The Arab Spring and the financial crisis have seen investors in the Middle East grow cautious. Now, are they feeling more optimistic and finding less restrictive ways to safekeep their money? Our roundtable finds out, and looks at some changes that have been predicted in this arena. Chaired by George Mitton.
Haissam Arabi, chief executive officer, Gulfmena Investments
Fadi Al Said, head of investments, Middle East and Africa, ING Investment Management
Sean Daykin, head of investment funds, Emirates NDB
Amin El-Kholy, managing director/asset management, Arqaam Capital
Pieter Hendriks, director of investment services, Middle East & Africa, T Rowe Price
Eric Swats, head of asset management, Rasmala Investment Bank
William Wells, director – Middle East, Schroders
Funds Global: Following the financial crisis and the political unrest of last year, it seemed many Middle Eastern investors wanted to put their money somewhere safe – in real assets, such as property and gold. Is this trend continuing or are investors rediscovering an appetite for adventurous investments?
Haissam Arabi, Gulfmena Investments: In the first quarter of the year, there was a major rally in markets like the UAE [United Arab Emirates] and Saudi Arabia, and that helped focus attention on local equities. A good indication is that volumes had almost quadrupled from a year before. But that was on the assumption that we had entered in a bull cycle. Now, with the resurfacing of the eurozone crisis, the question becomes, ‘are we shifting back to the risk off, risk on trade?’.
I don’t have the answer to that but I have noticed there isn’t as much of a shift towards gold as there was in the last couple of years.
We still see interest in fixed income securities and that might increase again now investors are concerned about what’s happening in Europe. Unfortunately, there may be less focus on equities in the summer period.
William Wells, Schroders: We’ve certainly seen continued interest in the lower risk part of the market: in fixed income and in what people perceive to be safe havens. We’re also seeing particular interest for income producing products, whether they be equities, fixed income or combinations. People in this marketplace, who two years ago were able to get 7% fixed deposits over one year, can no longer get those types of returns from holding money at the bank. They’re seeing what the inflation rate is doing to the value of their cash and are looking at income-producing products as a way to move money back into the market.
Amin El-Kholy, Arqaam Capital: For the sovereign wealth funds and pension funds, it’s business as usual. For the retail portion, there is a desire for equities to be as ‘fun’ as they used to be. But, there is a certain level of caution having had crashes in 2006 and 2008, so it’s not on fire as it was back then.
What is interesting is the response of the high-net-worth individuals and family businesses. There has been a lot of stimulus in response to the political events which favours Gulf markets over a medium term, maybe five years. These investors might find the local market attractive in a way not too different from the retail investors we’ve just mentioned.
However, I am not sure how confident these investors would be in investing heavily in their domestic businesses beyond five years, because there is a lack of clarity beyond that.
Sean Daykin, Emirates NDB: Most of the flows from our clients have been into the fixed income and sukuk markets, not into equity markets. There’s still a bit of risk aversion, particularly towards emerging markets like India, where we’re still not seeing much interest. We did see a lot of interest in gold last year and even the more exotic metals such as silver and platinum. But recent events have made some investors think gold is not really a safe haven any more.
In the commercial real estate market we have seen interest from family offices and larger investors in the GCC (Gulf Co-operation Council) who are now seeing the UAE property markets become more attractive. These are typically cash buyers and, with the banks not really lending on real estate, they get a good deal. We’ve seen people buying whole buildings and getting 8% yields.
Pieter Hendriks, T Rowe Price: When we speak to family offices, we see more interest for global liquid strategies, global equities, US equities, high-yield fixed income and emerging market debt instruments. These investors are still very exposed to the region in private equity, in real estate and in their own businesses, but we see more demand for global diversified strategies.
Investors have learned a lot from 2008. They will keep their exposure to the region because they live here and they build their businesses here, but with all the volatility over the past four or five years, they have developed a preference for liquid diversified instruments that can be deployed locally.
