Saudi EM Inclusion Stirs Burning Question: What About Those Opaque Investors?

(Bloomberg) -- Saudi Arabia’s inclusion in emerging market stock benchmarks highlights the role of largely opaque players in the kingdom’s market: government funds that could be ready to push the sell button.

FTSE Russell will start adding Saudi equities to its developing-nation gauges on Monday, with peer MSCI Inc. following suit later. Inclusion is eventually expected to trigger billions of dollars in inflows from so-called passive buyers, whose assets track benchmarks and must align with the gauges.

Other investors may hold off because they see funds with links to the government, whose holdings may have buoyed stocks during recent political turmoil, as primed to offload stakes as newcomers enter.

International institutional investors have suggested in meetings “that they are likely to take an underweight position in the market, mainly on valuation grounds and potential concerns about government-related entities selling into the event,” Arqaam Capital analysts Jaap Meijer, Michael Malkoun and Nadine Mdeihli wrote in a report on March 4.

• The Tadawul All Share Index has historically traded at a more expensive level than MSCI’s gauge tracking developing nations, but the difference has become more pronounced since November 2017.
• The gauge advanced 0.7 percent in Riyadh on Thursday, extending its increase this year to 9.7 percent

The kingdom’s Public Investment Fund is the biggest investor in Saudi Arabia’s $530 billion stock market, it confirmed to Bloomberg on Wednesday, giving credence to speculation from analysts, traders and investors who frequently said that funds tied to the government support prices during times of high volatility.

Any declines on the Saudi market’s benchmark index present “buying opportunities which would be acted upon by some of the funds,” a PIF spokesman said in an emailed response to questions.

Supporting Stocks

Market participants suspect that government-related funds swooped in to support the market after the imprisonment of local billionaires at the Ritz-Carlton Hotel in Riyadh in late 2017 and the international crisis following columnist Jamal Khashoggi’s murder at the Saudi consulate in Istanbul last year.

Some may see that as a convenient backstop to selloffs, making up for the political risks that have unnerved investors over the past few years. Not Mark Mobius.

“Many people are concerned about the political environment,” Mobius, a veteran investor in developing nations who set up Mobius Capital Partners LLP in 2018 after three decades at Franklin Templeton Investments, told journalists in Dubai this week. “It’s going to take a year or two before people really begin to say that Saudi Arabia is the place we want to be.”

Foreign Inflows

Passive inflows could reach about $20 billion once FTSE and MSCI complete their inclusions, according to the Arqaam Capital analysts. Active managers could bring in another $40 billion. At the same time, as much as $21.8 billion of government-related funds are earmarked for sale throughout the index inclusion process, said Meijer.

Those funds and early buyers positioning themselves to sell will generate so much liquidity that “the marginal investor will see little, if any, material benefit from passive buying,” said Adam Choppin, an investment officer at FIS Group in Philadelphia. “The absolute direction is harder to peg, but as a relative trade, I expect Saudi to strongly underperform most emerging markets” following recognition by index compilers, he said.

Read more: Saudi Fund Selling Unlikely to Weigh on Stock Market, according to EFG-Hermes

The Saudi stock exchange and the local regulator have worked since 2015 to earn the upgrades, allowing investors from abroad to trade directly, introducing new corporate-governance rules and adopting global accounting standards. Attracting foreign cash is a part of major reforms spearheaded by Crown Prince Mohammed bin Salman to modernize the economy away from oil.

With shares from the kingdom set to account for about 2.6 percent of MSCI’s benchmark, they’ll be hard to ignore, said Michael Bolliger, the Zurich-based head of emerging-market asset allocation at UBS Wealth Management’s chief investment office. For those new to this market, picking a few names is preferable to buying the overall index, he said.

But ultimately, there’s little visibility on what PIF-related funds own, according to FIS Group’s Choppin. So while he thinks they’ll be net sellers, there’s no telling the “scale of their selling.”

--With assistance from Arif Sharif, Matthew Martin, Abeer Abu Omar, Netty Ismail and Dana El Baltaji.

To contact the reporter on this story: Filipe Pacheco in Dubai at fpacheco4@bloomberg.net

To contact the editors responsible for this story: Celeste Perri at cperri@bloomberg.net, Tom Lavell, Monica Houston-Waesch

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