One of the most standout alternative investment stories to emerge from Saudi Arabia over the past two years is the growing interest in initial public offering (IPO) funds as investment vehicles. The Kingdom has long been a centre of mutual fund activity, thanks to the size of the domestic market and the community of sophisticated investors that interacts with it.
A report published in 2015 by the Jeddah Chamber of Commerce and Industry (JCCI) showed that in 2014 the Kingdom held $27.4bn worth of assets under management (AUM) by investment and mutual funds, significantly ahead of the second-placed jurisdiction in the MENA region, Morocco, which posted AUM of $14.6bn. Within the GCC region, Saudi Arabia’s AUM outstrips neighbouring financial centres like the UAE, with its $1.5bn in AUM, and Bahrain’s $1.2bn of managed assets. By 2015 there were some 266 funds licensed to operate in the Kingdom, distributed across 40 fund managers, representing a 20.9% expansion on the 220 funds recorded in 2013.
The relatively small scale of investment capital circulating in the Kingdom’s fund market is one of the reasons that Saudi Arabia is often characterised as the region’s sleeping giant, traditionally garnering few headlines in the financial press yet possessing formidable financial weight. The Kingdom occupies a more prominent position in the economic landscape these days thanks to its well-publicised efforts at economic reform and the opening up of its capital market to foreign investors in 2015.
While the fund expansion of recent years has encompassed a wide range of instruments – some with a local focus on equities, bonds, money markets and real estate, and others targeting international opportunities in similar segments – the IPO fund was the star performer in 2015 in terms of new additions. The number of IPO funds licensed to operate in the Kingdom more than doubled in 2015, with a record 16 established over the year to bring the total to 27, according to Bloomberg. Together they manage around SR5bn ($1.3bn), which represents a significant rise on the SR2bn ($533m) recorded at the end of 2014. These open-ended instruments, specialising in IPOs but having a broader remit, have never been more popular, and a host of firms regulated by the Capital Market Authority (CMA) – from international banks to boutique investment houses – have moved into the IPO fund space to capitalise on the new trend. Some of the more prominent international players to step into the market of late include the Ashmore Group, the large UK-based investment manager, which is itself a constituent of the FTSE 250 index, and Muscat Capital, the investment banking arm of Oman’s largest lender. Domestic participants include some of the biggest names in the market, such as Saudi Hollandi Capital.
A number of factors combine to account for the appetite for this variety of investment vehicle. The Kingdom’s IPO market has always been an attractive one, thanks in large part to the government’s long-held view that a public offering is a useful means to distribute wealth throughout the population. In order for capital to flow into the accounts of retail investors in this manner; however, IPOs must be priced in such a way as to ensure a yield for purchasers. While some private companies engage in standard book-building exercises, historically many IPOs of state-owned entities or companies with strong links to the state, such as those with fuel contracts with Saudi Aramco, come to market via a more managed mechanism at prices below true market value. The discount this practise engenders makes these IPOs attractive propositions to all types of investor. For example, the 2014 offering of National Commercial Bank was priced at an 18.8% return on equity, compared to a 13.4% average for the banking sector, according to Zawya Funds Monitor. Demand for the IPO was understandably high, and when the shares were listed, they climbed in price to hit the 10% daily limit on three consecutive trading days.
A Stabilising Measure
However, while the government’s policy with regard to pricing provides an encouraging backdrop to IPOs from an investor’s point of view, the surge in IPO funds seen in 2015 is largely thanks to a fresh regulatory stance on the part of the CMA, which has shown an increasing desire to quell the volatility of the market in recent years. One of the motivations cited for its decision to allow institutional foreign investors to partake directly in equities trading on the Saudi Stock Exchange (Tadawul) was the stabilising effect this would have on the market, which has often been overly influenced by the sentiments of an active cohort of retail investors.
While the CMA has not explicitly limited asset managers from partaking in IPOs by any other means – draft rules published in January 2016 had yet to be enacted as of mid-2016 – statements made by market participants to the press in 2015 suggested the regulator was strongly encouraging them to establish funds as a means to do so.
In May 2015 the CMA gave the clearest indication yet of its intentions regarding IPO activity on the exchange. Announcing that it planned to increase the proportion of IPO shares directed to institutional investors, the CMA explained that “increasing institutional investors’ strategic ownership in listed companies supports governance practices and increases transparency, a target that is hard to achieve amid the dominance of retail investors in the market”. However, the regulator intends to safeguard the ability of retail investors to access IPO deals by ensuring that 90% of the share allowance taken by institutional investors will go to firms that cater to retail investors.
The regulatory reforms signalled by the CMA have been a boon to the investment houses, which have established IPO funds in a bid to capitalise on the changes. Retaining the new subscribers to these funds, however, is not always an easy task. The fact that IPO funds are restricted to trading in IPOs and companies floated during the previous three years means that fund managers have had to effectively absorb the volatility that was removed from the exchange, as retail investors often subscribe to these open-ended funds prior to an offering and leave them soon after the listing.
Nevertheless, the renaissance of IPO funds has been an encouraging development in the asset management industry, and strong prospects for future IPO activity are acting as a catalyst for a newer instrument – the pre-IPO fund – which is providing investors with yet more routes to attractive returns. A number of Saudi firms have begun to offer these vehicles, which are close-ended funds designed to provide Saudi companies with both growth capital and advice from professional investors in return for an equity stake. Investors hold their interest until the company goes public and, as the transaction is treated in the same way as an ordinary Saudi fund, foreign investors are not compelled to obtain a licence from the Saudi Arabian General Investment Authority. This development forms part of a wider expansion of venture capital fund activity, which is providing crucial funding alternatives to Saudi Arabia’s growing businesses.
At the other end of the spectrum, the IPO pipeline taking shape in 2016 and 2017 looks set to push the IPO fund arena towards even higher growth rates. The recent revelation in early 2016 that the government was considering the possibility of listing shares in the government-owned oil company Saudi Aramco generated headlines across the globe. The current plan is to list up to 5% of the company in an IPO, which would value the enterprise at between $2trn and $3trn (see Capital Markets chapter). A further two dozen state-run companies are also in the running for potential upcoming privatisation as part of the government’s top-down reorganisation of the Saudi economy.