Indexing The Arab World

January 31, 2006

Can indexes help open an oil-rich region to foreign investors? MSCI captures a rapidly emerging market with its Gulf Cooperation Council indexes.

 

MSCI built its name in indexing by offering international benchmarks to U.S. investors. Today, their flagship EAFE (developed markets) and Emerging Markets indexes serve as benchmarks for countless billions of U.S. dollars, including two of the fastest exchange-traded funds in the world. For many, MSCI serves as a trustworthy guide to foreign lands, promising to provide diversified, balanced exposure to markets investors know little about.

In January, however, the company took things a step further, rolling out a new index series tied to a market in which, for the most part, U.S. investors can't even invest.  The new MSCI Gulf Cooperation Council (GCC) indexes track six countries in the Arabian Gulf - Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Bahrain and Oman - which are either entirely closed (in the case of Saudi Arabia) or partially closed (in the case of the other countries) to Western investors.[1]

"This region has become very large - the markets, both economically and from a capital markets view have exploded," said Khalid Ghayur, managing director and global head of research at MSCI. "The stock markets have risen 500-600 percent in the past five years, and there's a lot of interest in this region, both by domestic investors and international investors.

The "both" is critical. MSCI actually rolled out two complete suites of GCC indexes: One targeted at the domestic market in each country, and one that adjusts weights to take into account foreign ownership limits.

"We created these indexes primarily from the perspective of a domestic investor," said Ghayur. "But they're also a tool to help international investors prepare for eventual investment in the market.  They can start to do the research, understand the industry composition, etc., so that they'll be prepared when and if the markets open up."

That moment can't come a second too soon - in fact, it may already be a bit too late - as the region has delivered absolutely blistering performance over the past five years, rising on the backs of swelling oil profits and strong banking activity. That blistering return laid the groundwork for MSCI's domestic GCC indexes, and the truth is, the indexing company may do well even if the foreign market never materializes.

"The liquidity in these markets post-September 11th has been extremely high," said Ghayur. "After September 11th, these markets haven't seen the outflow of funds overseas, which was the case before. The funds are being invested domestically."

Ghayur said that the demand for robust benchmarks in the region was "tremendous," and that financial institutions are eager to launch mutual funds benchmarked against indexes of international caliber. Local financial houses already provide indexes in the region, but none of them come with the scope or branding of MSCI.

"It is our belief and our hope that these indexes will become the standard in the region, and that they'll be used as the basis for investment products," said Ghayur.

If that happens, any overseas interest will be icing on the cake. 

MSCI is following a similar approach in China, where it launched an A-share (domestic share) index targeted at the growing market of Chinese domestic investors. Foreign investors, however, are keeping a close eye on the Chinese A-share market, as China is expected to eventually open up the A-share market to foreign investors.

 A Look At The Indexes

The index series actually features seventeen separate indexes: six covering each of the countries from a domestic perspective; six adjusted for what MSCI calls the "foreign inclusion factor," which adjusts the holding weights based on foreign investor limitations; and five regional indexes:

  • GCC Countries Index, weighting all six countries into a composite index
  • GCC ex Saudi Arabia, representing the portion of the index investable by foreign investors
  • MSCI Jordan, Egypt and Morocco
  • MSCI  Arabian Markets (GCC+Jordan, Egypt and Morocco); and
  • MSCI Arabian Market ex-Saudi Arabia.

Saudi Arabia dominates the full GCC index, with a 56.9 percent weight, followed by the United Arab Emirates (21.3 percent) and Kuwait (11.4 percent).

When adjusted  for foreign ownership restrictions, however, the weights change dramatically - as differing levels of restriction boost the weight of the more liberal countries in the index.  Kuwait and the United Arab Emirates dominate the foreign-adjusted index, with 39.9 percent and 40.5 percent weightings, respectively.

 

Country Weights - Domestic and Foreign ex-Saudi

 

GCC Domestic

GCC ex-Saudi Arabia (foreign-inclusion factor adjusted)

MSCI Saudi Arabia Index

58.8%

-----

MSCI UAE Index

16.7%

39.8%

MSCI Kuwait Index

16.5%

39.9%

MSCI Qatar Index

6.5%

16.6%

MSCI Bahrain Index

0.7%

1.8%

MSCI Oman Index

0.8%

1.9%

Float-adjustment also has an enormous impact in this region, as, generally speaking, the largest companies are at least partially government-owned. The float-adjusted takes a 43 percent bite out of the region's $1.1 trillion regional market cap. The index also adjusts for minimum liquidity and minimum market caps, which further narrows the investment opportunities.

Because of these adjustments, MSCI tweaks the float-adjusted weighting to ensure that the indexes remain in-line with the broader industry representations: Securities are selected so that the industry group representation is at least 85 percent of the true, full market breakdown.

Somewhat surprisingly, pure energy companies actually have very little weight in the index - just 3.1 percent in the domestic GCC, and 4.7 percent in the foreign index. The reason is that the oil companies tend to be state owned, and therefore not publicly traded. Instead, the domestic regional index is dominated by Materials (34.5 percent) and Finance (30.5 percent), while the foreign regional index is dominated almost entirely by banks (68.9 percent). Still, many of the Materials companies operate on the fringe of the petrochemical industry - in plastics, oil engineering, chemicals, or fertilizers - and the banks benefit greatly from the oil-funded wealth in the region.

Could These Indexes Help Open The Market?

Because these regions offer limited investment opportunities for foreign investors, and because they don't attract the kind of financial coverage that China and India garner, these indexes will no doubt operate below most investors' radar.  But the region is booming - Egypt was the best performing country market in the world in 2005, up 154

percent - and oil isn't getting any cheaper. 

Total Returns, in U.S. Dollars - As Of 1/18/2006

 

1-Month

3-Months

6-Month

Since 6/1/05

Saudi Arabia

5.1%

13.2%

31.9%

39.6%

United Arab Emirates

-1.4%

-7.2%

16.0%

28.2%

Kuwait

4.6%

5.6%

20.0%

25.6%

Qatar

-10.1%

-14.8%

-0.9%

14.4%

Bahrain

-1.9%

-14.2%

-22.3%

-26.1%

Oman

3.1%

-15.8%

-14.7%

-8.4%

GCC Countries

2.7%

5.2%

27.4%

32.2%

GCC ex Saudi Arabia

-0.5%

-4.2%

13.3%

23.3%

Arabian Markets

3.4%

6.2%

27.4%

32.7%

Arabia Markets ex-SA

1.5%

-0.8%

15.7%

25.8%

Indexes that reveal these dramatic returns could easily boost investor interest in the region, which could help slowly open the doors to foreign investment; eager capital has a way of doing that. Ghayur said that it was "only a matter of time" before the region opened up further to investors, although he said that the decision is in the hands of local governments, and that many factors are in play.

For now, most of us will be left to watch: Because of the foreign ownership restrictions, MSCI won't even include these indexes in its Emerging Markets index.  At least not yet…


 

[1] . Non-Saudi GCC investors can invest in Saudi Arabia, subject to limits.

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