With about $360 billion of market capitalization, Saudi Arabia’s stock market is one of the largest among the emerging markets. However, despite its large market cap, Saudi Arabia does not figure prominently in either international benchmarks or country allocations. A review of the country allocations of MSCI Emerging Markets Free Index (an equity benchmark for emerging markets) reveals that South Korea, China, Brazil and Taiwan account for a combined weight of 48.90 percent in the index.
Saudi Arabia is an attractive investment proposition and it is apparent that the country does not get allocations in international portfolios due to foreign ownership restrictions. The decision of the Council of Ministers on Aug. 27 authorizing the Capital Market Authority (CMA) to remove restrictions on investors from the five other GCC countries is another step in the right direction toward liberalizing and opening up of the Kingdom’s capital market.
Although non-GCC investors can participate in Saudi equities through investment funds, Exchange Traded Funds (ETFs) offer good utility as viable investment products as these offer investors the opportunity to obtain broad-based exposure to the Saudi equity market.
An ETF is an index fund listed and traded on an exchange like a stock. It enables investors to gain broad exposure to an entire stock market (like iShares MSCI Japan Index Fund), a specific sector (like Dow Jones US Financial Sector Index Fund) or an asset class (like DB Commodity Index Tracking Fund) with relative ease and at a lower cost than many other forms of investing. Like stocks, these investments are also subject to market risk and fluctuate in value.
ETFs have been designed for investors seeking returns comparable to established equity benchmarks and to provide liquidity for active traders. Through ETFs, investors are able to obtain market, or “beta” exposure at relatively low cost.
The SPDR Trust (S&P Depository Receipt) was launched in 1993 and, currently with assets of over $59.50 billion, remains the largest ETF in terms of assets under management. Over the last several years, ETFs have gained popularity and can be effective tools for both active and passive institutional managers and retail investors.
At the end of June this year, the US-listed ETF market consisted of 542 ETFs with total assets of almost $510 billion and average daily trading volume in excess of $50 billion. Presently, investors have a wide array of ETFs available to track equity indices on a country, regional, or sector basis. Currently, international and sector-industry styles comprise 70 percent of the market share. It is interesting to note that US-listed ETFs based on international markets continue to generate the most new assets; an emerging market ETF, iShares MSCI Emerging Markets Index Fund had assets of over $20.20 billion (as of July 24, 2007).
As indicated above, there is strong demand for emerging market ETFs and the inherent benefits of these funds will be attractive features for Saudi Arabia’s capital market. The existing Investment Fund Regulations issued by the CMA provide a workable framework for launching and managing ETFs in Saudi Arabia. With the incorporation of some modifications and changes, a progressive ETF working model is conceivable under the existing regulations. In this light, all participating institutions must evaluate the benefits of offering a Saudi ETF and come forward with their proposals that can collectively benefit Saudi Arabia’s capital market.
There are several benefits of listing a Saudi ETF on Tadawul. First, compared to a mutual fund, an ETF is relatively more transparent as the components of the investment vehicle are disclosed every trading day and such disclosure often appeals to a broad range of investors. The underlying index for such an ETF could be the Tadawul All-Share Index or another representative index.
Second, in addition to providing greater transparency, such an ETF will be available to investors at a lower cost. Unlike an actively managed mutual fund looking to create value (or add “alpha”) over the respective benchmark, an ETF is a passively managed investment that provides an investor with “beta” exposure to the underlying asset class. Subsequently, embedded costs in an ETF are lower compared to an actively managed investment fund.
Thirdly, such a Saudi ETF will allow retail investors to have access to the same product as institutional investors and at a similar cost. Thus, the benefits of economies of scale inherent in an ETF are passed on to both retail as well as institutional investors.
Lastly, through an ETF, there is potential to broaden the Saudi market’s investor base and raise additional capital. Such an ETF is likely to attract new investors to the Kingdom’s equity market, such as international pension plan sponsors and asset allocators seeking market exposure. A Saudi ETF will appeal to various types and categories of investors. For instance, in the case of GCC and international investors looking to obtain beta exposure to Saudi Arabia, an ETF will be a more efficient way of investing compared to purchasing a mutual fund (possibly higher fees) or a basket of individual stocks (likely higher transaction charges).
In terms of investment strategy, a Saudi ETF can also be a “core” holding in a multi-asset GCC portfolio, providing a level of diversification and risk reduction that would otherwise be time consuming and expensive to attain by purchasing the underlying shares.
Inflow of capital from foreign sources allows a country to invest more than it saves. Despite some of its constraints, foreign portfolio investment is important for the growth and development of Saudi Arabia’s capital market. Through increased foreign participation will flow the benefits of exposure to a broader investor base and creation of new channels for marketing the Kingdom’s products and services.
ETFs have opened a whole new panorama of investment opportunities for both individual investors and institutional money managers and they are an efficient way of executing a Saudi investment strategy and reaping its benefits. Through ETFs, Saudi Arabia can attract investment into its equity market from both domestic as well as international investors. Currently, non-GCC investors are restricted from directly purchasing underlying equities. Till such time that these restrictions are relaxed and even beyond, ETFs can serve as an effective instrument for allocating capital into the Saudi stock market.
(The opinion expressed is that of the author himself and does not necessarily represent that of the organization he represents.)
(Farhan Mahmood is head of Asset Management at FALCOM Financial Services, Riyadh.)
