DISTRIBUTION PANEL: Exploring open architecture

Gulf fund management is rife with competition. The Funds Europe Gulf Distribution Panel, held in Dubai, discusses market entry and meeting investor needs.

Jamal Al-Naif (managing director, head of asset management distribution, Mena, Credit Suisse)

Eric Swats (head of asset management, Rasmala Investments)
William Wells (head of intermediary sales, Middle East, Schroders)


Funds Global: A key focus for asset gathering in the Gulf is the high-net-worth segment, who are typically targeted though private banks. Is the open architecture system of fund distribution, whereby a bank will distribute third-party asset management products as well as its own products, recognised in the Gulf?

Jamal Al-Naif, Credit Suisse: Credit Suisse has several channels of distribution, both in-house and third-party products. Our private bank has an open architecture platform while our private funds group is mostly a third-party asset raising business. Asset management distribution raises funds for Credit Suisse in-house managed products only and that is the area I was brought in to build in Mena [Middle East North Africa].

Eric Swats, Rasmala: At Rasmala Investments, we focus on managing Mena assets ourselves here in the region, where we have teams on the ground in Cairo, Saudi Arabia, the United Arab Emirates and Oman. Around 17 people in our asset management group focus on managing funds, portfolios, and segregated accounts for governments, ultra high-net-worth individuals, and some sovereign wealth funds and corporations.

But in order to provide our clients with access to global strategies, we offer access to global investment managers, both in a Sharia-compliant manner and in a conventional manner, through a fund of funds approach. We are responsible for the allocation, selection and monitoring of managers within those funds.

Therefore, we do provide open architecture in a ‘packaged’ way. That’s the way we describe it.

Funds Global: Eric, can you say how many third-party fund managers Rasmala has on its platform?

ES: Well, we don’t have a platform per se. Our clients cannot select managers A, B or C. They can, however, select the Rasmala Global Equity Opportunity Fund, which would have 12 to 15 underlying funds within it.

We look at ourselves as specialists in manager identification, manager due diligence, manager selection asset allocation and risk management. We manage a fund of hedge funds that works in a similar way.

Funds Global: Jamal, how many external managers does Credit Suisse in the Gulf have on its platform?

JAN: We have a few partnerships. We are partnered with Abu Dhabi-based Mubadala and Gulf Capital in regional infrastructure and private equity respectively.  We are also working on rolling out a few more during the course of 2009.

Funds Global: William, as someone essentially trying to sell funds for Schroders, a UK-based fund manager, into the Gulf market, how do you find the distribution system?

William Wells, Schroders: Within the Gulf Cooperation Council (GCC) there are a diverse number of different countries and each has its own regulations. So depending on where you are working with your clients, you will have to approach the market differently.

The UAE, for example, is quite open and there are a large number of banks. Traditionally, the leaders in fund distribution have been international banks that have had a longstanding presence. Many of those have operated open architecture platforms, but they are now moving towards more focused lists of managers and towards guided architecture, whereby they may have 30 or 40 different funds that they offer, but only from a select number of asset management groups. Schroders, clearly being present in the region, is one of those fund houses that sits on a number of open architecture platforms.

Gulf investors and Gulf equities
ES: What is happening on the ground here is that a number of local asset managers have partnered up with global players. A large global group might take a stake in a local firm to help them establish their presence here and they might also distribute their international products through these local partners.

But more interesting for local investment firms is the opportunity to gain access to international distribution for their Gulf strategies. There are examples of this in Saudi Arabia and the UAE.

Funds Global: It’s often said that sovereign wealth funds in the Gulf invest internationally. So how much money is sourced from other local investors and invested in Gulf markets?
ES: Local investors in these markets have a very small percentage of their assets actually invested in local market funds or managed accounts. Locally-managed assets as a percentage of market capitalisation is very, very low. Most of these investors also like to trade individual stocks in the region’s markets. Everyone has a view about which way stocks are going.

On top of this, the region is also quite lightly invested by international investors, and this is for a couple of reasons.

The first is that these markets themselves are quite outside of the mainstream. They are not developed equity markets – they’re not even in the emerging equity markets universe, they’re in the ‘frontier’ equity markets category, which covers markets in the Middle East, Africa and elsewhere.

The market cap could be relatively large if the region’s markets were included in the main emerging markets index – maybe 7%, principally driven by Saudi Arabia. But because of the stage of evolution of these markets, and given certain micro factors in terms of regulatory framework and access, they are not included in the main indices. There is a great opportunity, we think, for these markets to improve on their transparency and the regulatory framework, so that more international investors come into these markets.

That is something we often find of interest to international asset management organisations that also have a distribution network but don’t want to build up a team in London or Geneva to manage money in Gulf markets. They’d rather work with a Gulf asset management firm, but hopefully as well they are also gaining access to that local asset manager’s distribution network.

Managing partnerships
Funds Global: Eric, you were saying that you are a proactive selector of managers and funds. Nevertheless, do you receive a lot of unsolicited approaches from foreign investment managers?

ES: Rasmala is open to any manager, in principle, but we are also professional buyers of funds and we do not take meetings with people just because they want to come by and roll out their fund offering to us.

We have our own methodologies to take funds from the broad universe and ways of scaling them down. We are proactive in our approach to fund-selection and not really open to relationship-building efforts from managers.

