The long-awaited opening of the Saudi equity market to direct foreign investors represents a milestone in the development of capital markets in Saudi Arabia.
The Saudi exchange is not only the biggest and most liquid market in the Mena region but it was also, until Monday, the largest market closed to direct foreign investors.
We should expect these investors to find the country attractive and start investing despite the fact that the inclusion of Saudi stocks in emerging market benchmarks might take a couple of years.
This flow could take some time since these foreign investment managers have to be cleared first by the local regulator. Moreover, most of them will have to undertake a learning process since they are not necessarily familiar with the Saudi equity market despite those of the UAE and Qatar both being included last year in the MSCI Emerging Markets Index.
There are reasons to be optimistic. First of all, the Saudi equity market is very liquid, and the Tadawul has recorded an average traded volume of US$2.2 billion during the past six months, a very high figure in both absolute terms and in relative terms if you take into account the $570bn market capitalisation. Moreover, this liquidity is consistent. The Saudi exchange demonstrates the lowest volatility in terms of traded volume when compared to its peers. This aspect is particularly important since it will provide an exit to investors in case of an adverse scenario, an important consideration in a region where economies remain oil-driven and where the political and geopolitical agendas have been pretty rich for a long period of time. These factors are reflected in the volatility of regional equity markets, which can, from time to time, reach global highs.
Another attractive point is the low correlation with other emerging markets. The correlation of the Saudi exchange with the MSCI Emerging Markets Index is only 0.22 since June 2010, which makes it highly attractive from a diversification standpoint. The increasing correlation across emerging markets over the years is even making this point more relevant. The profitability of the Saudi-listed companies, which rank in the first quartile compared to their emerging peers, is also an interesting aspect.
More importantly, these lucrative corporates are not confined to the petrochemical sector, which benefits from a feedstock cost advantage. These high margins will provide a strong buffer for these corporates during adverse economic environments. Some sectors offer also a defensive profile. In the financial sector for instance, the largest listed one with a weight of 37 per cent in the local benchmark, banks have well capitalised balance sheets with an average Tier 1 ratio of 16 per cent above their peers.
At the same time, asset quality has increased significantly. Non-performing loans have decreased substantially to reach 1.1 per cent last year with coverage at a record high.
Another aspect, maybe counter-intuitive for most of the new players in Saudi Arabia, oil companies are not listed despite the economy still being oil-driven. This aspect has a positive effect on earnings volatility for the entire market.
Last but not least, the kingdom offers an attractive demographic play. Despite a small population compared to other emerging countries, 27 million including about 20 million locals, the population is expected to grow at a pace of 1.6 per cent between 20015 and 2020, one of the highest rates globally, and it is a young population with a median age of 29 years. Last but not least, the ages pyramid looks pretty appealing, with more than 66 per cent of the population in the age bracket of 15 to 59, and this part is still growing.
This combination offers a unique access to the fast-growing middle class, a theme that investment managers investing in emerging markets cheer.
Sebastien Henin is head of asset management at The National Investor
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