MSCI upgrade brings Saudi Arabia into mainstream: BofAML

Saudi Arabia has moved into global mainstream, being upgraded by MSCI to its Emerging Market (EM) index. The 32 Saudi candidate firms that will be included are set to account for approximately 2.6 percent of MSCI EM index rising to almost 4.4 percent if the potential Saudi Aramco IPO were included, Bank of America Merrill Lynch (BofAML) said in a recent report.

Saudi Aramco’s weighting would make Riyadh the seventh largest market in the index ahead of Mexico and Russia.

The Kingdom is likely to attract net inflows (from other MSCI EM markets) of $10 billion when including all passive funds tracking MSCI EM. This will likely be further boosted by inflows from active fund managers, the size of which will be dependent on the proportion taking a position in the market.

“If we assume 30 percent of active fund managers take an equal weight position (with the remaining 70 percent taking zero weight position), this would imply potential active flows of $10.7bn, taking total flows to c. $20.6 billion (71 percent of which would be accounted for by the ten largest constituents),” BofA added.

The EM index inclusion adds credibility and support to Saudi Arabia’s economic diversification program and market sophistication.

The bank added that it has maintained its positive view on the Saudi market, as it sees strong earnings momentum and rising appetite for Saudi equities among global investors, thanks to improving economic fundamentals underpinned by a more robust oil macro; attractive valuations, and the prospect for accelerating earnings, free cash flows and dividend growth on the back of reform programs, and expansionary budget.

Al Rajhi Bank, Samba Financial Group, while giant petrochemical producer SABIC and Saudi Kayan were selected as BofAML’s top picks in the banking and petrochemical sectors, respectively.

Meanwhile, ownership limits and the privatizations currently considered by the government, including the Saudi Stock Exchange, transportation assets and other industrial companies could increase weighting.

“Inclusion of these newly privatized companies would likely increase Saudi's weighting in the MSCI EM index and thus attract higher inflows to the market. However, quantification of this presently is difficult given the lack of certainty on what assets will ultimately be privatized,” the report added.