Fadi Al Said, ING Investment Management: Just one point – gold has been negatively correlated with equity markets in 2008 and been viewed as an excellent hedging tool. But if you look at what was happening lately, gold was positively correlated to equities. If you see any kind of panic selling, the gold price drops by 2.5%. Gold hasn’t been working as a kind of defensive tool or as a hedge in the past two years.
Eric Swats, Rasmala Investment Bank: Among a certain set of clients, particularly those from outside the region, we see a keen interest in understanding Egypt. Is this the beginning of some multi-year rally that these groups should be participating in?
Also, in niche strategies like the Palestine fund we launched last year, we continue to get inflows from different investor groups who understand or think they’re comfortable with the risk in Palestine. Otherwise, it tends to be focused on income and income-producing strategies.
Funds Global: Bonds have traditionally taken up a lower proportion of the capital markets in the Mena region than in the rest of the world (13% compared with 38%, according to an Internationl Monetary Fund report last year), but in recent years the proportion has risen fast. Will this grow to resemble the global average? How much of this growth is due to product innovation such as sukuk?
Daykin: If you look at the statistics, the total issuance in the Mena bond markets was about $30 billion last year.
And in the first four months of this year we’ve had about $18 billion. Historically, it was a lot more Mena fixed income rather than sukuk, but this year it’s been pretty evenly split, so that’s quite a change.
We’ve had about 45 issues this year, which is much higher than previous years, and many have been from new issuers like Majid Al Futtaim [a shopping mall developer] and Saudi Electric. If you look at the calendar of new issuance, there’s probably another ten from Dubai Islamic Bank, Emirates Islamic Bank, Abu Dhabi National Energy (Taqa) and Mubadala [a state-owned development company] coming, so we’re definitely seeing interest from issuers as well as investors.
Overall, it’s looking like a pretty good picture. You can see as the markets develop, people will want to invest more in these instruments and build diversified portfolios.
Arabi: We’re probably going to see a convergence with global averages. One of the advantages that our fixed income markets have is that we’re now considered a lot more liquid and less troublesome than some of our European counterparts. The creditworthiness of regional issuers, even on the corporate side, is considered reliable enough and safer than putting money into Europe.
Hendriks: It’s interesting that from an equity point of view, the regional markets are fairly low in global emerging market indices. But on the corporate bond side, the Middle East is a significant part of the global emerging markets corporate bond index. There is a considerable demand from global investors to take exposure in the Middle East to conventional bonds and sukuk in their emerging market debt portfolios.
El-Kholy: The reason there has been such a mismatch in the past is the structure of the markets historically. It used to be possible to go to the banks for loans and that’s always going to be more favourable to some of these large groups. The other aspect is that when equities were so highly valued it was tempting to go into initial public offerings. The markets were overvaluing everything, why not issue some shares?
The natural instinct, though, with a lot of family groups is to go to the fixed-income market. They are looking for credit, they can no longer go to the banks, so they naturally look more towards issuing bonds or sukuk, and the demand for both remains high.
We were with a Malaysian pension fund recently and one particular portfolio manager there buys and holds sukuk to maturity. She needed to deploy $370 million which, believe me, in the size of their book is actually a drop in the ocean. It took her one year to deploy that amount in sukuk, so the demand still is very strong, and that will continue driving issuance.
Funds Global: What is the reason for the increase in investor demand for sharia-compliant products? Do you see this demand continuing to rise and what implications will this have?
Al Said: The demand for sharia products has been always there, but supply usually didn’t meet that. Personally, I always invest in a sharia-compliant manner. In the past, I couldn’t find the right products. But over the past four years, we have seen better structured products, more innovation and more creativity. It was a supply issue, and I think it has been progressing nicely over the past years and I expect it to improve even more.
Wells: So much varies from market to market as to what the demand is but, simply put, there are opportunities. There are clients looking for sharia products and often they’ve only been looking in their home market. Take Saudi, for example. Look at the size of the Murabaha (money market) products there, as well as the amount invested in local equities. The investment is relatively large but their global exposure it is relatively small. There are already sharia investors, but now they’re looking for other opportunities.
