The Saudi market is the biggest in the Middle East and, after China, the second biggest in the world that is still closed to direct foreign investment. However, since 2009 it has been possible for non-Saudis to invest in companies listed on the Riyadh stock exchange – known as the Tadawul – via ‘the back door‘ or buying swaps and promissory notes through local brokers.
The kingdom has now signalled its intention to attract more international investment and reduce its dependence on oil revenue. Mohammad Al Tuwaijri, the Saudi chief executive (CEO) of HSBC in the Middle East and North Africa, described the move to the
as “one of the most important moments in the history of Saudi financial markets”.
Firms such as the San Francisco stock picking firm Passport Capital believe the Tadawul will prove highly attractive to investors outside of Saudi Arabia, as the home for growing industries that have little dependence on global growth and hosting many undervalued stocks with low correlations to world markets. These firms have already been investing over the past five years, in the expectation that valuations will be driven higher once the market opens up fully to foreign investors.
In the past, the Saudi market has not been for the casual investor. Domestic retail investors, who make up 90% of the market, dominate activity and there have been bear market slumps and bull market rallies since a spate of initial public offerings (IPOs) originally drove the market higher in the middle of the last decade. However even before the global financial crisis hit, the Tadawul suffered a sharp slump during 2006 when the all share index dropped by more than 60%.
The roller coaster ride continued as a bull market reasserted itself and the Tadawul rocketed in the second half of 2007, only to suffer an even bigger shakeout. Between January 2008 and March 2009 the index suffered a 65% reversal as allegations of insider trading and market manipulation flew back and forth.
This volatility is explained by Saudi retail investors‘ apparent tendency to pursue quick profits, sell stocks at the first sign of weakeness and base their decisions on news headlines and rumours, rather than adopt the longer-term valuations typical of fund managers.
Seeking to inject some stability by bringing in outside investors, the CMA relaxed its rule in 2008 to allow foreign investors to have an economic interest by holding stocks without actual ownership, something that remained a political taboo in the kingdom. Passport was among those to take advantage of the reforms and gain its Saudi exposure, a strategy that has proved highly successful. By mid-August 2014 the all share index has risen by 160% from its 2009 low to stand at 10,579; although this is still some way below its February 2006 all-time high of 20,635. Since the 22 July announcement, the index has risen by more than 8%.
Despite the relaxed rules, foreigners owned just 1.2% of the Saudi market via swaps, according to CMA data for 2013. The potential for this percentage to rise sharply from 2015 is enormous; fund managers suggest that if Saudi Arabia is added to global equity indexes it could attract more than US$50bn of fresh money from outside the country over the years ahead.
A total of 167 companies listed on the Tadawul have a combined market capitalisation of US$531bn, or about US$40bn less than Apple. Constituents include Saudi Basic Industries Corp (SABIC), the world’s biggest petrochemicals producer; Kingdom Holding Company, a diversified investment vehicle under the directorship of Prince Alwaleed bin Talal Al Saud that describes itself as ‘the world’s foremost value investor’; Al Rajhi Bank, the world’s largest Islamic bank based on capital; and Almarai, the world’s largest integrated dairy company.
There are also a variety of small to medium-sized enterprises (SMEs) that offer investors potentially better returns. They include several companies operating in the health care industry, which to now has not kept up with the country‘s growing population and rising incomes, and could therefore attract investors‘ attention.
Now that the green light has been given to foreign investment, local investors could respond by bidding stocks up sharply over the coming months, making the market opening less lucrative than international fund managers hope. It has also been suggested that the number of initial public offerings (IPOs) could fall if local companies are reluctant to give up stakes in their business to foreign control, with overseas investors now able to exercise voting rights for the first time.
Nonetheless, Saudi Arabia’s demographic and economic profile is still likely to attract investors, with the International Monetary Fund (IMF) having pencilled in gross domestic product (GDP) growth of 4.6% this year and 4.2% for 2015.
The private sector and stable oil output suggest that steady economic growth will be maintained over the years ahead, with major infrastructure projects and spending on housing supporting the non-oil sector. With nearly 30m citizens, the country has the highest population of any Gulf nation and close to half are aged under 25. Its wealth rests largely on being the world’s largest exporter of oil, with daily production of 11.6m barrels.
Offsetting these advantages is the possibility of political instability, with reports suggesting that the country’s unemployment rate is significantly higher than the figure of 11.5% indicated by government statistics. There is also the question of who will succeed the current Saudi monarch, King Abdullah, who is 90 years old. As the crown prince, aged 78, reportedly suffers from Alzheimers disease, for the first time in history the rule of the kingdom is likely to pass to an individual who is not a direct son of King Abdulaziz al-Saud, the eponymous founder of the nation.
The opening up of the Saudi market is likely be accompanied by a diminished role for domestic retail investors as financial institutions start wielding greater influence, valuing companies in the same way as developed markets and the market moving more in line with global trends.
However, such a change depends to some extent on local pension funds becoming more active in picking stocks and a different culture prevailing, in which retail investors begin entrusting their money to professional managers. Although both trends are anticipated, the change will not happen overnight and the process could take several years.
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