Unpacking the Saudi ETF

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January 5, 2025

The recent debut of two exchange-traded funds (ETFs) that incorporate "Saudi" in their names has opened a new gateway for domestic investors looking to access the Saudi Arabian capital marketThe initial trading days saw these ETFs soaring by more than 20%, with a "T+0" trading mechanism further fueling market enthusiasm among investors.

Saudi Arabia, renowned for its vast oil reserves and as home to the world's largest oil fields, doesn't have ETFs heavily weighted towards oil stocks as one might expectDespite the country's wealth from oil, the top-weighted stocks tracked by these Saudi ETFs reflect a broader diversification.

With its abundant energy resources and the government's ambitious "Vision 2030," a long-term economic reform plan, Saudi Arabia is rapidly becoming a hotspot for global investment

Investors are keen on the potential opportunities emerging from the kingdom’s strategic push toward economic diversification and modernization.

Analyzing the newly listed Saudi ETFs reveals substantial insights into the underlying mechanics of the Saudi capital market and the opportunities that lie therein.

A Stunning Debut

Since their launch, these two Saudi ETFs have emerged as the most captivating offerings in the public equity ETF space.

The trading volume reflects this excitement, with the ETFs managed by Southern Fund and Huatai-PB Fund collectively attracting over 50 billion RMB in the past two weeks

According to Wind data, from July 16 to August 1, the Southern Fund's Saudi ETF recorded a transaction volume of 34.154 billion RMB, trailing only the CSI 300 and SSE 50 ETFs in the market, while the other ETF managed by Huatai-PB saw over 20 billion RMB in transactions.

Thanks to the cross-border nature of these ETFs and their T+0 trading format, investors can freely buy and sell on the same day, which has resulted in a staggering turnover rateThe accumulated turnover rates for the ETFs from July 16 to August 1 were 3504% and 2130%, the highest among all equity ETFsNotably, the turnover rate on the inaugural trading day exceeded 300% for both.

The ability to trade these Saudi ETFs on the same day has significantly raised retail investors' trading sentiment

Reports surfaced of individual investors hitting up to 36 trades in a single day, with one investor showcasing an impressive profit of nearly 2000 RMB with just a 25,000 RMB investment within that daySeveral others demonstrated their abilities to "day trade," with one highlighting a remarkable 400 million RMB trade generated by only 40,000 RMB.

However, this meteoric rise comes with its own set of risks, particularly regarding the high premium on these ETFsIn the initial two trading days, the ETFs surged by over 20%, while the Saudi All Share Index (TASI) experienced a meager rise of less than 2%. In response, both Huatai-PB and Southern Fund issued multiple warnings regarding the risks associated with these premiums, urging investors to proceed cautiously to avoid substantial losses.

Fortunately, the initial premium did not sustain for long, with the ETFs retracting sharply after two days of strong gains

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From July 18 to August 1, both ETFs dropped by over 10%, and by the end of trading on August 2, their maximum premium rate had dwindled to merely 2.64%. Experts refer to this phenomenon as a "premium correction" reflecting a return to rationality in investment.

The introduction of these Saudi ETFs marks a significant opening for domestic investors into the Saudi capital market, albeit with distinctive features.

According to fund contracts, these ETFs track the FTSE Saudi Arabia Index through investments in the Southern Eastern Arab ETF, thus achieving their investment objectives.

This dual-listing approach raises the question—why adopt such a structure?

A primary reason is that entry into the Saudi capital market remains relatively restrictive

For most domestic investors, direct investment into the Saudi stock market presents significant challengesDespite recent relaxations on foreign investment restrictions, the "Qualified Foreign Investor Program" imposes strict requirements, limiting eligible investors to a small fraction.

The FTSE Saudi Arabia Index is designed with Qualified Foreign Investors (QFI) in mind, and its constituent stocks do not include those companies barred from foreign investmentFurthermore, the QFI designation also applies limitations on foreign ownership, weighing stocks by the lower of their free float and foreign ownership limits.

Financial Developments

Although Saudi Arabia is integral to the global oil industry, the index tracked by the Saudi ETFs features a limited representation of oil-related stocks

The FTSE Saudi Arabia Index comprises a variety of medium- and large-cap publicly listed companies, which some industry experts liken to a local version of the CSI 300 Index.

This index is heavily weighted towards the banking sector, with over half of the top ten stocks being banksThe top weight comprises the world's largest Islamic bank, Al Rajhi Bank, the largest bank in Saudi Arabia, the National Bank of Saudi Arabia, and other high-weighted companies including Aramco, the fourth largest company by market value globally, alongside the Saudi International Power and Water Company and the Saudi Basic Industries Corporation.

From a sector perspective, financials dominate the FTSE Saudi Arabia Index, accounting for 41.6%. Some analysts suggest that it resembles a "dividend index" similar to those in the Chinese market.

Half of the top ten components in the TASI index are also comprised of banks

Firms like the National Bank of Saudi Arabia and Riyad Bank have received "buy" ratings from Goldman Sachs, and Wall Street analysts highlight the financing opportunities resulting from "Vision 2030" expenditures for the Saudi banking system.

While promoting financial industry growth, Saudi Arabia is simultaneously accelerating the opening of its financial services sector to international stakeholders.

