Product Panel: Invesco’s Saudi ETF

In June last year, Invesco became the first EFT provider to take advantage of the inclusion of Saudi Arabia in MSCI’s Emerging Market index and in the intervening months the ETF has grown to be the largest fund zeroing in on the country at $351m.

Gary Buxton, head of EMEA ETFs at Invesco, said recently that the company has seen strong client demand for this ETF mainly because of the major reforms the Saudi authorities have undertaken intended to improve growth, diversify away from hydrocarbons and to make the country into an epicentre for global trade.

The reforms fall under the umbrella term Saudi Vision 2030 and are intended to reduce the economy’s dependency on government funding and oil exports. A further government objective is the potential for the state-owned oil giant Saudi Aramco to IPO this year, a move which could raise up to $100bn, making it the largest IPO in history.

We put the fund in front of the Product Panel to take a look at the constituents of the fund, assess its progress to date and judge what its appeal might be to investors looking for the broadest exposure to emerging markets.

Peter Sleep, 7IM

This ETF is already a commercial success for Invesco. Saudi is shortly going into the MSCI EM benchmark in two tranches where it will have a final weighting of about 2.8%. The entry into the MSCI EM index is clearly attracting a certain amount of interest from investors, some of whom may hope to front run the index inclusion. The ETF itself is a synthetic or swap-based, which seems to be less of a stigma than in the past. For those interested in such things, the ETF is collateralised with a basket of liquid equities that seems to be biased towards US tech stocks. This can change rapidly though. The index is not particularly well-diversified, as might be expected, and could become more concentrated if the long-awaited IPO of Saudi Aramco finally happens. At present though, there is a heavy weighting to financials and materials, which makes up 80% of the index. This may make the index quite volatile; generally the biggest contributors to volatility in any index are these sectors. In order to stay in line with UCITS guidelines the largest company is capped at 35% of the index and there is a 20% cap for any other index constituent. Such constraints are not unusual in the index world. The cost of the ETF is 50bps plus a 20bps swap fee. Fully-priced but given this is the only Saudi UCITS ETF on the market, that is fair enough.

Oliver Smith, IG Portfolios

Allocations to individual EM countries have increasing appeal due to the dominance of China , which has a 30% weight in the MSCI Emerging Markets Index. Correlations within EM countries remain low: a political event in Indonesia will have no impact on Saudi Arabian equities, whereas the US and UK will sell off together, adding to the attraction. Promotion to the MSCI EM index has seen Saudi become increasingly more mainstream (and richly valued), but investors should be aware that the top three stocks make up 42% of the index, which will naturally limit the exposures a portfolio manager can take. The attempt to diversify away from oil will take many years, and it seems unlikely that the shape of the index will change much in the near term. From a retail investor’s perspective, markets move in and out of fashion. Turkey was in the headlines last year, which led to high volumes in the iShares MSCI Turkey ETF (ITKY). Interest in Saudi may be less fleeting, but it will take many years to become a core part of an investor’s portfolio.

James McManus, Nutmeg

Single country emerging markets can often be much more expensive to trade than the wider EM broad index products, and typically have much smaller secondary markets for the ETF. This means investors will increase the need to create & redeem ETF units in underlying assets that can be expensive to trade in their own right. It is also potentially more expensive for liquidity providers to hedge single country exposures, and there are often higher costs associated with custody and administration adding to the cost of execution. It’s important for investors to understand the local market dynamics when taking single country EM exposure. In the case of Saudi Arabia for example, the local market is open Sunday through Thursday between the local hours of 10am and 3pm. A large trade Thursday afternoon in London would therefore result in a long period before a liquidity provider could cover their position and is likely to be significantly increase cost. Investors need to fully assess costs and ensure that this is factored into their investment view & strategy when investing in single country EM funds. MSCI EM inclusion is a watershed moment for the Saudi stock market, given it will become one of the 10 largest country holdings in the MSCI Emerging Markets index by market capitalisation. Ahead of the first round of inclusion activity in May, investors of all types may see the Saudi ETFs as providing an efficient and low-cost way to gain this exposure.

Nicolas Rabener, Factor Research

Invesco’s MSCI Saudi Arabia UCITS ETF has granted investors access to a stock market that has been inaccessible to most. Trading Saudi stocks is difficult for foreigners, which explains the synthetic index replication and associated 20 bps swap fee that needs to be added to the 50 bps management fees. The MSCI Saudi Arabia index caps the largest stock weight at 35% and next at 20%, perhaps in anticipation of the gargantuan Aramco IPO. The ETF has gathered $320m in AUM and is likely supported by the strong performance of the Saudi stock market, which is trading at a three-year high. Investor interest in Saudi Arabia will remain elevated given the inclusion in MSCI’s emerging benchmark index that is expected in June 2019. Theoretically, single-country emerging market ETFs are highly attractive products given the cheap access they provide. However, emerging markets are highly cyclical and in reality most investors tend to chase performance, which frequently results in investors buying country exposure at peak levels. In the case of Saudi Arabia a collapse of the oil price, a failure to transform their economy, further wars in the Middle East, or a change in regime are all risks that can quickly turn investor sentiment negative. Selecting a diversified emerging market ETF is likely a better approach to benefit from the cheaper valuations and higher growth of emerging markets.

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