Many equity funds around the world benchmark themselves against the index, and they will need to buy Saudi stocks when the change takes effect. With a capitalization of about $500 billion, Saudi Arabia is the Arab world’s largest equity market.
The decision is a boost to reforms launched by Crown Prince Mohammed bin Salman, who wants foreign investment to create jobs and diversify the economy, which has been hit hard by low oil prices, beyond energy exports.
To prevent Saudi Arabia’s large size from destabilizing other markets as funds shift money to Riyadh, the Kingdom will enter the index in several stages starting in March 2019 and ending in December 2019, FTSE said.
The Kingdom is projected to have a weight of 2.7 percent in the index, which could rise to about 4.6 percent because of the government’s proposed public offer of 5 percent of the shares of state oil giant Saudi Aramco, FTSE added.
Saudi authorities worked for years to meet criteria to enter the index, tightening rules on corporate governance, modernizing the market’s settlement system and easing — though not completely removing — restrictions on foreign ownership of stocks.
Regional investment bank EFG Hermes has estimated Saudi Arabia will attract about $5 billion of “passive,” index-linked funds because of FTSE’s decision.
In addition, rival index firm MSCI will decide in June whether to include Saudi Arabia in its own emerging market benchmark. A positive decision, which many fund managers expect, could produce around $10 billion of passive inflows.
Such numbers may only be the tip of the iceberg; a lot more new money could come from “active” funds, which have more discretion to move between countries.
All told, Saudi Arabia could see a total of $30 billion to $45 billion of inflows in the next two years if it reaches the foreign ownership levels of markets in the neighboring United Arab Emirates and Qatar, EFG Hermes thinks. Reaching the levels of Mexico and Russia would mean $90 billion of inflows.
“Saudi inclusion is a milestone event in the development of the region’s equity capital markets,” said Salah Shamma, head of regional equity investment at Franklin Templeton Investments, which manages some $745 billion of assets globally.
“It opens up the region to a dedicated investment pool otherwise unavailable.” Shamma added that the Saudi banking, insurance, health care, education and consumer staples sectors were potentially attractive.
Reforms may create new investment opportunities. A ban on women driving is to be lifted in a few months, which should aid auto-related sectors, and the Kingdom plans to develop non-religious tourism for the first time.
By increasing the presence of foreign portfolio investors in Saudi Arabia, entry into the FTSE and MSCI indexes may facilitate authorities’ plan to list shares in Aramco and reinvest the proceeds in new industries.
The government says it aims to sell about 5 percent of Aramco as soon as this year, listing it in Riyadh and possibly one or more foreign markets in what would probably be the world’s biggest IPO.
Crown Prince Mohammed bin Salman has predicted the sale will raise at least $100 billion. Many private analysts consider that too optimistic, but Riyadh’s market is still likely to need the participation of foreign investors to help absorb the huge IPO.
At present, foreign investors of all types own less 5 percent of Saudi Arabia’s market. Expectations for this ratio to rise have lifted the Saudi stock index over 9 percent this year.
Exchange data show foreigners have already begun buying more stocks, purchasing a net $1.64 billion year-to-date.
It is not clear, however, whether the market’s uptrend will continue in the coming months. The Saudi economy is still struggling with low oil prices, and at a valuation of over 16 times last year’s earnings, the market is not cheap compared to MSCI’s emerging market index at about 15.5 times.
Riyad Capital, a major Saudi investment bank, said in a report this week that the index had now hit its target for 2018 and while a further rise was possible, it might need triggers such as improvement in the corporate earnings outlook.
“We ... would avoid jumping on the speculative bandwagon,” it said.