RIYADH — A regulatory drive to reduce the volatility around initial public offers of shares is bolstering the Saudi funds sector and also creating an opportunity for international investors to sidestep the kingdom's foreign ownership restrictions. With Saudi Arabia about to open its $575 billion stock market to direct foreign participation for the first time on June 15, both local and international investors are positioning themselves to trade the largest Arab bourse. For the Saudi Capital Market Authority, a major motive for opening the market is the desire to create more stability in a bourse currently dominated by local retail investors who are prone to short-term thinking. The same desire for stability can be seen in the regulator's stance toward IPOs; listing of stocks has traditionally been accompanied by massive volatility in their prices, so the CMA is encouraging investments in share flotations by IPO funds. The result is a huge jump in the number of IPO funds offered in the kingdom. These open-ended funds, which specialize in subscribing to IPOs but often have broader remits, are run by CMA-regulated firms, from large commercial banks to investment houses. Of the 12 such funds tracked by Zawya Funds Monitor, a Thomson Reuters unit, nine have been established in the last 12 months. "It seems everyone is doing an IPO fund because the CMA is encouraging it and not allowing the (fund and asset) managers to take stakes in IPOs unless the companies do a fund," said James Stull, senior associate at law firm King & Spalding. The CMA didn't respond to requests for comment. The potential profits are considerable. Many Saudi listings are offered at a substantial discount to normal valuations as a way for the kingdom to spread its oil riches to the population. For example, when National Commercial Bank was sold to investors last year, it was priced at an 18.8 percent return on equity, compared with a 13.4 percent average for the sector. When NCB listed, its shares rose their 10 percent daily limit for the first three days. The average performance of Saudi IPO funds in the last three years has been 37 percent per annum, according to Muscat Capital, which set up its fund earlier this year. The wider stock market returned about 10 percent per annum in that time. "A lot of the older companies are out of fashion and unprofitable, but the new ones have a lot of scrutiny from the regulator (in the run-up to a flotation) so it is obvious to investors that they are good, clean companies," said Beshr Bakheet, managing director of Osool & Bakheet, which set up the first IPO fund in the kingdom. "And the pricing of these companies is below fair market value, so that is good for us." Around the Gulf, IPOs are often reserved for local citizens; foreigners are excluded from subscribing to them and can only buy shares in the secondary market. Putting money into IPO funds offers foreigners a way around this restriction, because when investing in the funds they effectively become classified as local investors. The extent of foreign investment in IPO funds varies from fund to fund. However, "anybody is welcome - an investor is an investor," said Bakheet, adding that foreigners from outside the kingdom needed to invest through a local counterparty. Foreigners are also being attracted by an even newer development in the Saudi funds sector, pre-IPO funds. Offered by Saudi investment firms, these closed-ended funds provide growth capital for Saudi companies and advice from professional investors in the run-up to listings in exchange for equity stakes. Investments are held until the companies go public. For Western private equity firms, which have increasingly been looking to do deals in the kingdom, the benefits of pre-IPO funds are two-fold. Western firms are drawn to sectors that tap into the country's young and increasingly affluent population. But many such sectors, such as retail and food and beverage, are underrepresented on the bourse, which is dominated by banks and firms linked to the petrochemical sector. Pre-IPO funds can help to solve this problem. They are also a relatively simple method of investing because they are treated as Saudi funds, foreign investors don't have to go through the process of getting a license from the Saudi Arabian General Investment Authority. "For years and years, people have been trying to bring investors in to expand the capital base before an IPO. Using the fund structure to do this is a very recent development," said King & Spalding's Stull. The size of the $750 billion Saudi economy, and the fact that only around 170 companies are now listed on the exchange, suggest pre-IPO and IPO funds will have plenty more business in coming years. "In a similar-sized economy, you would have hundreds more companies listed by now, so it just shows the potential," said Bakheet. — Reuters
