On Tuesday, index provider MSCI Inc. (MSCI) will reveal its annual market classification. That decision could have wide-ranging effects for an array of exchange-traded funds (ETFs). While many global investors are focusing on MSCI's decision regarding China A-shares, another country could be in the spotlight as well. The iShares MSCI Saudi Arabia Capped ETF (KSA) could also be in focus. Currently, Saudi Arabia is not on MSCI's list for possible inclusion in the widely followed MSCI Emerging Markets Index, but the kingdom has been taking steps to increase market accessibility with an eye toward becoming an emerging market.

In January, MSCI said "that it welcomes the recent positive market reforms undertaken by the Saudi Arabian Capital Market Authority (CMA) and the Saudi Stock Exchange (the Tadawul). These reforms should make a significant contribution toward bringing the Saudi equity market closer to Emerging Market accessibility standards." (See also: How to Invest in the Saudi Arabia Stock Exchange.)

Many of the reforms being implemented by Saudi Arabia to bolster market accessibility and attract foreign investment with the objective of currying MSCI's favor are due to go into effect next year. Still, the idea of Saudi Arabia joining the MSCI Emerging Markets Index at some point is enticing to some global investors. "The potential MSCI EM watch list announcement in mid-June and possible Aramco initial public offering (IPO) in 2018 are likely to fundamentally alter capital markets and aid diversification efforts, partly through investments led by [sovereign wealth fund] the Public Investment Fund," according to a Bank of America Merrill Lynch note cited by Arabian Business. (See also: Could Saudi Arabia Cancel Aramco's IPO?)

KSA, which turns two in September, is the only ETF listed in the U.S. dedicated to Saudi stocks. The ETF holds 72 names, and despite the kingdom's status as the largest producer in the Organization of Petroleum Exporting Countries (OPEC), energy is the ETF's smallest sector weight at less than two-thirds of a percent. KSA devotes 69.5 percent of its combined weight to financial services and materials stocks.

Estimates regarding the buying spree of Saudi stocks should the kingdom eventually find its way to the MSCI Emerging Markets Index vary, but all are significant. For example, Deutsche Bank believes that Saudi inclusion in the emerging markets benchmark could result in $35 billion of inflows to Saudi equities. Other estimates put the number at $50 billion when combining buying by active and passive funds. If Saudi Arabia makes it to the MSCI Emerging Markets Index, it would be the third Middle Eastern country to be included after Qatar and the United Arab Emirates. (See also: As Oil Slides Lower, Fitch Downgrades Saudi Arabia.)


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