July 2010

MENA FUNDS: Rugged charm

blanketsThere’s a lot more to Mena than oil, writes Nick Fitzpatrick, who finds a region piled high with investment opportunities.

You would be wrong to think that investment in the Middle East & North Africa (Mena) region is all about oil. Oil may be the most potent symbol of Middle Eastern wealth, but let’s not forget rugs. Those famous items of luxury upholstery with a Persian twist can provide a comfortable return. Cairo-based Oriental Weavers has proved it.

Over the years, and with stock market support behind it, the firm has picked up Walmart in the US as a customer, and like any business with international ambitions Oriental Weavers is now concentrating on Asia. After all, there’s no reason why Byzantine-styled carpets should not furnish Shenzhen halls as much as Parisian walls.

Oriental Weavers is one of around 1,470 companies in the Mena region that a large equity manager might have in its stock universe.

The growth in Islamic finance and the potential for mortgage and insurance products makes the banking sector also look attractive to some fund managers.

But oil is still a major portfolio feature, of course. If it is not oil-related companies themselves that attract investors, then it’s the bedrock of stability that oil revenues bring to many Mena economies through sovereign wealth funds. A recent survey
of independent financial advisers (IFAs) in the UK by Baring Asset Management proved this.

In its survey, 67% of IFAs who responded believed that investors in retail funds should invest in the Mena region due mainly to its exposure to natural resources and some 48% said it was because of the strength of the region’s sovereign wealth funds, which means there is little need for external financing.

However, 55% also highlighted the increased expenditure on infrastructure. Most of the IFAs surveyed said a retail investor’s allocation should be at 5%, but a fifth of them said it should be between 11-20%.

Fund managers with Mena funds would no doubt like to see similar amounts from institutions, but the problem with raising institutional funds is that Mena and its constituent parts like the Gulf Cooperation Council (GCC) states fall outside of main emerging market indices. Instead they are labelled as ‘frontier markets’.

Fund managers, both local and international, that run Mena and Gulf funds are busily trying to persuade investors of the reasons to see through this category division and to evaluate Mena on its own merits.

Walid El Hayeck, director of asset management at The National Investor in Abu Dhabi, says: “In our pitch for The National Investor’s Mena Ucits fund, we call Mena a ‘maturing frontier market’.

“The crisis has delayed Mena becoming an emerging market. But most of the Mena countries do not have the level of sovereign debt and vulnerability issues found in other frontier, emerging or even developed markets.”

Ironically a lack of sovereign debt, or specifically the lack of sovereign bond issuance, is a factor that holds back Gulf markets in terms of development.

El Hayeck notes: “To develop the markets further the GCC needs to issue central government bonds. This will enable us to have a regional monetary policy and a yield curve. Else we are reliant on the Federal Reserve interest rate policies as the regional currencies are pegged to the dollar.”

However, not all Mena countries fall into the frontier category. Egypt, Morocco and Jordan are already in the MSCI Emerging Market index and this is proof that Gulf states could be in there too, says El Hayeck.

“It is a question of regulation and not of market or economic maturity. The GCC countries are economically stronger and more mature than those countries included in the index, but Eqypt, Morocco and Jordan’s financial markets are ahead in terms of regulation, transparency and access.”

Similarly, Alan Durrant, chief investment officer at NBAD Asset Management, says: “Gulf markets are a frontier market. It’s a statement of fact – MSCI says so! But investors we’ve spoken to say that when you look at the size and importance of these countries, they look more like emerging markets. They are not tiny like other frontier markets and there are some very big businesses here.”

“It depends who you talk to,” says Mohammed Salih Al Hashemi, executive director, head of listed equities, at ADIC Investment Management. “Pension funds are more benchmark driven and they would be influenced by the non-inclusion in emerging market indices. But this did not stop BHF [the German banking client of ADIC that runs an emerging Arabia fund]. There are certain investor categories, though, that want to see the inclusion of these countries in broader indices before they make
more allocations.

“But regulations are helping bring us closer. Egypt and Morocco have got well regulated markets.”

