Gulf stock markets add listings, but foreign investors still skeptical

“Investing in DEWA is an investment in Dubai's future,” Sheikh Mohammed bin Rashid al-Maktoum said. The ruler of Dubai described state-owned utility Dubai Electricity & Water Authority (DEWA) as a “key pillar” of the Gulf’s financial and business hub development.

The company provides water and electricity services to the emirate’s 3.4 million people.

DEWA’s listing on the Dubai Financial Market in the coming months is part of a plan to sell stakes in 10 state-owned companies, to cash in on regional momentum. Gulf stock markets are up about 33% in 2021, some of the world’s best performance, largely boosted by a rise in oil prices. 

But a close look at the investor base reveals Gulf bourses are still a mostly closed loop, a niche market that takes a back seat in emerging market investing.

State entities, investors and wealthy citizens of the six Gulf Cooperation Council countries hold most of listed companies’ shares.

Gulf markets’ weights in mainstream indices tracking emerging markets (with the exception of Saudi Arabia) are “too small to merit much attention for an active institutional foreign investor,” said Hasnain Malik, the Dubai-based director of emerging and frontier market strategy at Tellimer, a UK-based emerging market information and data provider.

$28 billion shortfall

Foreign funds investing in Gulf markets enjoy monetary stability, as most currencies are pegged to the US dollar. Still, international investment funds are $28 billion underweight in Gulf equities, Vijay Valecha, chief investment officer at the Dubai-based financial consultancy firm Century Financial, told Al-Monitor.

Despite its inclusion in 2019 in the MSCI Emerging Markets Index,  the Saudi Stock Exchange (Tadawul) still struggles to attract foreign inflows. The trend did not reverse significantly with the listing the same year of fossil fuel giant Saudi Aramco, one of the world’s most profitable companies.

According to Tadawul’s website, foreign investors hold 9 percent of shares of companies listed on the Saudi Arabian exchange. Regulators cap foreign ownership to 49% of shares. More than half of all companies listed on the Tadawul, the Abu Dhabi Securities Exchange, and Dubai Financial Market recorded less than 5 percent foreign ownership as of early December 2021.

“This may be due to an aversion to hydrocarbon economies, concern over the speed of structural reforms, and elevated valuations,” said Tarek Fadlallah, the Dubai-based chief executive officer of Nomura Asset Management’s Middle East unit. Gulf stocks’ expected earnings in the next 12 months trade at about 30% higher than emerging-market stocks.

Gulf economies’ carbon intensity risks deterring international investors who face mounting public pressure to favor equities aligned with environmental, social and governance (ESG) criteria. For that reason, the Saudi government is preparing to sell green bonds.

But pushes to decouple Gulf economies from oil prices and develop non-oil economic sectors are yet to yield tangible results. 

Bring in diversity

“Petrochemical and banking names account for almost 60% of Tadawul’s market index weight,” Riyadh-based Al Rajhi Capital’s head of research, Mazen al-Sudairi, told Al-Monitor. 

Reforms led by Crown Prince Mohammed bin Salman seek to facilitate the emergence of new sectors, like entertainment, and diversify the economic fabric, which could offer investors more exposure to the Arab world's largest economy.

Valecha said companies currently listed on Gulf exchanges “do not truly represent” the diversity of non-oil Gulf economies, as most family-owned businesses and small and medium enterprises are not listed. Gulf governments listing more state companies will push private firms to follow suit, he said.

“The recent flurry of IPO announcements should help revive investor interest, but the next few listings will set the tone for wary foreigners,” Fadlallah told Al-Monitor.

Gulf equity markets especially lack tech stocks that have outperformed globally over the past two decades, as illustrated by stellar performances of the tech-heavy NASDAQ in the United States. The Abu-Dhabi based Arabic music streaming service Anghami shunned Gulf stock markets and went on to list on the NASDAQ. The Riyadh-based food delivery company Jahez is expected to become Saudi Arabia’s first initial public offering of a tech start-up. 

To accelerate new listings, the Abu Dhabi stock exchange proposed the Gulf’s first special purpose acquisition company (SPAC) regulatory framework to offer faster and cheaper execution. Yet, critics argue lighter due diligence and regulatory disclosures expose shareholders to more significant risks.

Faster listing is not the only challenge ahead for foreign investors entering Gulf markets. Majority-state owned companies may interest passive foreign funds, but active managers worry that state interests will “often outweigh theirs as minority shareholders,” Tellimer's Malik said.

The delisting in 2020 from the Nasdaq Dubai of DP World, one of the world's largest port operators whose global exposure attracted international capital, caught investors off guard.

Faster capital turnover

Better integration of Gulf stock markets into global cross-border financing flows would play a vital role in the economic diversification puzzle. It offers businesses an efficient vehicle to raise capital from domestic and international investors and provides a straightforward exit strategy to early-stage investors whose presence is key to funding entrepreneurial ventures.

For example, renewable energy utility ACWA Power raised $1.2 billion from investors by selling 11 percent of its existing shares during its initial public offering in October 2021. The move allowed ACWA Power’s biggest shareholder, the Saudi sovereign wealth fund Public Investment Fund, to unload shares and re-allocate capital to finance other companies.

“Listing on the Tadawul is also a key tool to force companies to adopt stricter corporate governance, which in turn benefits the Saudi Arabian economy as a whole,” al-Sudairi added.