A clash of civilizations: are foreigners newly entering the Saudi stock market about to face a culture shock?
Seventy-year-old Saudi Arabian stock speculator Mohamed al-Otaibi says he lost hundreds of thousands of dollars in the crash of 2006, but he’s back trading again as the Arab world’s biggest bourse prepares to open to direct foreign investment.
The activities of Otaibi and many thousands like him mean there will be a clash of investment cultures when international institutions enter the $580 billion Saudi market early next year, under a plan announced by the regulator last month.
Sitting on a sofa in a trading room at Saudi financial firm Falcom in Riyadh, Otaibi shuns shares in the country’s heavyweight petrochemical firms and banks, believing they’re not volatile enough to offer quick profits.
Instead, he simply scans an electronic screen for stocks in which buy or sell orders are building up strongly. These often include cement, agriculture and real estate shares.
“I trade on spot, buy and sell on the same day. Sometimes I wait for two or three days, a week or a maximum of 20 days, and then sell – whenever I see strong orders in a certain stock.”
Saudi Arabia is one of the last major markets in the world to open up, so the reform is attracting massive interest among international fund managers. But they will face an unusual and in some ways difficult trading environment.
Activity is dominated by about 4.3 million retail investors who buy stocks straight from the market rather than going through professional fund managers. These retail investors owned a little more than a third of shares at the end of 2013, according to Capital Market Authority (CMA) data, but account for over 90 per cent of daily trading volume.
The retail proportion of trading is much higher than in most other big markets around the world, a result of the slow development of the Saudi fund management industry. In many other emerging markets, retail investors account for closer to two thirds or half of turnover, and the proportion is much smaller still in developed markets.
Saudi retail investors like Otaibi tend to take a shorter-term approach than institutional investors, chasing quick profits, dumping stocks at the first sign of weakness, and basing decisions on news headlines, rumours or price momentum rather than the long-term valuations favoured by fund managers.
This poses risks for the foreigners. One is that local investors, anticipating the entry of foreign money, may bid stocks up sharply in the next few months, making the market opening less lucrative than international fund managers hope.
Another risk is that some shares could diverge permanently from levels which foreigners consider appropriate, because the two groups of investors use such different yardsticks.
Among the Saudi investors, events such as stock splits – when a firm divides its shares into smaller units to make them more liquid, without changing the underlying value of the company – can attract demand.
“The market is short-term and many people are investing on the basis of things like stock splits which have no fundamental economic value,” said Ali Al Nasser, who manages the Duet Group’s Middle East and North Africa Horizon fund from Dubai.
“Ninety per cent of the market may not look beyond 1-1/2 or two years of future corporate earnings, while institutions like us may be taking a five-year or longer view.”
In the long term, the gap between the perceptions of retail investors and foreign institutions is likely to narrow, bringing valuations closer to what might be expected in overseas markets, Nasser said. But that process could take many years.
At present, foreigners other than citizens of nearby Gulf states are limited to buying Saudi stocks indirectly via swaps involving international banks and through a small number of exchange-traded funds – expensive and inconvenient options.
In 2013, foreigners owned just 1.2 per cent of the market via swaps, according to CMA data. The potential for their portion to rise is huge; if Saudi Arabia is added to global equity indexes, it may attract over $50 billion of fresh money from abroad in the coming years, fund managers estimate.
But by the time foreigners are allowed to buy stocks directly in the first half of 2015, bargains may be few and far between. The main stock index has already jumped over eight per cent since the market opening plan was announced on July 22.
The same pattern was seen in the United Arab Emirates and Qatar before they were upgraded to emerging market status by index compiler MSCI in May this year. Stocks soared as local retail investors bought heavily, then plunged after the upgrade took place and foreigners declined to buy at inflated prices.
Robert Parker, head of the strategic advisory group at Credit Suisse in London, said the Saudi market’s surge in the past few weeks had left relatively little value on the table for prospective foreign investors.
“You have a market which is now a bit overpriced, because all the big domestic players have decided to get in ahead of foreigners. What was a cheap market is cheap no longer.”
Nasser estimated Saudi stocks were now trading at about 16 times their projected earnings for this year – at the high end of their historical range.
Small Saudi hospital firm Al Hammadi, which listed on the market in mid-July after an initial public offer at a price of SAR28 per share, is an example of how Saudi retail investors can bid stocks up.
The health care industry, which has lagged the country’s expanding population and rising incomes, is expected to be a focus of foreign investors, so local retail investors have bid Al Hammadi shares up frantically in the last few weeks.
The stock hit a record high of SAR101.25 this week. Assuming Al Hammadi will post earnings per share of SAR2.58 this year, twice its first-half earnings, that stock price valued it at a sky-high 39 times forward earnings.
In other areas, Saudi Arabia’s retail investors may keep stocks’ valuations frustratingly low from the point of view of foreign institutional investors.
The fate of smaller-capital shares can depend on whether they happen to win the attention of prominent individuals whose actions are widely imitated by a herd of smaller investors.
“There are many prominent names that are known and closely followed by traders in the Saudi market,” said Alhassan Goussous, a financial market expert in Riyadh. “You can find this on a very large scale, mostly in speculative shares.”
Some religious scholars in the conservative country have urged investors to shun shares in companies which they see as un-Islamic in some way – for example, those with links to the media, arts or interest-bearing finance.
Then there is Otaibi’s approach, which is shared by many retail investors. It is biased against big petrochemical firms and banks because those stocks are seen as too slow-moving; this may make the stocks cheaper for foreigners to buy, but may also condemn them to long-term underperformance.
One such stock is Saudi Basic Industries Co, one of the world’s biggest petrochemical firms, which looks certain to be a major index component if MSCI eventually gives Saudi Arabia emerging market status in the wake of the market opening.
SABIC shares rose after the reform was announced but are still trading at about 13 times this year’s projected earnings, according to Thomson Reuters Eikon. That is well below more than 15 times for major U.S. competitor Dow Chemical.
Nasser said opening the Saudi market was part of a process of developing it into a bourse where institutions played a much bigger role, which valued companies in similar ways to developed markets, and which moved more in line with global trends.
Other things are needed for this shift to happen, he noted: local pension funds would have to become more active in picking stocks, and a culture in which retail investors entrusted their money to professional managers would need to develop.
“I think the market will become more institutionalised as foreign investors come in over time…but for the impact to be felt, I guess it may take three to five years,” said Goussous.