Despite optimism for the opening up of the Saudi stock market to foreign investors in June, the initial response from qualified foreight investors (QFIs) has been subdued. This has been indicated by the monthly trading activity.
The initiatitve is supposed to allow foreign institutions to invest directly in shares listed on the Saudi stock exchange, also called the Tadawal All Share Index (TASI) after obtaining QFI status from the Capital Markets Authority (CMA)
Observers have cited limitations on QFI trading along with the ongoing weakness in oil for the tepid start. However, the long-term prospects of the move may still be sound. The initiative is supposed to help achieve certain reasonable objectives. Among them:
- to reduce the predominance of retail investors, given they account for approximately 90% of the trading activity. Opening up of the market to foreign participants would ensure lesser volatility associated with retail investors.
- to reduce the market's sensitivity to oil volatility through higher institutional investor participation. Oil fluctuations can have a profound impact on investor sentiment.
- to diversify the non-oil sector, which accounts for roughly 51% of Saudi Arabia's GDP.
On the first day of trading, only seven Saudi stocks attracted investments from the QFIs. The average traded value in June was just 13.8 million Saudi Riyal (SAR), insignificant compared to the exchange average trade of 112.8 billion SAR over the same period.
After the tepid start in June, trading activity ramped up as the total traded value rose from the 27.5 million SAR in June to SAR 92.3mn in August. The upside could be attributed to the resumption of the stock market after the Eid-break, which was preceded by Ramadan, when trading activity is generally subdued.
Although QFIs were net buyers (SAR 18.2mn) at the end of June, they turned into net sellers in July (SAR 21.3mn) and August (SAR 3.5mn), respectively. This was primarily due to Ramadan.
The factors that have limited QFIs are multi-faceted.
Capital Markets Authority Restrictions
Certain restrictions by the Capital Markets Authority limit the QFI's participation in the market. One of those restrictions states that QFIs can only hold up to 5% individually (and 20% collectively) of the shares of any traded company. Also, in total, foreign investors may hold a maximum of 49% of the shares of any traded company. Furthermore, total investment by QFIs is limited to only 10% of the TASI market cap.
Oil Played Spoilsport
The performance of the Saudi exchange has been weak since June 2015. It fell from 9,700 points in early June to below 7,600 points in August. The downside was a result of the dip in oil prices, with Brent declining over 50% year-to-year in August from more than $100 a barrel. Despite being a predominantly oil-based economy, historical data suggests a low correlation between oil prices and TASI. However, the scenario has changed in the recent past and the correlation has peaked (Year-to-date 2015 correlation stands at 0.82), fueled by the dip in oil prices. This has eventually affected TASI's performance.
Budget Cuts are Evident
Saudi Arabia's fiscal breakeven oil price has increased over the years to $106 a barrel in 2015 from $69 in 2010 mainly due to expansionary government spending. Saudi Arabia's breakeven price is the highest among the Gulf nations. An oil price shock is likely to trigger cuts in spending and its transmission to other areas of economy which is of immense importance to Saudi Arabia.
Premium Valuation "Unwarranted"
The high valuation of the stocks trading in Saudi Arabia's exchange dissuaded QFIs from participating in trading activities. TASI was the best performer among the Gulf markets until 2Q15. The index traded at a blended forward P/E multiple of 15.5 times compared with 11.8 times for the key Gulf markets and 12.3 times for the MSCI global emerging markets. Given the changing fundamentals of the economic scenario in Saudi Arabia, this does not warrant a premium valuation especially with the sustained weakness in oil price.
Despite the restrained start to the foreign investment activity in the Saudi Exchange, the framework offers a sound platform toward the development of the market. The large size of the Saudi market and initiatives by the government to make investment opportunities for QFIs more attractive could boost participation in the future.
Rishiraj Agarwal, Manager, Investment Research at Aranca co-authored this article.