Swats: When one looks at the universe of sukuk funds, you only get a handful that have critical mass. There is a good opportunity for other well-managed, well-structured funds in this space. However, demand is as much about income as sharia-compliance strategies.
One needs to make sure that the products are structured in such a way that they look and feel like a fund investing in conventional assets, but in a sharia-compliant manner, as opposed to selling it firstly as a sharia-compliant fund irrespective of what the underlying investment strategies are.
Funds Global: It’s been said that 70% or more of assets under management by Mena asset managers are in discretionary accounts. Does this present challenges for asset managers and does it diminish the importance of managers’ own funds?
Arabi: This is something we are debating internally, because we might have to shift our business model to focus more on discretionary portfolio management (DPM), because that seems to be where the real growth is.
We’ve seen other asset managers, without mentioning names of companies, where they would have, say, 14 funds with total assets of less than $100 million, but $7 billion in DPM. That’s not foreign institutional money coming into a managed account platform or segregated account, it’s ultra-high-net-worth individuals that aren’t comfortable going into a fund.
Probably, a lot of the funds are out there not just to scale those funds but to establish a track record simply as a mirror or as an attraction point for the DPM. The real bread and butter is in the DPM.
Wells: It’s showcasing. That’s the easiest way to show your performance to a broad range of potential investors.
I think everyone is happy with $100 million or $200 million for a segregated portfolio. The question is, do you take the $1 million, the $5 million, or the $10 million as a discretionary portfolio? And does that become economically viable as an asset management business?
That’s where you’ll see a greater divergence between the international asset managers with hundreds of billions under management and some of the local independent asset managers, who may have great capabilities but don’t have the scale behind them, and, therefore will take on some of those smaller mandates.
El-Kholy: It’s OK to take small mandates if you’re managing them exactly the same way as others. It’s when you start trying to customise the mandates that it becomes critical to ensure that you maintain your performance and quality of service.
Arabi: At which point are you going to start hiring more portfolio managers, because how many could a single manager manage? How many discretionary portfolios can you manage and still provide a good quality service that can be tailored and customised?
Al Said: It’s a very dangerous balance. We have seen amazing regional asset management operations that have been fragmented across hundreds and hundreds of small mandates, and we have seen that impacting on the overall performance.
Swats: Absolutely, because if you don’t scale it properly you can have one portfolio manager looking at 20 mandates. Which doesn’t make a lot of sense because you’re not charging the same; you’re probably getting half of what you get in a fund.
Daykin: We see that funds are critical to the business because they are your shop window and they allow you to distribute to so many more places than you do with discretionary mandates. We’ve got our funds on all the life platforms through Zurich and Friends Provident and that gets distributed around the world, so your shop window is global. It’s difficult to sell DPM services on a scalable basis.
Funds Global: Many people are anticipating that Saudi Arabia will adopt a Chinese-style system and open up its stock market to qualified investors from outside the Gulf for the first time. Is this likely to happen? What do you think the implications for fund managers in this region might be?
El-Kholy: If you’re going to talk about critical markets in the Middle East in terms of economics, size, population and natural resources, you have to mention Turkey, Egypt and Saudi Arabia.
As much as there are interesting opportunities elsewhere in the Mena region, the rest are really secondary.
There will be a lot more interest in other markets in the Gulf once Saudi is open, this impact is relatively easy to assess. I don’t think we should overblow it but it really does make a difference to have a large liquid market to attract investor attention.
Arabi: Unlike the UAE and Qatar, which combined probably don’t make 50 basis points on an index, Saudi will make up about 6% to 6.5% of a global emerging market index. That is difficult to overlook if you’re a passive allocator. There are going to be some direct benefits and it will have a spillover effect as well. If you’re going to put 6.5% in Saudi, you might put another 50 basis points in Qatar and the UAE.
Al Said: But I think we need to see what the motive is for Saudi Arabia to open the market. In my opinion, the motivation isn’t there. Saudi is already the country that attracts the most foreign direct investment in the GCC, in industrial sectors mainly related to petrochemicals and joint ventures into the sector. What does Saudi really benefit from opening the market to foreign investors? I don’t see any benefit for them. In fact, they are concerned because they saw the social impacts that resulted from the crash in 2006.
