With 139 listed companies and over $356 billion in market capitalization, Saudi Arabia is one of the largest equity markets among emerging countries; although its trading value is down 43 percent over last year, Tadawul still trades close to $800 million a day, making it a relatively liquid market.
Over the last several years, ETFs have gained global popularity and are effective tools for both active and passive institutional managers and retail investors. At the end of December last year, the total global ETF market consisted of 1,947 ETFs with total assets of over $1.03 trillion (as compared to 1,590 ETFs with total assets of over $711 billion at the end of December 2008).
Presently, investors worldwide have a wide array of ETFs available to track equity indices on a country, regional, or sector basis. It is worth noting 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 currently has assets of $34.75 billion.
An ETF is an index fund listed and traded on an exchange like a stock, designed for investors seeking returns comparable to a benchmark and to provide liquidity to active traders. Through ETFs, investors are able to obtain market, or "beta" exposure at relatively low cost.
There is strong and growing demand for emerging market ETFs and the inherent benefits of these funds will be appealing for investors looking to access Saudi Arabia's equity market. This applies to both local as well as international investors.
Currently, non-GCC investors can only invest in Saudi equities either through swaps or mutual funds. According to Tadawul, ETFs will be available to all categories of investors registered to trade at the exchange. Saudi-based ETFs would thus be viable products, as these will offer investors the opportunity to obtain broad-based exposure to the Saudi equity market.
Among other things, the success of a Saudi-listed ETF will depend on the type of market exposure it provides investors as well as the associated costs. Investors looking for broad-based market allocation will consider such an ETF as it would give them quick exposure without having to go through the process of carrying out research, investment analysis and stock selection, like a mutual fund.
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 on each trading day and such disclosure will appeal to a broad range of investors, especially after the challenging market conditions of 2008 caused a significant shift in investors' risk appetites and their desire for greater transparency and liquidity.
Second, an ETF will be available to investors at a lower cost. Unlike an actively managed investment fund looking to create value over the respective benchmark, an ETF is a passively managed investment that provides an investor with exposure to the underlying asset class. Subsequently, embedded costs in an ETF should be lower compared to an actively managed investment fund.
Thirdly, such a Saudi ETF will allow retail investors access to the same product as institutional investors and at a similar cost. Thus, the benefits of economies of scale inherent in an ETF would be passed on to investors.
Lastly, through an ETF, there is potential to broaden the Saudi market's investor base and raise additional capital. A Saudi ETF is likely to attract new investors to the Kingdom's equity market, such as asset allocators who want to obtain market exposure quickly or individual investors who may not have the resources available to carry out detailed due diligence of the underlying stocks. Despite Saudi Arabia being an off-benchmark bet, there is considerable foreign interest in the Kingdom's equity market; since official data became available in March 2009, net purchases by foreigners through swaps have totaled about $792 million.
However, growth in ETFs is likely to be gradual as evidenced by the fact that mutual funds in Saudi Arabia have grown to SR90 billion in assets over a period of 18 years. Through ETFs, Saudi Arabia can continue to attract investment into its equity market from both domestic as well as international investors. Such interest is likely to trickle down through ETFs over time, provided there is healthy liquidity and the associated costs are competitive.
(Farhan Mahmood, CFA, is head of investment management at Morgan Stanley in Saudi Arabia. The opinion expressed is that of the author himself and does not represent that of the organization he represents.)
