ABU DHABI ROUNDTABLE: A large pool of assets

Companies in Abu Dhabi have cleaned up their balance sheets and the stock market is growing fast. Asset managers say the UAE capital is a good place to be. Chaired by George Mitton.

Abu Dhabi roundtable

Mark Friedenthal, head of capital market solutions (Abu Dhabi Commercial Bank)
Karine Kheirallah, director, advisory & execution, investment solutions (Falcon Private Bank)
Firas Mallah, managing director, Mena (Bank of Montreal Global Asset Management)

Funds Global: What are the advantages of Abu Dhabi as a place to base an asset management business? How do these benefits compare with those of Dubai or Doha?

Firas Mallah, Bank of Montreal Global Asset Management: We took a long time comparing Abu Dhabi with Dubai before setting up in Abu Dhabi.

The paperwork is probably easier in Dubai, but we were more comfortable with Abu Dhabi’s approach to long-term planning.

Abu Dhabi has made public their 2030 initiative and it says a lot in terms of planning and commitment. We felt, strategically, it made more sense to be aligned with Abu Dhabi, particularly if you are working in institutional asset management or corporate banking. We feel cities like Dubai and Doha will probably grow their financial sectors into something more specialised.

Mark Friedenthal, Abu Dhabi Commercial Bank: Abu Dhabi has a large pool of wealth and a significant sovereign wealth fund presence. This draws talent and high-quality service providers to the region.

A benefit of Dubai is its free zone system, which allows 100% company ownership by foreigners. As a foreign bank, one can establish a representative office here in Abu Dhabi, but if you’re a small asset manager and you want to set up a business, the ease of doing business in the DIFC [Dubai International Financial Centre] is slightly higher at this stage.

However, in the long term, the Abu Dhabi 2030 plan is clear and robust. There is a clear framework for growing financial services there.

Karine Kheirallah, Falcon Private Bank: The government gives support to banks and asset management firms to set up their business. They want to attract companies to come and set up in Abu Dhabi.

For our clients, it’s important for us to be in Abu Dhabi. There is a lot of wealth out here. You have to be close to your clients and show that you have a presence here.

Funds Global: Though the Abu Dhabi Securities General Market Index has risen this year, it is at roughly half the level of its peak reached in 2008.  Do you ever hope to see a return to pre-financial crisis?

Friedenthal: We avoid looking at markets in terms of the 2008 highs. In behavioural finance, we call this tendency an anchoring bias. Fixating on prior reference points obscures the opportunities currently available. The 2008 levels are largely irrelevant to us. The period between 2005 and 2008 was an extraordinary period in financial markets. We saw extreme levels of credit expansion and massive amounts of liquidity brought into the financial system, which caused asset price bubbles around the world. The UAE was a classic case of this.

Ironically, UAE markets in 2008 became a victim of their own success. Because of their liquidity, they were among the first markets that got hit. Investors who needed to raise liquidity for margin requirements in developed markets exited positions on the higher end of the risk spectrum and sold the most liquid stocks in the UAE.

However, irrespective of the highs of 2008, equities now represent a great investment opportunity from a valuation perspective.

Mallah: The crisis in 2008 was a huge correction, but it was also an opportunity, particularly in Abu Dhabi, for firms to restructure and clean up their balance sheets. We still see ongoing restructuring and reorganisations and we think this can increase the health of balance sheets of firms in this market.

Kheirallah: In 2008, investors in the region were used to making money and high returns. Local and regional investors want to get back to these 40% or 50% returns, but for the past two or three years, they were not getting them in the stock market. The markets became very thin, even though there is still a lot of cash sitting on the sidelines, because people were trying to find alternative investments.

This year, I believe we’re going to see high returns on some stocks. It doesn’t mean we’re going to get to the 5,000 level that we saw on the exchange in 2008, but don’t forget that last year some stocks did very well. Aldar Properties was up 38%, for example.

We are seeing a lot of companies restructuring and cleaning up their balance sheets. We’re seeing mergers and delistings. We’re seeing all kinds of moves towards a healthier market environment.

We’ve started seeing an upturn in trading. Since the beginning of this year, even international players have started to come back into the market. Abu Dhabi and Dubai have trading volumes of about $80 million to $90 million a day. It’s been a while since I have seen those levels.

