Foreign investors pulled a record amount of money from U.S. equity funds tracking Saudi Arabia in October as the Middle East's worst violence in decades shook the region's business-friendly narrative. The iShares MSCI Saudi Arabia ETF saw record net outflows in October of more than $200 million, LSEG data shows, cutting 20 per cent from what it held at the beginning of the month.

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Exchange-traded funds (ETFs) providing exposure to stocks in Qatar, the UAE and Israel also suffered outflows, with investors worried about instability, and flows have been muted this month.

"Capital flight can be quite indiscriminate," said Torbjorn Soltvedt, principal analyst for the Middle East and North Africa with Verisk Maplecroft.

"It's not necessarily 100 per cent based on the fundamentals for each country. And so obviously, right now, there's a perception that risks are increasing throughout the region. And we're seeing a negative impact as a result of that," he added.

The iShares MSCI Qatar ETF lost $7.7 million in funds in October, while the iShares MSCI UAE ETF (UAE.O) suffered outflows of $2.75 million.

Exchange-traded funds tracking Israel such as the iShares MSCI Israel ETF, ARK Israel Innovative Technology ETF and BlueStar Israel Technology have seen net outflows between $2.5 million and $9.3 million since the October 7 attack by Hamas militants.

The outflows from ETFs tracking Gulf countries far outpace those from most emerging markets in the same period, while outflows from Israel are also above average.

Israel's war with Hamas is the second time Israeli markets have faced turmoil this year after the earlier fallout from the government's judicial reforms ramped up pressure on them.

Natalia Gurushina, chief economist for emerging markets with VanEck, said the latest turmoil had compounded outflows.

"The FDI story – Israel as a destination for tech investment - this took another hit, and a big one," Gurushina said."From a structural perspective, Israel being a safe and attractive place for these kinds of inflows, that's one of the reasons (ratings agencies) were considering a downgrade before."

Those concerns were "not going to get better any time soon," she added.

However, ETFs tracking the region have also mostly bounced back from losses incurred just after Hamas launched its attack into Israel on October 7.

BROAD RESILIENCE

The ETF cash flight points to cracks in investor confidence in what have otherwise been surprisingly resilient markets.

Israel has recouped losses in the shekel and its bonds have rebounded. Bonds in most Gulf countries showed little knock at all from the conflict.

Sergey Dergachev, a portfolio manager with Union Investment, noted that the turmoil had not slowed new issuance in the Gulf, pointing to a sukuk from Saudi Arabia's Public Investment Fund.

"It's very interesting to observe that you don't see any big fear of contagion risk," he said, while noting there had been no corporate debt sales from Israel since the start of the war.

Nearly all the region's main economies are strong enough to weather some turmoil, investors say. Israel has nearly $200 billion in reserves and the Gulf states are propped up by surging oil and gas prices.

But the equity investor cash flight highlights the still-serious risk to these economies, and their efforts to diversify, as the region falls back into conflict.

Soltvedt of Maplecroft said that continued war could undermine Saudi efforts to curb its reliance on oil, while Dergachev and other investors said the length of the conflict – and how badly it damaged Israeli businesses and investment – could wreak further havoc on its economy.

"For Israel, the big question is what will happen afterwards? This is not really priced in," Dergachev said.