Slow trade
Index builders look for liquidity, restrictions on capital and foreign ownership, and at governance and transparency.

Liquidity is a particularly difficult point. Tariq Al-Samahiji, CEO of BNP Paribas Investment Partners, Mena, says: “When people talk about ‘old money’ here in the Middle East they are talking about money made as recently as the 1960s and even 1980s.

“People save money here although not in cash. Its mainly invested in property.

“Savings are also directed to stocks, of course, but they for the most part do not trade them. There are people that bought stocks 30 years ago and still own them. They bought them and left them while reinvesting the dividends back into the same company, and one day they wake up to realise they own a small percentage of a company. That’s not done intentionally; that’s because of saving.”

Catherine Doherty, head of Mena at investment management consultancy Investit, says: “If the GCC could attain emerging market status then it would receive much more investment. Any investor with a global mandate would then allocate to the GCC.

“But there is still a long way to go, with many issues that need to be dealt with, such as ownership rules and liquidity.

“It is an IPO market here. There are not many stocks listed on the exchanges and those that are do not trade. Investors buy and hold, or the bigger ones invest in private equity. Many sovereign wealth funds are in private equity. They have a lot of money,
but when you see what’s inside them, it is just a few holdings held privately. Also it has to be said that private equity is a good structure here.”

But there is a “bright spot”, says BNP Paribas’ Al-Samahiji. Not only does the younger generation want to invest differently to their elders, but there is a new appetite by Gulf institutions for local products, although it isn’t certain that there are enough investment opportunities at the moment to sustain the industry.

He also points out that banks have become more involved with mutual funds since revenues from brokerage proved to be volatile.

On a similar note, Al Hashemi at ADIC Investment Management, says: “We’ve seen positive moves. Saudi Arabia for many years did not allow foreign investors to buy shares directly. It would only let GCC-domiciled funds invest, but not in banks. But recently it has opened the entire market to GCC funds.

“Also the swap programme initiated in 2008 means foreign investors can get exposure to Saudi returns that way.”

Saudi Arabia also changed regulations to allow ETFs to be listed and foreigners can buy into them.

“All these changes have enhanced liquidity in Saudi Arabia,” he says.

Qatar last year passed a law allowing foreigners to own 100% of companies in certain sectors, and Al Hashemi says Abu Dhabi is also moving in the same direction, with a law mooted that would allow foreigners to own more than 49% of companies in certain sectors.”

Of course, the slow pace at which Gulf markets are moving shouldn’t be seen as a bad thing. “These markets are cautious in nature and they do not want to go through the mishaps of other emerging markets that opened up too quickly.”

Ignoring the index makers
“A lot of investors would classify many Middle Eastern countries as emerging markets regardless of what MSCI says,” says Yazan Abdeen, investment manager, Middle East equities, at ING Investment Management, who points out that FTSE, the London-based index provider, classifies the United Arab Emirates as an emerging market, unlike MSCI.

ING Investment Management runs a Mena fund launched in December 2008. It now has $59.3m (€48.2m) under management, but is targeting $500m, and returned around 34.21% year to date at the end of 2009, compared to 9.33% for the MSCI Arabian Markets ex Saudi Arabia Index.

“There is more risk in Mena and more speculators. But with the rally in emerging markets last year, global emerging markets are trading at a premium to frontier markets since mid-last year and we believe that this is not sustainable.”

He points out that GDP growth from 2003 to 2008 in the GCC was equal to emerging market growth of 6.9%, but Mena is now outperforming emerging markets.

“Liquidity is important and it is at its lows currently, especially in the UAE. Because of reduced institutional investor interest, liquidity is dropping.

“Yet there are great opportunities in the UAE. We meet a lot of international investors who think the region is all about oil, so markets only rise if oil rises. But there is not one mainstream oil and gas company listed in this region.

“Remember that the origins of Dubai are not as an oil producer, but as a trading hub, so there are airlines, shipping or internal logistics sectors here all packaged in a user-friendly, service oriented manner.

“Emirate Airlines is a major brand and there are plans to IPO part of it. The industrial and oil & gas sectors in Abu Dhabi are also potential listing candidates.”

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