The macro story is positive, in terms of growth and in terms of GDP. The core sectors of the UAE are doing very well.

Funds Global: Have local investors learned lessons from the financial crisis? For instance, to be wary of hot money that can flow out of markets as fast as it flows in?

Friedenthal: Being wary of hot money is a part of it, but remember that markets are cyclical. Generally, at the start of market cycle we see domestic high-net-worth investors entering the market, which creates liquidity and starts some upward momentum. Institutional investors enter once there is sufficient liquidity and they then legitimise the momentum. Later in cycle when markets are topping we see unsophisticated retail investors enter the market, and they’re often the ones that get hurt when the correction occurs.

After the 2008 crisis, investors moved en masse into fixed deposits. As markets stabilised and rates started subsiding, investors moved aggressively into lower risk sovereign fixed income in their yield quest, then into emerging market fixed income and investment grade corporates and ultimately into the speculative high-yield space. High-yield fixed income delivered around 25% last year to investors.

Equity markets now appear to have bottomed, and with equity dividend yields looking very interesting, a cyclic transition into equities has started. We’ll see sophisticated investors taking equity positions followed by institutions on improving liquidity and valuations, and that repeats the cycle.

Before 2008, it was all about the easy money. Equity markets were fuelled by demand frenzy. I still remember a day in 2008 when investors broke down the door of a branch of one of the Dubai banks to get their applications in for an IPO [initial public offering]. Those were extraordinary times. We’re not going to see markets like that again, but having said that, there are still opportunities. You can still get excellent dividend yields and growth stories in some of these companies.

Kheirallah: In the bond market nowadays, you don’t get what you used to get in terms of yields, because demand and supply have played an important role as well as the recent US ten-year treasury yield movement. But I don’t think we’re going to see a shift from the fixed income market to the equity market. Those investors who were sitting on cash, and have been sitting on fixed deposit and money market funds, will deploy money back into equities, but they will also invest some in fixed income.

Funds Global: You’re not expecting a great rotation from bonds to equities?

Kheirallah: No, I think fixed income will still be there. As mentioned, the rotation will be more from cash to equities. Fixed income will still be part of their asset allocation as part of a diversification tool.

Mallah: We’re seeing a lot of appetite for global high yield and emerging market bonds as well as corporate bonds, but we’ve also seen a gradual shift into US and global equities.
If you look at what the US market has done in the last year, it’s made pretty decent returns for a very developed market. There’s still a lot of money flowing into high yield bonds, but equities are back, moving gradually.

Funds Global: There has been uncertainty in the UAE over the implementation of the Investment Funds Regulation from the Securities and Commodities Authority (SCA). Has this uncertainty affected your business, for instance in the areas of distribution, product development, and so on?

Mallah: As an institutional asset manager, which looks to work with large government clients, the regulation is not a direct concern. But, when you have a fund platform, you want to be clear who you can sell to and how. So far, our understanding is not 100% clear.

From our interaction with the authorities, we feel the aim of the regulation is to protect investors and not clamp down on the industry. That promises to be constructive and we
feel this is just the first phase of an evolution.

Friedenthal: These new regulations have been a work in progress for more than two years. Throughout their consultation phase, SCA received a substantial number of comments on the draft regulations, which have all been reviewed and carefully considered.

Yes, there are still parts of the new regulation that have not been well defined and are not clear, so this has definitely slowed down product development. You can’t develop a new product if you don’t know what you’re actually permitted to do.

In terms of distribution of products, we’ve continued with a business as usual approach, under the approvals that were given by the Central Bank. With effect from August of last year, any new funds which we wish to distribute have to go to SCA for approval.

Funds Global: What are the prospects for the regulatory environment now that the rules are published and the SCA is engaged in dialogue with the industry? What are the main points that still need clarification?

Friedenthal: The SCA and UAE authorities need to be commended on what they’ve achieved over the past two years. The new regulation is a huge step up from what existed before, under the previous Central Bank mutual funds regime. The Central Bank circular, which has been the full extent of the regulation for domestic mutual funds since 1994, consisted of only a couple of paragraphs.

