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Emerging market ETFs look light on Saudi engagement

The Kuwait Boursa trading hall in Kuwait city. ETFs are more closely aligned to weightings of Kuwait, Qatar and the UAE Reuters/Stephanie McGehee
The Kuwait Boursa trading hall in Kuwait city. ETFs are more closely aligned to weightings of Kuwait, Qatar and the UAE
  • Some ETFs have no Gulf exposure
  • Other GCC countries better appreciated
  • Emerging market sentiment improves

Exchange-traded funds (ETFs) that track the MSCI Emerging Markets Index are underexposed to Saudi Arabia but are more closely aligned to weightings of the other three Gulf countries included in the benchmark, an AGBI analysis shows.

The inclusion of four Gulf countries in the MSCI Emerging Markets Index over the past decade has led to multibillion-dollar inflows into companies on the quartet’s bourses from ETFs that track the benchmark.

The MSCI Emerging Markets Index spans 24 countries, including China, South Korea, India, Brazil, Mexico and South Africa.

Among Gulf countries, Saudi Arabia’s weighting is the biggest, at 4.4 percent, as of February 15, followed by the United Arab Emirates (1.3 percent), Qatar (0.9 percent) and Kuwait (0.8 percent).

“Equity ETFs seek to fully replicate the underlying index exposure,” said Todd Rosenbluth, head of research at VettaFi, a company specialising in ETF analysis.

“While some emerging market stocks are less liquid, managers want to closely align with the performance of the benchmark. Some stocks might not be inside [the ETF] but the sector/country exposure should be very similar. Investors expect returns that are the same as the index minus the expense ratio of the fund.”

An AGBI analysis of seven leading ETFs that have combined assets under management (AuM) of $131 billion and which track the MSCI Emerging Markets Index show variance, although for some that may be due to the ETFs themselves creating a custom benchmark that differs slightly from the MSCI weightings.

Overall, the average Saudi weighting among the seven MSCI index-based ETFs is 4.27 percent, 14 basis points (bps) below the kingdom’s benchmark weighting. 

For the UAE, the funds are on average 3 bps overweight. They are 1 underweight on Kuwait and equal weight on Qatar.

The seven ETFs combined hold $9.5 billion in Gulf equities. Of these, $5.5 billion is in companies from Saudi Arabia, $1.6 billion in UAE equities, and $1.1 billion in each of Qatar and Kuwait.

Active funds also track the MSCI emerging market index but have the freedom to under or over-invest in each constituent country. 

For example, none of Lazard Emerging Markets Equity Portfolio’s $2.7 billion of AuM is in Gulf stocks, while the JPM Emerging Markets Income Fund has 2.4 percent of its $1.2 billion portfolio in Saudi Arabia and zero in each of Kuwait, Qatar and the UAE.

Similarly, the Avantis Emerging Markets Equity ETF is actively managed and none of its $5 billion of assets is in Gulf stocks.

There is potential for greater allocations to the Gulf, as well as increased investments into both ETFs and active funds that track the MSCI and similar benchmarks, as emerging market sentiment improves.

Lazard Asset Management wrote in a note in January: “We believe emerging markets remain one of the most mispriced asset classes globally. Relative to developed market equities, valuations remain generally inexpensive.”

There is also the FTSE Emerging Index, which had $120 billion of AuM tracking it at the end of 2022. Much of this is from the Vanguard FTSE Emerging Markets ETF, which has $98 billion of AuM and is slightly underweight in the four Gulf markets. Nonetheless, it holds $8 billion of Gulf stocks.

Emerging markets are priced at discounts of 30 and 40 percent respectively versus developed markets and United States equities, Lazard estimates.

“Over time and barring any adverse geopolitical or economic events, we would expect this valuation discount to narrow, driven by a combination of stronger earnings growth,” Lazard wrote.

“Much capital has left emerging markets in recent years, and many parts of the [equity] asset class remain markedly under-owned despite being attractively valued, with high and improving economic growth and financial productivity, such as return on equity, free cash flow yield, and dividend yield.”

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