The Saudis view international investors as the kind of hot money that’s going to come, rip off the retail investors, take the money and go. That’s why they want to make sure the investors are qualified, so they can minimise the pain that is caused when hot money flows in and out.
Wells: Assuming it’s a qualified foreign institutional investor (QFII) scheme, limited to, say, a 20% cap for all international investors, which manage $5 billion plus, then you start to get a much more sensible client base.
It’s the type of investors you want in there: the smart money, the dedicated investors.
Whether Saudi Arabia is 6% or 3% of an emerging market index, depending on how much is free float, that’s about the same as South Africa. For the rest of the region it is also positive. Every fund manager who treks down from New York or London to Saudi Arabia, they’re going to come to the UAE, they’ll go to Qatar and there will be huge benefits for the industry as a whole.
Swats: But funds are already open to these people. They can gain access to professionally managed investments in the region, it’s just not under their own investor number and over their own control.
It would be positive if Saudi opened up, but for those who want to, there are already many vehicles to gain exposure to the Saudi equity markets.
Al Said: I’m really impressed with the Saudi companies’ management. If you look at the rate of improvement and regulations from the Capital Market Authority in Saudi, which is doing a great job, and you compare it to all the regulators, I think it’s one
of the best. Although in the UAE we have a more open environment to do business, Saudi companies are very impressive in terms of profitability and management.
Funds Global: A quick round-up, what changes to the industry do you expect to see over the next twelve to 18 months?
Wells: Easy, regulation. The world has been responding to the global financial crisis. Regulators around the world are making changes to try to protect retail investors. The Middle East is no different from the rest of the world.
We’ve talked about Saudi regulators being very positive. A lot of people around this table are involved in informal and more formal discussions with the regulators here: the UAE Securities and Commodities Authority (Esca), in terms of the mutual funds industry, as well as regulators in Qatar and Kuwait. How this pans out will have a huge bearing on how this industry grows over the next 18 months.
Hendriks: Esca on the distribution side is a real game-changer for the UAE. It’s not about managing a fund, it’s about how we sell the fund into the market and the regulatory requirements surrounding that process.
If you see what’s happening in Europe, the retail distribution review in the UK, for example, that could happen here also, maybe not today but in four or five years’ time.
If Esca goes down this path, they want to make sure every investor in the UAE knows what they are invested in, because a lot of people didn’t know. They were just throwing money at markets that were going up. Now, the regulation is coming in and that will change the whole mutual fund industry in the UAE.
El-Kholy: We must also think of the geopolitical situation. Some of our investors are waiting to see if any confrontation with Iran breaks out. If it does, interestingly, they would be seeking to invest afterwards based on the analysis that every party to the conflict will have an interest in dampening it down quickly and finding some other solution.
But in the meantime, while risk of confrontation is diminishing, there is still some residual risk.
Then there are domestic politics in areas like North Africa where things have already broken loose, and their echoes in the Gulf.
The changes brought on by the Arab Spring within the Gulf are a lot deeper than people imagine. Everybody started panicking about demonstrations on the streets in Riyadh. It didn’t happen and was not likely to happen. But the wake-up call has come and there are moves by governments to respond to social and economic problems before they occur, whether it’s on the GCC regional front or domestically.
These moves could end up being positive in terms of investor interest in the Mena region.
Swats: The risks that you mention are not at the underlying economic level here in the region. The corporates are doing relatively well, save for the banks, maybe, which are stable, and so as these things pass these companies are continuing to generate reasonable profits and grow their earnings.
What’s attracting people are the high growth rates that we’re seeing here at a time when other parts of the world are unattractive in terms of performance.
Higher oil prices are giving the governments the necessary monies and confidence to spend, spend, spend. They are raising salaries for the citizens, and that’s just more money to spend on television sets, consumer products and other items.
If you can find access into these growth areas, there are good investment opportunities here.
©2012 funds global