned with international standards.
The efforts of the CMA and Tadawul were rewarded with a 2.5% weighting on the FTSE Russell EM Index announced in March 2018. With MSCI’s recent announcement of the Kingdom’s inclusion – at a weighting of approximately 2.6% (with 32 securities), it is likely that foreign inflows from active and passive funds will reach $45 billion.