Middle East’s largest stock market set to open

So far, foreign investors have not been able to invest directly into Saudi Arabian stock market. However, this year there have been positive signs that in the first half of 2015, one of the biggest closed stock markets will finally be accessible for foreign capital. Asset managers that are located outside the Gulf Cooperation Council (GCC) area have been waiting for this since 2008, when foreign investors got an opportunity to start investing in Saudi Arabian companies through derivative instruments and exchange-traded funds.

The Saudi stock exchange is interesting for many reasons. Firstly, its stock market (Tadawul) is the largest in the Middle East with $580 billion market capitalization (ca 1% of world’s stock market). To compare, the cumulated market capitalization of United Arab Emirates’ (UAE) Dubai and Abu Dhabi is around $245 billion and Qatar’s is $200 billion. There have been several initial public offerings and liquidity is high. According to Deutsche Bank, Saudi Arabia’s stock market is the most liquid in the Middle East and North Africa (MENA) region. The last 6 months’ average daily trading volume has been $2.5 billion, which forms 65% of MENA region’s total market liquidity. In addition, the Saudi Arabian stock market has diverse sector selection and more companies listed than any other market in the region. MSCI Index research managing director Sebastien Lieblich has stated that after its stock market opening, Saudi Arabia might be added to MSCI emerging markets index earliest in 2017 making up around 4% of the index.

Saudi Arabia’s stock market is also attractive in the context of macroeconomics. Saudi’s economy is the largest in the region with GDP of $745 billion. Due to high income from oil sector, its current account and government budget were strongly in surplus in 2013. During the last years, the government has been spending vigorously on several projects in order to ensure sustainable economic growth and diversification. On average, GDP has been growing 6.4% per year. This year, IMF forecasts a bit slower growth, which will stay above 4% and is very attractive in the global context. Saudi Arabia’s demographic position is also considered as one of its strengths with 29 million habitants having median age of only 26.4 years.

Today, only local investors and foreign investors from GCC countries are able to trade stocks freely. Money managers outside of the GCC region have had rather limited access as the market is only accessible through derivative instruments and local funds.

With every passing year Saudi Arabia’s economic prosperity and attractive future outlook has been constantly increasing the interest of international investors. Most of the attention has been caused by big companies that have showed decent profitability in the recent years and have complied with generally approved transparency standards. Considering that current trading volume of Tadawul is dominated by local retail investors, the addition of international institutional investors will considerably increase trading activity, volume and liquidity. It is estimated that foreign investors own only 5% of Saudi Arabia’s market and form only a fraction of its trading volume.

When opening the stock market for foreign investors, Saudi’s agents of power want to use a quite regulated system in order to ensure slower capital inflows. Although global investors have been waiting for the opportunity since 2008, the process of market opening has been extremely careful and has been spoken of for over 10 years. It is expected that some limitations will still be established. Investors speculate that foreign investors who would like to directly invest into Saudi Arabian market will need to have at least $5 billion of assets under management. In addition, there can be an establishment which prohibits a foreign investor to own more than 5% of Saudi Arabian listed company and all foreign investors to cumulatively own more than 20% of the company.

The government has been extending the stock market reform for many reasons. Some of the reasons are possible excessive volatility and political sensitivity that could be driven by foreign investors’ strategic ownership in Saudi Arabia’s biggest companies.

The most suitable scenario for foreign investors is where the barriers are the lowest. However, it should be taken into consideration that the opening of the stock market will not necessarily make Saudi Arabia more liberal, it rather indicates more pragmatic political culture by the authorities. The agents of power are looking forward to opening the stock market in order to create new jobs, diversify the economy to be less dependent on oil sector, and to increase transparency of the local companies by being compliant with stock market standards.

Transparency remains to be an issue that needs to be resolved, especially in the case of smaller listed companies. On the other side, after Qatar and UAE were added to MSCI emerging market index this June, Saudi Arabia might miss relatively cheap capital inflows by extending the stock market opening, which could cause slightly slower economic growth than of the neighbour countries.

According to Reuters, foreign investors have an ownership of up to 15% in some of the smaller stock markets in Persian Gulf region (Dubai for example).  Capital inflows to Saudi Arabia might increase by $40-50 billion once foreign investors will have the right to increase their holdings in Saudi companies.

The opening of Saudi Arabian stock market might change the thought pattern of global money managers about the Persian Gulf region, which is already considered as a high-potential emerging market rather than an exotic and risky region. The opening of the stock market will surely add a liquidity boost to Saudi Arabian companies and the capital inflows will probably be reflected in the stock market growth.

Tadawul’s general index has reached new highs since January 2009, with price-to-earnings ratio being 16.2x and price-to-book ratio of 2.5x.

Tadawul augustis 2014

Source: Bloomberg

LHV Persian Gulf Fund invests in listed equities in the GCC (Gulf Cooperation Council) region –the United Arab Emirates, Qatar, Saudi Arabia, Oman, Kuwait and Bahrain. The fund is publicly offered in Sweden, Finland, Norway, Estonia, Latvia and Lithuania. Fund units can be bought and sold through the following intermediaries: Pensionsmyndigheten (PPM), Avanza Bank, Nordnet, MFEX Mutual Funds Exchange, Fondmarknaden.se, Aktieinvest, NFM, Eufex Bank Ltd (Finland), LHV Bank, Estonian Central Register of Securities. Please see additional information from www.persiangulffund.com.