Winter 2018

TALKING HEADS: The prospects for 2019

Funds Global MENA asked a range of asset managers for their assessment of the past year and their predictions for the coming 12 months.
ATAF AHMED, HEAD OF ASSET MANAGEMENT, QINVEST What is your outlook for investments in the MENA region over the next 12 months?
We expect the region to continue to witness volatility over the next 12 months, with oil stabilising between $70-$80. However, regional markets continue to demonstrate their resilience in the face of macroeconomic headwinds. Historically, the main driver for market performance has been higher oil prices and index-related events. Looking at the top performers within the MENA region over the past year, the standouts have been businesses in Qatar and Saudi Arabia. Qatar’s market has been pulled higher as the increase in foreign ownership limits result in an increased weighting for some of its largest stocks within emerging market indices. Within Saudi Arabia, the impending MSCI reclassification has resulted in significant investor positioning. We have also seen entities which benefit from higher oil prices, such as those operating in the petrochemical sector, post strong returns. Looking ahead, we see much higher dispersion within markets, especially Qatar, as new companies see their foreign inclusion factor lifted by index providers, resulting in higher weightings for companies such as Mesaieed Petrochemical, Barwa and Qatar Fuel. For Saudi Arabia, the final inclusion may act as a positive catalyst for markets, although typically this has already been priced in and a brief correction could be experienced. What are your top investment concerns?
Three concerns which require close monitoring are continued geopolitical tensions, the rising strength of the US dollar and current stock valuations. Historically, the region has suffered tremendously from geopolitical volatility. Within the last 18 months, we have witnessed the imposition of the blockade on Qatar, intensifying international pressure on finding a solution in Yemen and renewed tensions related to Iran. While these events have not dampened international investors’ appetite to date, they may continue to cause concerns amongst investors in the coming year and beyond. In addition, if the US continues its rate-rising trajectory, we anticipate a dual impact on the region. A stronger US dollar will have a negative impact on oil prices which will negatively impact regional fiscal strength as government revenues decline. We may also see investors rotate out of emerging markets, which could see selling pressure on those regional markets included in the emerging markets exchange traded funds. Finally, valuations today are somewhat stretched as a result of index related activity. Further significant multiple expansion is unlikely, so future growth will have to derive from earnings performance. We therefore need to see real growth to sustain the current valuations. Are you planning any product launches in the MENA region? If you have launched a product in this region in the past 12 months, please give a performance review and your expectations.
Earlier this year, the Ijarah platform launched the QINVEST SQN Income Fund III, which was significantly oversubscribed in the offer period, raising $65 million. The platform has now grown to $165 million in less than two years, paying investors a healthy distributed yield on a monthly basis. In Turkey, the team benefited from volatility in the markets and continued to deliver top quartile performances.
SALMAN BAJWA, SENIOR EXECUTIVE OFFICER, EMIRATES NBD ASSET MANAGEMENT What is your outlook for investments in the MENA region over the next 12 months?
The MENA region can be broken down into two parts; the Gulf Cooperation Council (GCC) bloc of oil-exporting countries and the rest, who are net importers of oil. For the GCC countries the first three quarters of 2018 resulted in massively increased revenues in line with the oil price spike. While this was offset somewhat with the resulting decline in the fourth quarter, the expectation is for stable oil prices for 2019. In such a scenario the economies of the oil exporting countries should benefit from increased liquidity. On the other hand, oil importers are faced with three challenges on the macro front: higher cost of energy leading to current account deficits and imported inflation, rising interest rates and potential currency weakness. We expect this to lead to higher input costs and consequent pressure on earnings. Overall, for the oil-importing countries, we are more selective on sector/stock-specific stories that are better equipped to navigate the above challenges. What are your top investment concerns?
We have seen heightened geopolitical tension caused by idiosyncratic events and this has increased risk premiums. While we expect this issue to clear out in the medium term, for the immediate short term it may continue to overshadow sector or stock-specific stories. Despite higher oil revenues during most of 2018, spending by the oil-exporting sovereigns has not yet fully trickled through the system, and this might lead to lower-than-optimum systemic growth. This decline in spending may worsen in the future as the price of oil remains volatile. Lastly, macro factors including rising interest rates, US dollar strength, higher energy prices and subsidy rationalisation in certain geographies are likely to lead to cost pressures for exposed companies that may not be able to offset through cost-efficiency programmes. Our investment team keeps a close eye on these imbalances, to differentiate potential winners from losers. Where do you see the best opportunities for investors?
The banks showed strong performance in 2018 as they benefited from the rising rate environment. We believe they continue to offer an attractive investment proposition in 2019 as well. Given pegged currencies and the fact that a significant portion of bank deposits are low-cost (or in some cases zero cost) we expect banks’ net interest margins to trend up, while credit costs are likely to be contained – providing earnings strength for the banks. Overall, Saudi consumer companies’ earnings are under pressure from expat departures and the higher cost base from expat levies and, to some extent, from higher energy/utility prices. That said, some market leaders are benefiting from industry consolidation and their ability to manage costs through economies of scale and cost-efficiency programmes. While we expect this trend to continue, some of these names offer interesting investment opportunities. Do you think the region will sustain economic diversification efforts given the good oil run at present?
We do not believe geopolitical tension will ever completely dissipate in any market. Markets, from time to time, will continue to factor in a risk premium, sometimes higher and sometimes lower, depending on prevailing circumstance. Furthermore, depending on how individual sectors/companies are positioned, reforms create structural shifts that result in long-term winners and losers. While we keep a keen watch on emerging long-term themes and geopolitics, through both our top-down and bottom-up analysis, we prefer to invest in sector or stock-specific stories that are likely to dominate others on a 12 to 18-month horizon.
