Summer 2014

INSIDE VIEW: The giant hiding in the shadows

IV picThe UAE and Qatar have been reclassified from frontier to emerging markets by MSCI. However the region’s giant, Saudi Arabia, looms large, says Akber Khan, of Al Rayan Investment.

MSCI’s reclassification of the UAE and Qatar from frontier to emerging markets was akin to these two countries winning a prize on the global stage. MSCI began consultations as long ago as July 2008 after which local investors watched the index provider’s annual June updates with bated breath. 

In June 2013, MSCI finally announced Qatar and the UAE were to be upgraded at the May 2014 reclassification.

Active investors began positioning themselves and helped Dubai’s benchmark index rally 108% during the year, making it the second best performing equity market in the world (after Venezuela). Abu Dhabi and Qatar were also among the top ten performers. In the first five months of 2014, Dubai continued its remarkable ascent, climbing 51% to claim the top spot among global equity markets. Qatar was in second place, rallying 32%.

After tremendous excitement, extensive press coverage and billions of dollars of foreign inflows, the long-awaited upgrades are now behind us. But what happens next? How will MSCI’s decision affect these markets and the region?

Some effects from the upgrade are already visible while others will take years to emerge. Quick wins included the virtuous cycle fuelled by a jump in daily liquidity which squeezed bid-offer spreads, in turn attracting greater volumes and helping the cycle continue. In Qatar, average daily trading volumes in the first five months of this year were triple their levels in the same period in 2013. In the UAE, they were quadruple.

Heightened international awareness of both countries is another positive. 

Dubai’s narrative will no longer be about only tourism and real estate and Abu Dhabi’s domestic spending plans will enjoy greater external attention. Qatar will see articles about more than just its own investments abroad, though, unfortunately, the MSCI upgrade has coincided with negative press about its hosting of the 2022 World Cup which has reduced some of the active buying expected around the MSCI upgrade.

Over time, increased capital inflows will expand local equity markets. Sustained high oil prices have meant regional banks are flush with cash and are looking to aggressively deploy their balance sheets. There will also be a recalibration of shareholders who – although they remain minorities because of foreign ownership limits – will gradually bring in change. UAE and Qatari equities will increasingly feel pain during times of sour global sentiment when top-down “de-risking” drives indiscriminate selling. However, some of these new investors have considerably longer investment horizons than the local retail investors who dominate GCC equity markets. UAE and Qatari companies will be increasingly conscious of demands to improve transparency and investor communication if they wish to benefit from the significant foreign capital available. Improvements to corporate governance will be positive but likely take several years to be felt.

While attention has been on UAE and Qatar, the real prize in the GCC would be to add Saudi Arabia to the fold. 

In early 2013, Mohammed Al-Sheikh was named chairman of the Capital Markets Authority (CMA). He has western experience, having studied at Harvard Law School, worked at a major US law firm and held a senior position at the World Bank. A few months after his appointment, the work-week was adjusted to the regionally conventional Sunday-Thursday, increasing overlap with international markets. 

In addition, the CMA held consultations with foreign brokers to discuss a framework that would allow foreign investors to directly access the Saudi capital markets. 

Frenzied speculation about imminent change followed but unfortunately so did silence from the CMA. 

Anticipation of opening up the kingdom’s listed companies to direct foreign ownership has since waned; however, this is unlikely to be the end of the road. Regulatory change in Saudi Arabia is never rushed.

For Saudi Arabia to be eligible for a globally equity index other changes are necessary, such as the T+0 settlement process. Although extremely popular with retail investors, who account for 90% of daily volumes, international investors may be less enthusiastic.

However the country’s size and potential are compelling. The $750 billion economy, which accounts for almost half of the GCC’s GDP, should continue to grow in the mid-single digits. Saudi Arabia’s 28 million people represent more than 60% of the region’s population and Saudi nationals make up 75% of their country’s population; in stark contrast to Qatar and the UAE where just one-in-nine people
are citizens. 

While Qatar boasts the greatest proportion of millionaire households in the world (at 14%) and Abu Dhabi’s $100,000-plus GDP per capita is one of the highest globally, Saudi’s more modest GDP per capita of $26,000 reflects a demographic closer to an average emerging economy. Although Saudi Arabia has its fair share of ultra-wealthy, it also has a large proportion of middle class and lower income workers as well as the unemployed. 

This brings to bear familiar themes for global investors such as urbanisation and industrialisation which are limited in the rest of the region.

The Saudi stock market offers superior breadth and depth versus regional peers. There are 164 listed companies (compared with 92 in the UAE and 43 in Qatar) with an average daily volume in excess of $2.2 billion – more than double the UAE and Qatar combined. The Saudi Tadawul index has 50 stocks that trade more than $10 million a day.

The kingdom also offers superior diversification and is not just dominated by banks and real estate companies, allowing more nuanced investment. There are numerous listed petrochemical producers which benefit from some of the cheapest feedstock in the world as well as dozens of consumer and industrial companies which are key beneficiaries of enhanced government spending.

In terms of significance, the $450 billion market capitalisation of the MSCI Saudi Arabia index compares to MSCI South Africa’s $420 billion, which has a weight of about 7.5% weight in MSCI emerging market index. 

Implementing foreign ownership limits would lower Saudi’s index weight, but with Qatar and the UAE already included, the Gulf’s overall contribution would be significant.

The UAE and Qatari equity markets are basking in their upgrade to emerging market status, but the region will truly come of age if, or perhaps when, Saudi Arabia joins them.

Akber Khan is head of asset management at Al Rayan Investment

©2014 funds global mena

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