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Could this be the next major emerging market for investors?

18 July 2017

With Saudi Arabia under consultation for inclusion in the key MSCI Emerging Markets index benchmark, FE Trustnet explores the outlook for the Middle Eastern powerhouse.

By Rob Langston,

News editor, FE Trustnet

Strong returns have made emerging markets much more appealing in the low growth environment as investors have sought out new areas for better returns.

Indeed, the underperformance of developed markets versus their emerging peers has pushed investors further up the risk scale in search of new areas to invest in.

In June, index provider MSCI announced that it was launching a consultation on the potential inclusion of the MSCI Saudi Arabia index into one of its best-known benchmark indices – the MSCI Emerging Markets index.

The move follows initiatives by the Saudi Capital Market Authority, including the relaxation of foreign ownership limits and the lowering of minimum AUM requirements for qualified foreign investors.

Saudi Arabia could be an interesting addition to the MSCI Emerging Market index given some of the strong economic and demographic drivers for the market.

Over one year the MSCI Saudi Arabia index has delivered a 22.6 per cent return, compared with a 18.3 per cent gain for the broad MSCI World index, as the below chart shows. (It should be noted that the index responded very positively to MSCI's June announcement).

Performance of MSCI Saudi Arabia vs MSCI World over 1yr

Source: FE Analytics

The Saudi stock exchange – the Tadawul – is the largest in the Middle East & North Africa region. According to the World Federation of Exchanges, the Tadawul had a market capitalisation of $471.3bn and 183 listed companies.

Emily Fletcher, director and portfolio manager at BlackRock, said the review on whether to include Saudi Arabia into the emerging markets index was an endorsement of the positive Saudi Arabian stock market reforms.

She said: “Over the past few years, the Saudi Arabian authorities have implemented a range of changes to further open the local equity market to international institutional investors and have even drafted the rules for the introduction of covered short-selling as well as the borrowing and lending of stocks.”

One Saudi company not currently listed on the exchange is oil firm Aramco. The state-owned oil behemoth is expected to list shortly, with London the preferred destination for a primary listing and the domestic exchange for a secondary listing.

The company has been valued at up to $1trn and its initial public offering (IPO) is expected to boost both the local market and government coffers.


BlackRock’s Fletcher said even without the Aramco IPO, the Saudi market could account for between 2-3 per cent of MSCI Emerging Markets, making it a significant component of the index from the outset.

The IPO of Aramco – as well as the opening-up of the country to foreign investors – is part of the Saudi ‘Vision 2030’ unveiled by crown prince Mohammad bin Salman, son of Saudi king Salman bin Abdulaziz, which aims to diversify away from the economy’s dependence on oil.

The dependence on oil has had a significant impact on the economy as oil prices have fallen in recent years. As well as being one of the largest producers Saudi Arabia also has the largest reserves – managed by Aramco.

However, the fall in oil prices has placed increased pressure on government spending. While its foreign reserves have shored up the economy, prolonged oil weakness could have a big impact.

Performance of Bloomberg Brent Crude Sub over 3yrs

Source: FE Analytics

“The Saudi economy has slowed down – with lower oil prices revenues having put pressure on the fiscal deficit, international reserves and liquidity,” said Oliver Bell, portfolio manager of the T. Rowe Price Frontier Markets Equity strategy.

“Saudi needs to diversify its economy away from oil and the 2030 Vision provides some encouragement that there clearly has been a mind shift in the kingdom.”

Carlos Hardenberg, co-manager of the Templeton Global Emerging Markets Strategy and the Templeton Emerging Markets Investment Trust, said the success of Vision 2030 is likely to rest on the will of the people.

“Over the long term Saudi can still get it right,” he said. “It will be interesting [to see] if they can reform, if the government are stopped by quite a conservative population.

“It’s the opposite of what you have in other countries [in the region]. In many other countries, the government stops what the population wants, but [the Saudi] government wants reform and the population stops it.”

Hardenberg said the country also faces external challenges particularly given its involvement in the Yemen civil war and the regional boycott of neighbour Qatar.


Jason Tuvey, Middle East economist at consultancy Capital Economics, said: “Saudi Arabia’s economy recorded its first outright contraction since the global financial crisis in Q1, driven by the impact of oil production cuts.

“The contraction is likely to deepen over the rest of year and, while the economy should return to growth by next year, the pace of growth is likely to be weaker than most expect.”

Although Tuvey believes the economy should return to positive territory in 2018, he said that further oil-driven austerity could result in weaker growth than anticipated.

However, Saudi Arabia is not alone in facing these challenges and has won support for measures to shore-up oil prices from its compatriots in the region and from further afield, such as Russia.

If it does enter the MSCI Emerging Markets index, it will not be the first country from the Gulf included in the index with Qatar and the UAE added to the basket of countries in 2014.

However, since inception the MSCI Saudi Arabia index has outperformed its peers in the Gulf Cooperation Council (GCC) – which includes Bahrain, Kuwait, Oman, Qatar, and the UAE – returning 37.39 per cent against an 18.76 per cent return for the MSCI GCC Countries ex Saudi Arabia index.

Performance of indices since MSCI Saudi Arabia inception

Source: FE Analytics

Any potential upgrade is expected to happen by 2019. Yet, for investors, one of the biggest challenges currently is the lack of vehicles available to investors. There are only a handful of Middle East & North Africa funds in the IA universe, although there are more within the wider offshore FCA-recognised universe.

In the IA universe, options for investors are mainly funds with a Middle East focus, including Fidelity Emerging Europe, Middle East and Africa, Baring MENA and JP Morgan Emerging Middle East Equity funds.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.