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Index weighting makes Saudi Arabia hard to ignore

Oliver Bell said Saudi Arabia’s ‘vast IPO pipeline’ could raise its weighting in the Emerging Markets index to as high as 10% within the next five years.

While a number of managers already have exposure to Saudi Arabia, they expect the country will receive more attention following its promotion by MSCI Inc. to its Emerging Markets index.

Fiera Capital Corp. holds a 17% allocation to Saudi Arabia within its frontier portfolio, and while the upgrade is not a "key determinant for our investment decision, we certainly expect it to help," said Dominic Bokor-Ingram, portfolio adviser in London.

The country's expected 2.6% weighting in the MSCI EMI "is big enough to make sure most funds don't ignore Saudi as they did Pakistan," which only accounts for 10 basis points of the index, he said. "So in theory there could be some rebalancing, which takes money out of the other emerging markets to put into Saudi, but the impact will be very small."

And T. Rowe Price's Oliver Bell, portfolio manager in London of the firm's Middle East and Africa Equity and Frontier Markets Equity strategy, expects the country to become a bigger part of the index. "Saudi's initial weight in the MSCI EM index is likely to be around 3%, but we anticipate this potentially rising to 8% to 10% over the course of the next three to five years given its vast IPO pipeline. Near-term IPOs could total around $150 billion, and that is before counting the Aramco IPO." Those changes could also put more emphasis on the Middle East region of the MSCI Emerging Markets index that now accounts for 1.5% of the index.

But promotion for Saudi Arabia does not automatically means active managers will allocate to the country.

Franklin Templeton (BEN) Investments (BEN) has a long-standing, off-benchmark overweight position in the market, and the reclassification is just one factor in its allocation decisions.

"In Saudi's case, our constructive view is based around the country's supportive economic fundamentals. The results of the kingdom's far-reaching economic and social reform agenda are starting to show. With its budget deficit significantly reduced, and despite record budget expenditure planned for 2018, we are of the view that the overall economic fundamentals continue to improve," said Bassel Khatoun, managing director, frontier and MENA at Franklin Templeton emerging markets equity, Franklin Templeton Investments, Dubai. "This is now being reflected in corporate earnings, while valuations also remain attractive in specific pockets of the market."