In 2021, the Saudi Central Bank launched an open banking initiative to bolster the development of its financial sector, seeking to establish Saudi Arabia as a "global fintech center." Subsequently, the bank rolled out various regulations to enhance foreign investor engagement within the finance sector.

In this environment, Goldman Sachs could become the first Wall Street bank to receive approval to establish a regional headquarters in Saudi Arabia

According to Bloomberg, the investment bank has secured permission from the Saudi Ministry of Investment to set up its base in Riyadh.

Additionally, the Saudi Public Investment Fund (PIF) has announced partnerships with major Chinese financial institutions, aiming to boost capital flows between the two countries.

Standard Chartered Bank started its operations in Saudi Arabia in 2021 and is looking to expand its footprintThe bank’s CEO for Saudi Arabia projects a doubling of their business in the coming years.

Emerging Opportunities

The fervor for Saudi ETFs among investors stems from perceived opportunities associated with Saudi Arabia's transformative economic initiatives.

Saudi Arabia stands as the world's largest oil exporter, with an economy historically reliant on the petroleum industry and government revenues heavily dependent on oil exports, as seen when from 2009 to 2014, oil-related revenues consistently comprised over 85% of government income.

This heightened dependency has made the Saudi economy vulnerable to fluctuations in international oil prices, compounded by shifts in energy demand and production structures, prompting a resolute commitment to diversify its economy.

Crown Prince Mohammed bin Salman candidly stated, "Oil once provided us with revenues far exceeding our needs

However, with the slowdown in oil output growth and a rapidly rising population, oil cannot satisfy all our demands anymore."

In 2016, Saudi Arabia unveiled the "Vision 2030" blueprint, delineating its goal to position itself as a pivotal player in the Arab and Islamic world, a global investment powerhouse, and a major international hub connecting Asia, Europe, and AfricaThis plan features 96 distinct strategic goals and a suite of ambitious reforms aimed at multiplying non-oil revenue by more than six times and doubling foreign investment.

Now, as "Vision 2030" enters its second half, recent reports from the National Industrial Development and Logistics Program indicate that Saudi Arabia's diversification efforts have reached vital milestones, achieving a non-oil economic output of $453 billion, which now constitutes 50% of the nation's GDP, marking a 74% increase from 2022.

This transition has catalyzed a myriad of investment opportunities within Saudi Arabia's capital markets

For instance, Saudi Aramco's IPO raised $256 billion, marking the highest globally, thus drawing global investors’ attention to the Saudi Stock Exchange, which is the only exchange in the country for trading stocks, bonds, ETFs, and derivatives across various sectors, including Energy, Finance, Materials, and Telecommunications, with Aramco playing a key role.

Economists highlight that Aramco's listing is pivotal for the "Vision 2030" objectives, representing a significant privatization effort, providing cash flow to finance governmental restructuring efforts.

Prior to Aramco's IPO, Saudi King Salman declared that the proceeds would be allocated to the PIF to fuel investments in overseas projects and stimulate domestic economic growth.

Another crucial economic engine lies in foreign direct investment (FDI). According to the Saudi Investment Authority, last year the country attracted 19 billion Riyals in FDI, reverting to levels seen before the pandemic.

To lure foreign investors, Saudi Arabia announced the creation of four new economic zones in Riyadh, Ras Al-Khair, Jazan, and King Abdullah Economic City, alongside a competitive package of incentives including tax breaks.

A New Direction

In addition to financial services, Saudi Arabia is focusing on establishing itself as a regional headquarters hub.

By November 2022, Saudi Arabia had issued licenses for local headquarters to 180 firms, and in March 2023, Amazon Web Services announced plans for a $5.3 billion investment to establish data centers in Saudi Arabia by 2026. Microsoft, too, has committed to expanding its investment in the country, particularly in data center development and AI technology.

This reflects Saudi Arabia's aspirations during its digital transformation journey

The head of the PIF stated that leveraging the nation’s abundant energy resources and financing capabilities could position Saudi Arabia as a leading hub for AI activities outside the United States.

Moreover, Saudi Arabia is committed to energy reform by developing clean and renewable energy sources, enhancing the diversity of its petrochemical energy structureOn July 16, the PIF announced agreements with three Chinese enterprises to establish joint ventures focused on localizing the production and assembly of wind and solar related equipment.

The kingdom aims to derive 50% of its electricity from wind and solar by 2030 and reach net zero emissions by 2060, including significant investments in nuclear and hydrogen energy.

Looking forward to sector opportunities, Bai Wenxi, vice-chairman of the Chinese Enterprise Capital Alliance, stated that the PIF’s investments in Chinese renewable energy firms demonstrate Saudi Arabia's proactive approach to promoting a green transition and economic diversification

The market is poised for a continued focus on financial services along with growing investments in renewable energy and other sectors.

However, he cautioned that potential drawbacks of investing in Saudi Arabia include geopolitical risks, market entry restrictions, and the regulatory environment surrounding foreign investmentsInvestors must weigh these factors against their risk tolerance and investment objectives.

Zhi Peiyuan, an advisor at the School of Management, China University of Mining and Technology, emphasized that compared to other emerging markets, Saudi Arabia's capital market benefits from substantial oil wealth and the government’s steadfast commitment to economic reform, providing a relatively stable investment environment