The Daily Update - Think Creditors vs Debtors

Earlier in the week MSCI announced the inclusion of Saudi Arabia in the Emerging Markets Equity Index in June 2019 following a two step inclusion process. This follows an announcement earlier in the year that the FTSE Russell Emerging Market Index would also include Saudi Arabia (in phases) from March 2019. We would expect Saudi Arabia and its issuers to continue to take a more prominent role in global equity and bond indices, particularly if the proposed listing of Saudi Aramco goes ahead.  In our opinion, Saudi Arabia is under-represented in indices for an economy with a 2017 GDP of USD684bn.

That said, we do not think of Saudi Arabia as an ‘emerging market’ and instead of classifying markets as ‘emerging’ versus ‘developed’ we prefer to think of our universe in terms of creditors versus debtors. Saudi Arabia has a strong net foreign asset position so fits with our preference to position in creditor nations and countries with net foreign liabilities (NFL) less than 50% of GDP. IMF research indicates NFL above this threshold are associated with increasing risk of external crises and as we have seen over the past few weeks a number of debtors’ asset markets have come under pressure as the Fed continues to tighten and rein in US dollar liquidity.

Given its strong balance sheet Saudi Arabia has been a relatively infrequent issuer in the Eurobond market: it was only in October 2016 that it debuted an USD17.5bn multi-tranche issue. This is also true of Kuwait which debuted a two tranche USD8bn issue in March 2017; incidentally, Kuwait was added to the 2019 MSCI watchlist for reclassification from ‘frontier’ to EM status. These nations looked to international bond markets as a funding source in response to the collapse of oil prices in 2014, helping to fund deficits rather than totally rely on their asset buffers and sovereign wealth funds. Given their strong credentials we think these type of issuers are an attractive place to be positioned and in our opinion a lot of the geopolitical risk has already been priced in by markets. On our valuation model Saudi Arabia (rated A1/A+ by Moody’s/Fitch) screens attractively: For example, US dollar denominated Saudi International 4.5% 2046 trades ~4 credit notches cheap and at a yield of 5.1%.

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