The announcement at the end of June of the upcoming addition of Saudi Arabia to the MSCI Emerging Market (EM) Index was not only a win for Saudi Arabian companies, but also a win for investors who took advantage of the news to invest in BlackRock’s Saudi Arabia ETF (KSA)—which is up 17% year to date, outperforming the MSCI EM Index by 25%. Blackrock’s Saudi Arabia ETF is currently the only game in town for investors looking for direct ETF exposure to the country, but competition is coming. Franklin Templeton has filed with the Securities & Exchange Commission (SEC) to launch the Franklin Saudi Arabia ETF, along with the Franklin Latin America and South Africa ETF.
MSCI, which has more than $1.9 trillion in assets benchmarked to its group of emerging markets indexes, will reclassify Saudi Arabia with implementation of its indexes starting in June 2019.
Almost 90% of KSA’s $272 million in assets under management have by acquired this year, according to Chris Dhanraj, director, head of ETF investment strategy, at BlackRock. “The main driver behind these flows was the expectation that Saudi Arabia would likely be included in the MSCI EM benchmark. The focus on this index event has contributed to performance and inflows,” he said. “The total Saudi Arabia weight in the MSCI EM Index is expected to be 2.3%; should additional IPOs (initial public offerings) of state-owned entities proceed, Saudi Arabia would become the 13th largest EM market,” he noted.
Many investors into the region had also been buoyed by the expected upcoming IPO of Saudi Arabia’s state run energy company, Saudi Aramco, the world’s largest company, on the Tadawul Exchange, the Saudi Arabian stock exchange. Last Thursday, however, it was reported that the IPO, estimated to be worth up to $2 trillion, was being put on hold indefinitely.
Currently in a quiet period regarding the forthcoming launch of its new ETFs, Franklin Templeton declined comment on its country-focused strategy. The ETFs are tentatively slated to be listed on the NYSE Arca. Franklin Templeton’s family of cap-weighted country and regional ETFs combined have approximately $580 million in AUM as of June 30,2018.
If an investor holds the MSCI emerging market benchmark, the addition of Saudi Arabia will drive them to reallocate.
Attraction of Saudi Arabia
Three factors have largely contributed to making Saudi Arabia more attractive to investors, of late: the IPO (now on hold); the launch of Vision 2030, which is a series of reforms the Saudi government adopted in 2016 to reduce oil dependence, diversify the economy, improve public services, and increase the privatization of business activities; and the most pertinent, the MSCI market inclusion, according to Dhanraj.
A further driver of inflows and returns (for KSA) has been the Vision 2030 plan, he said. “This is meant to transform Saudi Arabia from being an oil producer towards becoming a global financial hub.” The MSCI event affects the holdings of institutional investors, who are largely benchmarking themselves to the broad EM. “If an investor holds the MSCI emerging market benchmark, the addition of Saudi Arabia will drive them to reallocate,” he explained.
Investors are looking increasingly for more granular exposure to emerging markets through country, industry and factor exposure, Dhanraj said. “They are constantly looking at ways to slice up exposure and get more granular views implemented,” he said. With that in mind, “Over the past couple years, the ETF market has been developing with a focus on more precise products, and as they come out, investors will look at ways to include those in their investment views,” Dhanraj said. “Looking at emerging markets as a whole, some investors want broad international exposure, because they have had none, but going forward, internationally, many want a country angle,” he noted. “They are saying, ‘We need a more precise view, and the trend is to invest by country.’”
More than just financial instruments
Institutional investors, typically, have used ETFs to express both near- and medium-term views from an asset allocation and trading implementation perspective,” Dhanraj said. “They are now increasingly looking at using ETFs as financial instruments to protect portfolios, to get long-term exposure to markets, and as a way to achieve more granular exposures,” he said. “Investors are increasingly using them across their portfolios as expressions of market views. As investors look across the suite of ETFs, they think of not just one asset class, but look at the market as a multi-asset framework,” he said.
Other than the BlackRock ETF, and the pending Franklin Templeton ETF, there are currently no other Saudi Arabia ETFs or mutual funds available to international investors that focus solely on investments in the country. “For those that want exposure, they have been buying individual shares mostly through institutional products, because you can’t buy them directly,” Dhanraj said. “They can buy swaps on the index or through a broker, but there is no easy way to buy access on a direct basis and no active fund management is available to non-domestic institutional clients,” he said. “That’s why the fund is of interest to them, as a way to get access,” Dhanraj noted. “In the post Dodd-Frank world, where banks are reducing their balance sheets and are moving away from swaps, institutional investors are going the ETF route.”
They are now increasingly looking at using ETFs as financial instruments to protect portfolios, to get long-term exposure to markets, and as a way to achieve more granular exposures.
Other countries in the Middle East/Africa region that Blackrock offers to investors as singular ETFs are South Africa and Qatar. The South Africa ETF was launched in 2003 and has underperformed the emerging market ETF, down 17% YTD compared to the EM index, which is down 9% over the same period. “The primary factor for the weakness of the South Africa ETF is the exposure to the floating currency, the rand (ZAR), which went from 11.5 per dollar to 13 per dollar. So, this is feeding through into the ETF, which includes currency, causing the depreciation,” Dhanraj said.
The BlackRock Qatar ETF, which was launched in 2014, also underperformed the Saudi Arabia ETF, up 3% for the year. The currency, the Qatari riyal, is more difficult to buy. “It’s a managed currency, so has not depreciated at all, but is more difficult to trade,” Dhanraj noted. “The BlackRock Qatar ETF was one way of playing the view of the Middle East, but it and the Saudi Arabia ETF were both were launched within a year of each other, so you had opportunity to take the granular view pretty early on,” he said.
South Africa has a more mature market that has been traded by institutional investors for a long time, including through bonds, equites and currencies, Dhanraj added. By contrast, Saudi Arabia and Qatar are more closed markets—they are the first way investors are looking at the Middle East region. All three properties, South Africa, Saudi Arabia and Qatar are unique from an investment strategy perspective. They are different areas with different investment theses, he said.