Expulsion impact

by Amrith Mukkamala, director, asset allocation/advisory, Kuwait and Middle East Financial Investment Company

3 Dec 2010

Saudi Arabia was expelled from the MSCI indices in September. This is the first such event with a market the size of Saudi Arabia. There are various reasons floating around but most of them are very qualitative and seem to be related to policies.

Quantitatively, it does not impact Saudi Arabia much, at least for now. The four broad users of the index can be classified as Saudi Arabian domiciled investors, GCC ex-Saudi Arabia investors, Arabian ex-GCC Investors and foreign non-GCC investors. Of these, the expulsion of Saudi Arabia from MSCI indices is expected to impact fund managers who fall under the latter three classifications. If the latest data points are considered, close to 90% of the value generated on the Saudi Arabian exchange is from Saudi Arabia domiciled investors. The rest of the pie is broken almost evenly between the other categories of investors. Therefore, the size of the impact is too small to be meaningful.

Also, Saudi Arabia was not even considered as a frontier market under MSCI classifications before its removal. It was considered a standalone market. This is one step below the frontier markets. Very few markets get classified as stand alone markets and the reason is mainly due to foreign investment restrictions. Apart from Saudi Arabia, the Chinese A shares market and other smaller markets such as Jamaica, Botswana and Ghana were classified as stand alone markets. Therefore if there had been an upgrade, it would have been upgraded to frontier market status, not directly to emerging market status as most analysts and fund managers expected. Therefore Saudi Arabia, even though it forms a part of organised indices, its classification was never a constituent of any international/emerging/frontier index. So, investors taking exposure to Saudi Arabia were historically taking a bet on it as an off the benchmark exposure or on a custom index such as the GCC index including Saudi Arabia.


The impact has been on fund managers running pan–GCC or pan-Arab mandates and the index provider. The overall size of equity funds with such mandates is estimated at around $2bn. This is close to 15% of the total assets under management in equity funds in the GCC region. Examining the fund fact sheets, it is estimated that close to 80% of the assets under management managed under GCC mandates were based on MSCI benchmarks. Managers operating these mandates were forced to shift to other index providers like Standard & Poor’s.

Risk & return characteristics

Choosing a relevant benchmark is vital for long only equity funds. In comparison between two benchmarks relating to a similar geography, an ideal benchmark would be one which has a better risk adjusted return and less concentration. Comparatively, the Standard & Poor’s GCC all cap index has a better risk adjusted return profile than the MSCI GCC all cap index. Both the indices offer a similar number of stocks.

Weight changes – additions and reductions

A fund manager looking at changing their benchmark from MSCI to S&P will have significant impact, more so on Shariah-compliant portfolios than on conventional ones. On the conventional side, the major change has been that of a decrease in Sabic’s weight from 11% to 7% in an all cap benchmark. Also, the concentration of the top 10 constituents as per weights reduces to 37% in Standard & Poor’s from 43%in MSCI.

There are significant changes to Shariah-compliant portfolios. The additions as compared to MSCI indices are large cap stocks such as Sabic, Zain, Safco & Emaar properties. The reduction is in Al Rajhi’s weight from 20% to 11% in Standard & Poor’s indices. Kuwait Shariah-compliant portfolios face the highest impact among individual country indices due to the introduction of Zain in Standard & Poor’s Shariah-compliant index. Zain has a 48% weight in Standard & Poor’s Kuwait Shariah-compliant index and it was not considered as a Shariah-compliant stock in MSCI. This reduces the concentration of Kuwait Finance House from 43% in MSCI Kuwait Shariah Index to 20% in S&P Kuwait Shariah Index.