Winter 2015

CHEAP OIL: Hard times

Oil pumpsWith the likes of PineBridge Investments cutting back its Middle East operation and sovereign wealth funds withdrawing their money, it’s been a difficult year for asset managers in the Gulf. How long will this tough patch last? George Mitton reports. Global asset manager PineBridge Investments set up a Middle East operation in 2012 with plans to build a private equity investment house that would span the MENA region, including Turkey. Regional chief executive Talal Al Zain said growth prospects were good. Not even political unrest in Bahrain, where the Middle East office was set up, could dent his enthusiasm. Three years later, PineBridge Investments Middle East has struggled to live up to its ambitions. The firm is restructuring and Al Zain has left. At the time of writing, it is unclear how many of the roughly 30 employees in Bahrain will keep their jobs. The US-based parent firm would like to maintain a presence in the region, but the scale of that presence remains to be seen. What went wrong? PineBridge was operating in a difficult economic environment in which competition for assets was fierce. Not only that, but in the past year the dramatic fall in the oil price has shaken regional economies, forcing governments to rein in spending and, in some cases, to withdraw money from external managers. As the oil price shows no sign of rising, is there any hope for asset managers in the region? FEELING THE PINCH
The oil price is particularly troubling because the region’s largest investors, sovereign wealth funds, are funded by oil surpluses. When a barrel of crude fetched more than $100, there was plenty of money flowing into the likes of the Saudi Arabian Monetary Agency (SAMA). But with the price less than half that, governments are having to slow or stop inflows into these funds or even withdraw money to meet spending needs. The value of SAMA’s investments in foreign securities, for instance, fell by a fifth in the 12 months ending September 30, according to the agency’s monthly report for October. At $446 billion, the value of this part of SAMA’s portfolio is the lowest it has been since 2012. Some of the decline is attributable to market movements, but reports say redemptions from external managers are to blame too. There is evidence of withdrawals by other Gulf governments. Although the largest sovereign wealth fund of the UAE, the Abu Dhabi Investment Authority (ADIA), does not reveal the value of its assets, the National Bank of Abu Dhabi (NBAD), the emirate’s top state-owned bank, has reported a withdrawal of $13 billion of government deposits in the 12 months to September 30. All this comes on top of a separate trend for the sovereign wealth funds to manage more of their money themselves. In the last issue, Funds Global MENA reported that between 2013 and 2014, ADIA took back a tenth of its assets from external managers. Evidence from a survey of sovereign wealth fund employees by asset manager Invesco suggested the Abu Dhabi fund was not an isolated case. The study identified “a decades-long trend towards developing in-house investment capability”. NO RETAIL CLIENTS
The lack of new inflows from the sovereign wealth funds in the Gulf would be less troublesome if there were a large retail market to supply asset managers with inflows, but that market is small. Regional assets under management have been estimated at single-digit percentages compared with regional GDP. Part of the problem is the habit of expatriate workers to send their savings to their home countries in the form of remittances, rather than invest them with locally based fund managers. Another issue is the tendency of locally based high-net-worth investors to book their investments outside the region, in wealth centres such as Switzerland or Singapore. If wealthy Gulf citizens do invest locally, it is often directly in the equity market or in real estate, rather than in funds. (Some high-net-worth investors have sizeable portfolios held locally in private, segregated accounts; their size is hard to estimate.) There is one investor segment that could supply assets at a time when they are so hard to come by: family offices. Insight Discovery, a Dubai-based research firm, says there are about 300 family offices in the Gulf countries that are potential clients for asset managers. Firas Mallah, managing director of BMO Global Asset Management, MENA, says: “When there is less deal flow coming from government-related entities, you would typically rely more on the private sector for business.” TOTALLY SAFE
Not everyone agrees that the outlook is gloomy for asset management. Some say the withdrawals from sovereign funds, because they are a natural response to what will most likely be a temporary period of low oil prices, are nothing to fear. Indeed, the withdrawals show the Gulf governments are exercising sensible fiscal management, says Dino Kronfol, chief investment officer for Franklin Templeton Investments (Middle East). “It doesn’t make sense to have reserves and not use them,” he says. “When you have volatile oil markets, that’s when you dip into your reserves. That’s what they’re there for.” Kronfol argues the period of low oil prices can ultimately be a good thing, because it will force subsidy reforms in the Gulf economies that will make them more competitive. The UAE has already cancelled a fuel subsidy and other states are predicted to follow. The Gulf countries may also look at increasing tax revenues, if not by income tax, then by some kinds of sales tax, such as VAT. These changes, he says, are necessary steps that will put the region on a stronger economic footing. Kronfol dismisses talk that the Gulf states may have to abandon their currencies’ long-held peg to the dollar as they seek to manage their economies in these turbulent times. “The dollar peg is totally safe,” he says. “There is no stress in terms of the external balance of payments. The peg has worked for them for a long time.” SAUDI GROWTH
