Investors have flooded into Saudi stocks this year after the kingdom's share market was included in widely followed benchmarks that guide trillions of dollars in assets.
Mutual and exchange traded funds that invest in companies on Riyadh's Tadawul stock exchange have rocketed to US$4.8 billion ($7.2b) in assets from just US$356 million at the start of the year, according to EPFR Global data.
The growth comes after indexing groups MSCI, FTSE Russell and S&P Dow Jones Indices included the stocks in popular emerging markets benchmarks and as the government has eased rules governing foreign ownership of shares.
The surge in assets reflects the heft that index providers wield in guiding investor assets across global financial markets. Inclusion in a benchmark induces active fund managers to buy the stocks to keep pace with the indices they are ranked against, while passive funds automatically hoover up the shares by design.
The asset growth also raises questions about how index companies should treat authoritarian regimes such as Saudi Arabia, which was implicated in last year's grisly killing of journalist Jamal Khashoggi at the Saudi consulate in Istanbul.
"The directionality and the magnitude of the inflows are significant," said Ben Johnson, director of global ETF research at Morningstar. "It mostly has to do with the graduation of Saudi stocks into the emerging market classification as deemed by MSCI, and other instances of index inclusion."
Saudi stocks will make up 2.7 per cent of the popular MSCI emerging markets index next month, completing a process to include the shares that began earlier this year. The benchmark is tracked by an estimated US$1.9 trillion in assets.
The two largest Saudi ETFs together hold US$3.2b, with one — from Atlanta-based fund manager Invesco — gaining US$1b in inflows this month alone to boost its assets to US$2.3b. The other, from BlackRock's iShares division, has grown fourfold to US$833m this year.
Speaking on the group's second-quarter earnings call on Thursday, Invesco's chief financial officer Loren Starr highlighted the Saudi fund's "significant inflow" as an example of the strong performance of the company's passive investing franchise.
The Saudi stock market is heavily skewed toward the energy and financial sectors and has 194 listed companies — many of which are relatively unknown. The largest companies are Saudi Basic Industries, Saudi Telecom and Al Rajhi Bank. The market has returned 6.1 per cent over the past 12 months, outperforming the FTSE All World by nearly 3 percentage points.
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"The Saudi stock market has a lot of sector-level concentration given the limited diversity of the economy on the ground," said Morningstar's Johnson.
The inflows are the latest signal that the unease some investors felt about the kingdom in the aftermath of Khashoggi's death has abated. In April, the country's state-owned oil company Saudi Aramco increased the amount it raised in a bond sale to US$12b after initial investor interest topped US$100b.
Investors are grappling with a country that has embarked on sweeping change under the "Vision 2030" plan introduced by crown prince Mohammed bin Salman three years ago, which aims to diversify the economy beyond the oil and banking businesses that dominate local industry. The reforms include a target to reduce unemployment by adding 450,000 private sector jobs by 2020.
Written by: Richard Henderson
© Financial Times