ERIC SWATS, SENIOR EXECUTIVE OFFICER, RASMALA What is your outlook for investments in the MENA region over the next 12 months?
Our long-term view on the region remains positive, driven by economic and social reforms. Various reforms have been implemented and we expect further measures to be introduced to address the structural imbalances in the ecosystem. Furthermore, regional governments are paving the way for a higher private-sector participation in driving future economic growth. MSCI/FTSE classification is likely to increase the audience following the region and expand market coverage, which should lead to additional capital flow into regional markets coupled with new breeds of investors. The GCC region is expected to make up 4.0% of the MSCI EM Index, a size that passive investors cannot overlook and hard even for active managers to ignore. We expect the MENA region to command a permanent allocation in any global emerging market portfolio as opposed to being just a trade relative to the emerging markets. We expect many products to be created on the back of MSCI Saudi Arabia and GCC Indices. Such products and structures should generate a steady and consistent flow of capital into the GCC equity markets. Additionally, we expect market liquidity and efficiency to improve, and this in turn should encourage further listing in the region. Where do you see the best opportunities for investors?
The underserved nature of the healthcare and education sectors represent a lucrative investment opportunity for the private sector. The young and growing population in the region necessitates large investments in these key sectors. Therefore governments are aiming to shift the burden of catering to the growing demand for such services to the private sector, not only targeting to reduce the burden on their budgets but also to increase the standards and quality of services. The region’s young and growing population is expected to boost the demand for services and consumption which should support economic growth. Creating jobs for citizens through the displacement of foreign labour is a high national priority for regional governments, which in turn should result in a higher disposable income, further supporting demand for services in the long run. Foreign institutional participation in regional equity markets remains considerably low compared to peers, and we believe this would change over the next 24 months post-Saudi Arabia’s inclusion into the MSCI EM Index, which presents a great opportunity for long-term investors. This is particularly true given the retail investor dominance of regional equity markets, which has resulted in continuous pricing inefficiencies and valuation gaps.
ERIC ANDERSON, SENIOR GLOBAL EMERGING MARKETS PORTFOLIO MANAGER, MILLTRUST INTERNATIONAL What are your top investment concerns?
This remains one of the world’s most complex regions defined by geopolitical tensions, regional conflicts, unique political and legal structures and the changing social landscape (large youth population, unemployment and women’s rights). Any setback from the above could stall the realisation of the growth potential in the region. This is particularly significant in Saudi Arabia, where the country is currently immersed in a major domestic economic revival programme which could collapse should serious conflicts arise or the political environment deteriorate. The same applies to the UAE, whose business model relies on political stability in the region. Obviously, many MENA countries rely on crude oil to support their growth, so oil price remains an important risk factor to monitor until we see enough diversification in the different market economies. Do you think the region will sustain economic diversification efforts given the good oil run at present?
As we have seen across most emerging markets in 2018, geopolitical tensions can cloud investment opportunities, weigh heavily on sentiment and cause heightened volatility in the short term regardless of the underlying fundamentals. These tensions are the noise and subsequent volatility that investors have to bear until reform measures take over the headlines. The key challenge is to avoid being embroiled in these short-term developments and instead use this opportunity to build positions in high-quality businesses whose valuations have been beaten down. These tend to be more domestically focused businesses and sectors that are more insulated from global risks; for instance, in Saudi Arabia, our local team has found opportunities in key domestic areas like education, healthcare, insurance and entertainment.
WALID MOURAD, PORTFOLIO MANAGER/ANALYST, MIDDLE EAST NORTH AFRICAN EQUITY TEAM, LAZARD ASSET MANAGEMENT Where do you see the best opportunities for investors?
Asset flows into MENA have been largely driven by technical factors over the past year. This has resulted in a bifurcation in the market between large-cap, MSCI-related stocks, and small and mid-cap stocks that have benefited less from MSCI-related flows. In the latter, we see many opportunities that are being overlooked by investors. Sentiment has been dominated in recent months by Saudi Arabia’s inclusion in the MSCI Emerging Markets Index, causing investors to overlook other countries. For instance, Dubai’s benchmark stock index is trading at a seven-year valuation discount relative to Saudi Arabia’s equivalent index. Once Saudi Arabia is formally included in the MSCI Emerging Markets Index, and investors’ global portfolios have adjusted to reflect this (largely through passive flows), we believe technical factors will give way to a renewed focus on the underlying fundamental drivers of individual companies. Are you planning any product launches in the MENA region? If you have launched a product in this region in the past 12 months, please give a performance review and your expectations.
We believe the MENA region offers investors tremendous opportunities. There is a scalable opportunity in the market, for instance among less liquid, deep value, small and mid-cap stocks. Historically, these segments of the market have been difficult for investors to access, but they are beginning to open up to international investors. We believe that there are also tangible benefits available to investors to create long-term shareholder value, and in advising company management on how to unlock value from their businesses.
PIETER HENDRIK, HEAD OF MIDDLE EAST AND AFRICA, GLOBAL INVESTMENT SERVICES AT T ROWE PRICE What are your top investment concerns?
Our top three investment concerns are a global economic slowdown, leading to a sell-off in risky assets while central banks have limited firepower, a rise in inflation or the impact of tightening monetary conditions, which both could lead to a sell-off in government bonds and equities at the same time. A disorderly Brexit would lead to regional problems across Europe. ©2018 funds global mena

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