The SCA has been highly cooperative in terms of listening to the industry and being available to take our queries and address those queries where possible. But, to move forward, there needs to be greater consistency. There are still a few unaddressed issues in the regulation which we hope will be resolved soon.

Mallah: For us, it’s about trying to understand the cut-off point that determines who is a qualified investor and what kind of discussion you can have with that investor. Is it allowed to sit down with someone and have a chat about your views on the market, and what you do? Or do you need to screen that investor and prequalify them before you can do that?

Funds Global: Some say the Mena region needs to see more IPOs to invigorate trading levels. Do you agree? Would you support some kind of government-led initiative to increase the number of publicly listed companies in the UAE?

Mallah: It’s interesting, because the GCC’s main economy, oil, is never going to be listed. The companies on the stock markets are a byproduct of the real source of GDP.
The question is, who has companies that could be listable? Those are either big families, or certain non-core government entities, and the question is why would they do an IPO?

Look historically at stock markets globally. Why did the stock market ever get created in the US? It’s because raising equity made more sense than raising debt.

It’s easy to tell big families, you need to IPO your business, but it has to make financial sense for them. They already have access to a lot of liquidity and are well funded.

Friedenthal: The point you make about not having an IPO purely for the sake of doing an IPO is very important. That should be avoided at all cost. Ultimately, I believe the issue in the UAE is a structural one related to the representativeness of the stock market.

The local stock market is dominated by banks and real estate. Oil and gas represents more than 60% of the Abu Dhabi economy but only 4% of its market capitalisation and 10% of the traded value.

Telecommunications makes up only 3% of GDP but represents 39% of the Abu Dhabi Exchange and 16% its traded value. Financial services accounts for 5% of GDP, but 48% of market capitalisation and 30% of traded value. Real estate is only 4% GDP but 34% of the traded market volume. This is as per data compiled by ADCB.

Funds Global: What is the significance of the Al Maryah Island project, which includes the Sowwah Square financial district? Will this area become a focus point for finance and asset management in Abu Dhabi?

Friedenthal: I wouldn’t want to draw too many parallels to the Dubai International Financial Centre (DIFC). The intention is not for it to be an independent free zone. The intention is to create a financial hub, where you bring together all of Abu Dhabi’s banking and finance-related businesses. It is an important part of Abu Dhabi’s 2030 plan to develop the island as a financial services centre.

Mallah: We’re looking at the option of moving there. Our feeling is that if it builds up as a financial downtown, it will make sense for us to be a part of that.

Kheirallah: The development is not only financial. There are a lot of law firms and consulting firms that have moved there. The Exchange hasn’t moved there yet. When it does, that will be a major pull as it will bring the brokerages there too.

Funds Global: What are your growth forecasts for Abu Dhabi and the wider region? What equity sectors do you think will perform well in the next few years?

Friedenthal: Looking at Bloomberg consensus estimates in terms of expected market moves, the numbers are around 12% for global markets plus a 3% dividend yield. For Mena markets, it’s somewhere around 16.5% on a 4% dividend yield, and for Abu Dhabi the consensus market gain is around a 19% equity gain with an excellent 5% dividend yield.

In terms of sectors, UAE banks are among the cheapest in the world. Abu Dhabi banks, in particular, trade at a significant discount to their peers in spite of a robust banking sector characterised by improving asset quality, strong capitalisation and earnings growth recovery on the back of lower provisioning.

In terms of real estate, the Aldar and Sorouh merger is an important signal of an acceptance of the need for consolidation, an important step on the recovery path, but it’s still too early to talk of recovery. We’re seeing some early signs of improvement in Dubai but we may still have a bit of a supply overhang here in Abu Dhabi, so it’s probably going to be some time before we see a tangible improvement in the real estate sector.

Kheirallah: Some of the banks in Abu Dhabi are very well capitalised. They’re solid. They don’t have exposure to international credit and debt. They have high profit margins, low non-performing loans, and they have support from the government.

In Dubai, real estate prices have been going up in prime locations. Don’t forget what has been happening in the neighbouring countries. A lot of people have come to Dubai from Syria, Egypt, Tunisia and elsewhere, which has boosted the real estate market.

©2013 funds global MENA

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