Why Saudi & Argentina ETFs Will Rally

Last week, investors in Saudi Arabia equities rejoiced after the country was upgraded to emerging markets status by index provider MSCI. The move will bring an important new constituent into the widely benchmarked MSCI Emerging Markets Index following a two-step inclusion process in May and August 2019.

"This decision follows the implementation in the Saudi Arabia equity market of a number of regulatory and operational enhancements which effectively increased the opening of the market to international institutional investors,” said MSCI. “The proposal for inclusion received the support of the vast majority of international institutional investors that participated in the consultation."

Following its inclusion in August 2019, on a pro-forma basis, Saudi Arabia will account for 2.6% of the emerging markets index, making it the eighth- or ninth-largest emerging market, "just behind Russia and on par with Mexico," according to analysts at UBS.

Investors Buying In

With $1.9 trillion benchmarked to the MSCI Emerging Markets Index, the upgrade to Saudi Arabia's status will certainly lead to more investment dollars making their way into the country's stock market. In fact, it's already begun.

The iShares MSCI Saudi Arabia ETF (KSA) has raked in nearly $234 million in new money this year, making it one of the fastest-growing ETFs of 2018. Assets in the fund now stand at $264 million, compared with a mere $14 million at the start of the year.

To top it all off, KSA has a year-to-date return of 20%, putting it among the best-performing single-country ETFs of 2018.

Even before the MSCI announcement had been made, investors were taking heed of the market-friendly reforms that Crown Prince Mohammed bin Salman is making, and rewarding Saudi stocks. By the time it released its decision last Wednesday, most investors had already expected MSCI to upgrade Saudi Arabia to emerging market status—it wasn't much of a surprise.

Buy The Announcement

If that's the case, is all the good news already priced into Saudi Arabia stocks?

Not necessarily.

Analysts at UBS say that the historical patterns of other countries entering the MSCI Emerging Markets Index suggest that more gains could be in store for Saudi Arabia and Argentina—the other country that MSCI said will graduate into the Emerging Markets Index next year.

According to their analysis, "the typical historical record is that new market entrants tend to rally (and usually outperform) on the announcement that they will join the index and then sell off when they actually join the index (implementation) around twelve months later."

In other words, "buy the announcement, sell the implementation."

The analysts said that this pattern took place in the case of Qatar and UAE, which joined the MSCI Emerging Markets Index in May 2014, as well as in the case of Pakistan, which joined the index in May 2017.
 

Will History Repeat?

While acknowledging that the Saudi market already has discounted some of its promotion into the index, UBS analysts still believe further near-term gains are likely.

Likewise, Argentina—a country demoted from emerging market status to frontier market status in May 2009 due to capital restrictions placed on the stock market by the government—should also receive a boost from the MSCI decision, they say.

The two largest Argentina ETFs, the $161 million Global X MSCI Argentina ETF (ARGT) and the $50 million iShares MSCI Argentina and Global Exposure ETF (AGT), are down about 17% each so far this year amid a plunging currency, widening deficits and high inflation.

The MSCI news provides "a break from the less than positive news flow that market has faced in recent months," UBS explained, while noting that "since the election of President Macri in October 2015, the new government has taken steps to lift capital controls and abolish foreign exchange restrictions."

When it's added in 2019, Argentina will only have a 0.37% weighting in the MSCI Emerging Markets Index, making it the sixth-smallest market in the index. Only foreign-listed Argentina stocks, such as ADRs, will be included in the index because of the low levels of liquidity in the domestic Argentina stock market.

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2