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Saudi Arabia’s inclusion in the MSCI developing-economies equity benchmark has failed to pull in active emerging-market funds because of high valuations and reputation risks, an analysis by Copley Fund Research showed.

The Saudi Stock Exchange (Tadawul) – the region’s largest – completed the second and final phase of joining the MSCI Emerging Markets Index, with its weighting set at 2.8 per cent, at the end of August. Stocks listed in the kingdom will also be included in other indexes, and Tadawul says it has attracted billions of dollar in recent months.

However, the stocks have found little love from active global emerging markets funds, 85 per cent of which have yet to invest any money at all, Steven Holden at Copley Fund, analyzing monthly filings from 193 such funds with a total of about US$350-billion in assets under management.

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One reason investors wanted to keep their distance was the killing of journalist Jamal Khashoggi by Saudi operatives in the kingdom’s Istanbul consulate a year ago, Mr. Holden said.

“High valuations, a relatively small investment universe and reputation risk a year on from the Khashoggi debacle are of foremost concern for investors,” Mr. Holden said.

Global emerging funds remain starkly underweight in Saudi assets, with an average holding of just 14 basis points, the biggest underweight among developing countries after China and Hong Kong, Mr. Holden said.

MSCI upgraded Saudi Arabia from “standalone” to “emerging” market in June, 2018, and concluded the process at the end of August.

More than US$1.8-trillion of assets were benchmarked against MSCI’s emerging market indexes by June, 2018, the index provider said. This would include passive as well as active investments.

The Saudi benchmark enjoyed a stellar start to the year, climbing more than 20 per cent in the first four months of 2019.

However, escalating trade tensions, unsteady oil prices and rising geopolitical risks have weighed heavily on the market since then. The index is now up just 1.4 per cent since the start of the year. MSCI’s Saudi domestic index has risen 1.9 per cent over the same period. MSCI’s wider emerging benchmark added just more than 3 per cent.

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An attack on key Saudi oil facilities mid-September, sharply highlighting the kingdom’s economic vulnerabilities, roiled Saudi markets.

“There are certain geopolitical risks in Saudi Arabia and we see that with the attack on the oil installation,” said Marshall Stocker, a portfolio manager at U.S.-based investment-management firm Eaton Vance. The jury was still out on what effect the kingdom’s reform plans would have, he added.

Index provider FTSE Russell is also adding Saudi to its emerging and global equity indexes in a year-long, five-step process set to conclude in March. Its weighting will be 2.86 per cent in the emerging and 0.31 per cent in the global benchmark.

Index inclusion and foreign investor cash will also be key to Riyadh’s plans to sell about 5 per cent of its oil giant Aramco in an IPO and reinvest the proceeds in new industries.

In a filing at the end of August, Tadawul said foreign investors had accounted for a fifth of trading activity in the first seven months of the year. In September, foreigners bought a net 5.69 billion riyal (US$1.52-billion) of stocks, Tadawul added.

Looking at the individual stocks listed, Mr. Holden found that Al Rajhi Banking & Investment Corp. has emerged as the least unpopular. U.S. financial institutions TIAA CREF and USAA and asset manager Robeco all bought into the stock over the past six months.

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