• The Saudi stock exchange, the Tadawul, is expected to see only a small inflow of foreign capital when it opens to direct foreign investment on 15 June
  • Activity has slowed due to seasonal factors, including the start of Ramadan
  • Capital inflows will be gradual but could reach $50bn by 2017

The Saudi Stock Exchange (Tadawul), is expected to see only a small influx of foreign investment when it opens to qualified foreign investors (QFIs) on 15 June.

Tadawul always slows in the hot summer months, while Ramadan is due to start on 18 June.

“This is a regular seasonal trend before Ramadan; there is always subdued performance,” says Fahad al-Turki, chief economist and head of research at local Jadwa Investment. “It usually picks up at end of Ramadan as low prices are attractive, and this year it will be combined with the opening, which will support sentiment – it is seen as a positive thing.”

The most interested foreign investors are already trading under the existing Swap system and owned around 1.2 per cent of shares listed on the Tadawul at the end of May. It has a market capitalisation of around SR2,137bn ($570bn), according to US-based MCSI. Others are likely to take a wait-and-see approach.

“After the regulations were announced, there was about $2bn invested from abroad in April,” says Aditya Pugalia, analyst at Dubai-based Emirates NBD. “In May there was actually a small outflow. There was a lack of a market catalyst, once euphoria over the regulations faded. People were biding their time and there was more sideways trading, and lower volumes.”

The Tadawul All Shares Index (TASI) still rose by 0.9 per cent today in anticipation, although it has fallen by 2.4 per cent since the new regulations were published on 5 May.

Most analysts expect very limited capital inflows.

The regulations reduce the possible influx of capital to just 10 per cent of total ownership. The minimum size for QFIs, of $5bn of assets under management is also a barrier. Very few banks and asset managers in the region will qualify, leaving only major international players. The Tadawul and the Capital Markets Authority have not announced how many, if any, investors have qualified in time for the opening, despite high interest.

These large institutional investors are more likely to invest on the Tadawul if it is included on MCSI’s emerging markets index. MCSI will study putting Saudi Arabia on its emerging markets index watchlist once the rules have taken effect, with a view to upgrading it. However, this process will be complete by 2017 at the earliest.

“Both steps need to happen and in terms of putting the Tadawul on the map, the decision to open the market to foreign investors is more important,” says Al-Turki. “But being listed on the MSCI emerging markets index would unlock more investment from pension funds and sovereign wealth funds which are constrained to MSCI indexes, and lead to a larger inflow of capital.”

Jadwa Investments expects an inflow of $40bn to $50bn before 2017, but starting very gradually. This will also depend on market conditions and the weighting MSCI gives Saudi Arabia, which will probably be between 3 and 4 per cent.

However, Emirates NBD sees the Tadawul as slightly overvalued, with the price to earnings ratio at 16.5x, 30 per cent higher than MSCI’s emerging markets index. The less attractive dividends may cause volatility and deter foreign investors from developing a portfolio.

Pockets of good value remain for prospective investors.

“Investors will look at the sectors most linked to the driving force of economic growth and sectors linked to government subsidies,” says al-Turki. “Petrochemicals have a competitive edge over international peers, and sectors linked to the large consumption market such as retail and banks benefit directly from strong purchasing power in Saudi Arabia.”

As a larger, more liquid and diversified market, the Tadawul is unlikely to experience the same overvaluation volatility as Dubai and Qatar when they were upgraded to emerging market status.

Lower oil prices will also dampen the effect of the opening, as the TASI has fallen 14.6 per cent since its high on 9 September 2014. The Saudi government plans to keep spending at 2014 levels to shield the public sector from its effects.

“Petroleum stocks dipped, and they are the second largest sector after banking, so obviously the oil price has had an effect,” says Pugalia. “But the significance of oil has come down as the price has settled into a tighter range. Earlier with the sharp falls it had a pronounced impact.”

Oil price-related volatility has had a noticeable effect on companies considering listing on the Tadawul, but this may pick up later in the year as the market settles and valuations recover. Jadwa counts three IPOs going ahead so far this year, with another 23 in the pipeline.

The expected rush to make the most of foreign investor capital has not materialised, and the QFI participation in initial public offerings (IPOs) will be decided on a case-by-case basis.

Regional instability is not expected to have a severe negative impact.

“In the last five years despite the back drop of regional geopolitical tension, global investors have been provided with ample evidence, through continued stability and sustained economic growth, to be able to differentiate Saudi Arabia’s outlook from other troubled regional economies,” says al-Turki. “We do not see any reason why this would change.”