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Death of journalist puts Saudi Arabia investing on hold

Paul McNamara doesn’t think the Saudi Arabian market will be affected by the scandal.

Allegations and theories surrounding Saudi Arabia's involvement in the death of journalist Jamal Khashoggi will keep investors' fingers firmly on the pause button when it comes to allocating to the country, managers said.

The unfolding story over recent weeks has also led the fiduciary of a $195 billion pension fund to urge major index providers to reconsider including Saudi Arabia in global indexes.

Details around Mr. Khashoggi's death inside the Saudi consulate in Istanbul are continuing to emerge. His death has made headlines, with leaders around the world issuing cautious condemnations. It also prompted a number of high-profile figures — including U.S. Treasury Secretary Steven Mnuchin and professionals from the world of money management — to shun planned participation in the Riyadh-based Future Investment Initiative conference, Oct. 23-25, and is impacting investor sentiment.

The Saudi stock market fell 7.2% between Oct. 10-14 while the story was developing, and "there was definitely a bit of panic going on," said Nick Wilson, Isle of Man-based chairman of Gulf Investment Fund PLC, which invests in listed equities in the Gulf Cooperation Council region.

The Saudi Tadawul All-share index gained 8.4% year-to-date through Oct. 26. However, for the month through Oct. 26, it had lost 2.07%.

Similarly, the Mideast-based MSCI GCC Countries index, which has a 60% weighting to Saudi Arabia, gained 12.64% for the year through Oct. 26, but was down 0.42% for the month through that date.

Mr. Wilson said investor flows also show the impact of the news on sentiment, with a reversal of the net inflows that had followed index providers' decisions to upgrade the country to emerging market status. MSCI Inc. will include Saudi Arabia in the MSCI Emerging Market index starting June 2019; FTSE Russell will upgrade the country to secondary emerging market status in its global equity set of indexes starting March 2019; and S&P Dow Jones Indices will change the country's classification to emerging market beginning in March 2019.

Pressure ramped up

The pressure on index providers ramped up Oct. 24 after New York City Comptroller Scott M. Stringer penned letters to the CEOs of FTSE Russell, MSCI and S&P DJI.

In the letters, shared with P&I, Mr. Stringer expressed concern that Saudi Arabia's inclusion would expose the New York City pension funds and other investors to "investments out of the scope of suitable markets." The $195 billion in assets across the five pension funds that make up the New York City Retirement Systems are heavily indexed, meaning the funds and other passive investors automatically would invest in Saudi Arabian equities should the country be added to the indexes. As of Sept. 30, 2017, the retirement systems reported a total of $11.45 billion in passively managed international equities, with $5.58 billion in passive emerging markets strategies, P&I data show.

The letters stated the kingdom has been implicated in the disappearance of Mr. Khashoggi.

A separate comment from Mr. Stringer, provided by the representative, said: "The disturbing murder of a journalist by Saudi Arabia demonstrates a flagrant disregard for morality as well as the rule of law. It is clear from both an ethical and fiduciary standpoint that New York City pension funds should not be invested in Saudi Arabia. To protect the retirement security of hundreds of thousands of city workers and retirees, the markets our pensions are exposed to must be financially sound and able to provide the oversight necessary for long-term stability — which is a standard Saudi Arabia has demonstrated they can't meet."

Spokesmen for MSCI and S&P declined to comment. Spokesmen for FTSE Russell did not respond to a request for comment.

Mr. Wilson said: "The recent news flow has increased the perception of risk in Saudi — concerns have been reflected in $1.07 billion of foreign outflows in (the week of Oct. 15.) That more than reverses the $1 billion in inflows we had seen since the beginning of September," he said.

Whatever the impact on flows and however the story continues to unfold, sources expect Saudi sentiment to continue to be affected.

"It's very difficult to really assess what's going on," said one emerging markets debt manager, who spoke on condition of anonymity. "There's definitely some concern amongst investors on a few different levels. … It does have implications for longer-term investment and arms deals," he said.

The source said there is added pressure given the kingdom's work to bring foreign investment into Saudi Arabia under Vision 2030 — a project to diversify the country's economy — and the Future Investment Initiative conference. There are concerns over whether this is "the right environment to attract investment into Saudi Arabia. It makes it quite difficult to justify that. Certainly, I think anyone thinking of buying into Saudi is sitting on the fence now at least," he said.

Paul McNamara, an investment director and lead manager on GAM's emerging market bond and currency long-only and hedge fund strategies, based in London, highlighted fundamentals supporting the Saudi market.

"It's very hard to damage a country with that much oil and a strong balance sheet. I don't expect much impact, but the investor approach of keeping (Saudi Arabia) on a long leash and not (having) major holdings is probably a sensible way to proceed," he said. Mr. McNamara has no exposure to Saudi Arabia.

"All of these economies — Saudi, the UAE, Qatar — are treated in pretty much the same way; (investors) don't look at the GDP per capita or overall wealth, (but) treat (them) as slightly exotic plays on commodity or energy prices. Investors always treated these countries with a certain amount of suspicion," and this reinforces that sentiment, Mr. McNamara said.

And even though a market sell-off would usually present an opportunity to stock pickers, Mr. Wilson agreed now is not the time to invest. He also said "the larger investment community will hold back from building any meaningful positions until the current situation clarifies.

GIF is underweight Saudi for a number of reasons, with a 39% position vs. 62% in its benchmark.

Looking for fallout

Some money managers are waiting to see if the fallout affects Saudi Arabia's economy.

"In assessing those tricky political situations, we always look through the prism of economic impact," said Yerlan Syzdykov, global head of emerging markets at Amundi in London.

In difficult political situations, executives at the firm try not to think about that aspect of investing. "In the same vein we're using that approach to Saudi Arabia, which caught us by surprise. We are assessing the political situation in respect of the impact it may have on the economic development of the country."

A number of money managers contacted for this story — including those that had previously discussed opportunities in Saudi Arabia following the announcement of its inclusion in global indexes — either declined to comment or did not respond to a request for comment.