Some suggest other reasons to be optimistic. One positive development is the opening this summer of the Saudi Arabian stock exchange, the Tadawul, to direct investment from international investors. The hope is that international investors will allocate more capital to Saudi Arabia now that they can invest directly, which will draw investors’ attention to the Gulf region as a whole and create more business for asset managers with operations in the area. “China opened up over many years, and it’s still opening. For us as Middle Eastern investors, Saudi Arabia is our China,” says Salah Shamma, head of investment, MENA equities at Franklin Templeton Investments (Middle East). The Tadawul has yet to attract the inflows that some expected. According to Arindam Das, head of HSBC Securities Services in the region, the slow start is due to regulatory problems that the Saudi authorities are solving, gradually (see pages 26-28). In the meantime, many foreign investors are still investing via swaps rather than going through the difficult process of gaining qualified foreign investor (QFI) licences. In time, though, many of them could switch to investing directly, and, after the slow start, foreign participation in the Tadawul could rise. The biggest change would be if Saudi Arabia were included in the widely followed Emerging Markets index from MSCI – a change that would force institutional investors around the world to increase their allocations to the country. Saudi Arabia is on review for a potential inclusion in 2017. THE IRAN FACTOR
A further possibility – that sanctions on Iran will be lifted, prompting large flows of foreign capital into the region – would certainly be good news for asset managers. The framework deal in April, signed in Lausanne, Switzerland, between Iran and the major world powers, may ultimately sweep away the sanctions that prevent Iranian institutions engaging with the global financial system. Once the ban is lifted, international investors could once more buy stocks on the Tehran Stock Exchange. Regional asset managers, particularly those with frontier market funds, could play a role in channelling this capital, if they are quick to exploit the opportunity. According to Renaissance Capital, an asset manager focused on emerging markets, Iran is “the largest and most important economy that is still closed to institutional investors”. Its population is as big as Turkey’s; its GDP, at more than $400 billion, is larger than the UAE’s; and the market capitalisation of the Tehran exchange, at $95 billion, is comparable to that of the Dubai Financial Market. Fund managers say the Tehran exchange is cheap, on a price-to-earnings basis.  If estimates about the post-sanctions opportunity in Iran are correct, a huge amount of foreign direct investment is likely to flow into the country and trade volumes between Iran and the Gulf states are likely to revive. The resulting economic boost would aid the wider region. That said, Iran’s opening-up would stoke tensions with Saudi Arabia over regional dominance. Whether asset managers are able to benefit from the Iran opportunity depends on their willingness to engage with a country that has for years been deemed an enemy of the US and its allies. ADAPTABLE SHALE
Needless to say, a rebound in the oil price would revive the Gulf asset management industry like an electric current to the chest. If oil were to rise to more than $100 a barrel, money would course back into the sovereign wealth funds. Much of it would likely filter through to external managers. It’s hard to know if that will happen. The shale oil industry in the US and elsewhere has not yet been destroyed by OPEC’s policy of holding down prices. Many shale producers are heavily indebted, but many are still in business, and some are even adapting to the depressed environment.  Meanwhile, should sanctions be lifted on Iran, a flood of Iranian oil supplies on to the market could worsen a global oversupply and further depress prices. OPTIMISTIC
It is a difficult time to be in asset management in the region. However, figures from the Dubai International Financial Centre (DIFC) in the UAE, the home of scores of asset management company offices, suggest few firms have downsized as yet. According to its own figures, occupancy rates in the properties managed directly by the centre are nearly 100%. Buoyed by this success, the DIFC is expanding, with at least two separate office projects and a new retail section. Another financial free zone, the recently opened Abu Dhabi Global Market (ADGM), is hoping to attract asset managers to set up offices in its newly built properties on Al Maryah Island. ADGM hopes to defy the current atmosphere of gloom by registering a wealth of new financial firms. Asset management heavyweights that have yet to establish a regional presence are looking at ways to do so. Martin Gilbert, chief executive of Aberdeen Asset Management, says his firm will open its first Middle East headquarters by the early part of 2016. “We’re looking at setting up here in the UAE,” he says. “We need an office here to service clients. Our natural progression has been to locate asset managers locally, as we’ve done in Kuala Lumpur, Bangkok, Jakarta and Hong Kong. Inevitably, we’ll have some asset managers here at some stage.” If Aberdeen and others like it can make regional operations profitable, despite the challenges presented by cheap oil, there may be hope for the industry in general to survive this difficult period. It’s not been an easy year, and 2016 could be even harder, but there would be rewards for those who can weather the tough times. Perhaps they would emerge stronger. ©2015 funds global mena

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