Amidst the excitement over Saudi Arabia’s rapid reform agenda, Ross Teverson, Head of Strategy, Emerging Markets at Jupiter Asset Management, provides a reminder and some pointers in dealing with this market.
Saudi Arabia has attracted international attention for the reform agenda being driven by Crown Prince Mohammad bin Salman, and the social and economic opportunities that are being created. Change in the Kingdom is having a direct and tangible impact on its equity market. With Saudi Arabia’s recent inclusion on MSCI’s Emerging Market Index, the country is an exciting prospect for global investors.
RAPID, DRAMATIC AND POSITIVE CHANGE
Observing Saudi Arabia from afar, as well as from within, reforms are real, wide-reaching and taking place at remarkable speed. There has been a crackdown on corruption; the ultra-conservative elements in society have been side-lined; an entertainment sector is being allowed to develop; and women’s rights have been brought to the front of the agenda—supported by growing female participation in the workforce.
Ambitious reform agendas require financing, and Saudi Arabia has been highly active in the international debt market. Bolstered by the sovereign’s $12.4 billion international Islamic bond offer in September, Middle East debt issuance reached a record $103.7 billion in 2017, 33 per cent more than the previous year. Saudi Arabia was the region’s most active issuer, accounting for 33 per cent of activity by value.
In the domestic market, equities are set to play an important role in supporting growth, as well as Vision 2030’s privatisation programme. The tabled listing of the state oil company, Saudi Aramco, in 2019, will make it the most valuable listed company in the world.
Earlier this year, the Kingdom was d to emerging market status by FTSE Russell, a development which is expected to pump billions of dollars of foreign investment into the region’s biggest stock exchange, Tadawul, which has a market capitalisation of $500 billion. That alone is expected to attract up to $5 billion of fund inflows from global investors. The inclusion of Saudi Arabia on MSCI’s Emerging Markets Index—the most widely followed of all indices—at a weighting of 2.6 per cent, effective in 2019, will place it even more on the radar of passive and active investors, and is expected to attract foreign inflows of as much as $45 billion.
IS IT REALLY ‘THE CHINA OF THE MIDDLE EAST?’
With this rapid progress of social and economic reform, Saudi Arabia has been referred to on more than one occasion as the “China of the Middle East”. There are many important and fundamental differences between these two markets—not least that one is a monarchy and the other a communist state—but similarities can undeniably be drawn.
Saudi Arabia will host the G20 summit in 2020, at the King Abdullah Financial District—an important opportunity for the Kingdom to position itself as a key player on the global economic stage, while highlighting the progress of its diversification agenda. The venue, here, is important.
When visiting the King Abdullah Financial District—which is still mostly under construction—one is quickly reminded of similarly enormous developments in Beijing and Shanghai, where it was political will and ambition that drove the rapid completion of projects. Much the same can now be said of the Kingdom.
Another similarity is that Saudi Arabia appears to be taking cues from China’s fixed asset investment model, by investing in infrastructure projects to remove bottlenecks to economic growth. In the region, the appetite for investment in infrastructure assets has increased, and Saudi Arabia is creating further opportunities for investment with the construction of large-scale projects such as Riyadh’s metro system and high-speed airport rail link.
INVESTORS MUST BE SELECTIVE
While the Saudi equities market presents considerable opportunity to global investors, they will need to both allocate and manage their capital wisely. Passive money will blindly buy into the largest MSCI EM Index constituents, one of which is now Saudi Arabia, and so active investors must be selective to realise the market’s true potential.
One sector that shows particular promise is healthcare, where we believe there to be several under-researched, well-run businesses that are set to benefit from rapid pace of change. Healthcare spending in Saudi Arabia is set to rise, as medical insurance moves from the state to the private sector. In 2017, the budget for healthcare and social development increased by nearly $5 billion to reach a total of $32 billion.
While public spending dominated at 79 per cent, the private sector is catching up, in part thanks to the National Transformation Programme (NTP), which seeks to increase the contribution of the sector to the national economy. In 2015, the Kingdom’s healthcare sector contributed $20.8 billion to Saudi GDP, and is projected to grow by 13.7 per cent by 2025.
Improved availability of high-end services and a raft of initiatives being rolled out by the Ministry of Health means that where many patients had in the past chosen to travel overseas for treatment, more are now likely to spend money on healthcare at home. Furthermore, a high incidence of chronic conditions such as diabetes and rising demand for long-term care for elderly patients also suggest structural growth in healthcare spending.
Meanwhile, in the short-term and at macro-level, a number of much needed economic reforms may initially inhibit economic growth—for example, the removal of fuel subsidies, the introduction of VAT and levies on expat workers who may consequently choose to exit the labour market.
As it stands, foreign investor participation in the Saudi stock market is low, but that situation is changing, and changing fast. Overseas investors bought $1.18 billion in MENA equities in March 2018, of which a large proportion were traded on the Saudi exchange, in anticipation of the index announcements. With the inclusion of Saudi Arabia in the MSCI Emerging Markets Index now confirmed, the Kingdom is set to become an increasingly important player in the EM landscape.
But investors should approach with care. Blindly following the indices isn’t the way to go, whatever weighting Saudi may be given. Instead, stocks and sectors should be selected based on in-depth qualitative and quantitative research, and investment strategies must be actively managed. That is what will deliver the potential that the market offers, and that is how genuinely attractive returns will be achieved.