Our advice often to these groups who are looking to establish relationships here is to tack the Gulf operation onto their European business and pick one person who is going to come out every other month, spend two weeks out here and start to develop things.

I think there is often a misperception amongst international managers that if you just start showing up here you’ll start taking business. But it’s a very competitive marketplace; all of the large players are here, so if you want to make an impression it will take time.

The other aspect is that if you’re looking at the really large investors in the region, then having someone dedicated full-time is probably money not well spent. Many banks have paired up already with international firms and it’s not like there are a lot of new relationships, I think, being established. So I often counsel people to give the responsibility for this to somebody in the European distribution side of the business. Give it to them and tell them they have to be out here two weeks every other month, and in a year’s time make your own opinion about what the opportunities are here.

Funds Global: Jamal and William, what peculiarities are there for foreign asset managers trying to access Gulf clients?

JAN: Institutions in general have developed a very good manager selection process which can be somewhat long in nature.

On the HNW side, the selection process can vary from being very simple in nature to ultra sophisticated.

WW: It very much depends which channel you are looking at. For the pure institutional channel you need to build long-term relationships and you can service them whether you’re here or whether you’re in New York or London or anywhere else.

But if you are looking at a distribution business, it’s different. Schroders started off by covering the Gulf from London and I did that for a number of years. Although you can build up the business to a certain level, to actually really build it on a long-term basis and turn it into a scalable business you need to have a presence in the region. For distribution it is very, very difficult to do it from afar. I agree with Eric that it might be a way to start out in the market, but if you’re actually going to build a credible business here, servicing your clients, working with your clients, you need to be able to go in and see them whenever you’re needed.

Some of our competitors have a presence here but a lot don’t. It’s those people who are no longer travelling here because their companies are slashing travel due to the current financial crisis that will suffer.

Schroders is very fortunate in that we are one of the leading independent international asset managers and so we have global relationships with a lot of big international banks. We have a lot of agreements in place with the banks and it’s a case of servicing them locally.

Having a local presence does help you build strategic relationships with local asset managers and banks. Many managers come down here and set up a sales and marketing office. Schroders did exactly the same, but then we added to that with a local investment management capability as well, and the feedback from institutions that we talk to is very positive that we’re adding something back into the local market as well.

ES: As a local bank, we want access to the investment managers for products such as emerging markets. But we would not expect these people to be travelling out here and be distracted from their job.

But a local, on-the-ground presence is increasingly important in a market like Saudi Arabia, where the Capital Markets Authority has taken a very strong approach with respect to fund distribution by requiring asset managers to seek out approved persons, approved authorised firms, to help them oversee the marketing of their funds. We have met with a number of firms who are looking really just for someone to partner that has approved-person status.

High net worth and retail
Funds Global: Where is the ultra-high-net-worth wealth, which everybody wants to plug in to? Is it, as some people say, actually being advised on and invested from Switzerland, not in the Gulf? And what about retail business from non-resident Indians (NRI) and non-resident Pakistanis? How significant is this?

ES: With respect to ultra-high-net-worth people that we deal with, their money is very segmented. They have got offshore money, which might be in Switzerland most likely, but it could be in London or New York as well, and then they have their local monies for investments. From time to time, they do asset allocation shifts between these two pots of money, but very often they’re quite separate, they’re thought of quite differently, they source different providers of services.

The money that finds its way into Switzerland tends to be much more conservative in nature. The money that’s in the Gulf is much more for speculative or risky investments, be it in real estate, public equities or in investment products.

JAN: Switzerland is still very significant in terms of private money for this part of the world, but so is London. I think generally the larger private banks will manage their wealth management businesses either from London or Switzerland. However, there are also a few that have managed to make a success of booking assets in countries such as UAE, Bahrain and Saudi Arabia.

On the retail side, take a country like Saudi Arabia where the banks have been quite successful in developing retail distribution. A bank like National Commercial Bank (NCB) has 250+ branches across the Kingdom so if they put an investment product on the shelf with a minimum investment of $2,000 you can expect to raise a decent pot of money for that product. The challenge for the likes of NCB is what product to select for that shelf since success for investors means repeat business and more
fee revenues.

Funds Europe: Is the mass retail market relevant to Schroders here?

WW: It is very much part of the business, and it is one of the parts of the business that is growing. But we’re coming from a very low base in terms of the retail investor’s propensity to save, and this is something that we’re trying to work on with our distributors, to help with the educational side, about the importance of long-term savings.

Product demand
Funds Global: What assets and strategies are most in demand by Gulf-based investors and has this changed significantly over time?

ES: The investment strategies that we see gaining in interest right now are on the conservative side, on the fixed-income side. We’re not talking about US or European government bonds or even high-grade corporates, however. We’re talking really about bonds of the Gulf. They became deeply oversold due to what we would consider to be the indiscriminate nature of the credit crisis and the nature of the investors that held these bonds.

Where we have been able to capture investor attention and interest is in fixed-income strategies related to the UAE and to the Gulf in general. We have also seen interest in Saudi Arabia, in particular, amongst both regional investors and international investors. With oil prices having moved up, with underlying economic fundamentals being quite solid, with the performance of the Saudi equity market being quite good, we’ve seen interest in the Saudi equity market from both international and GCC investors.

WW: If you look at investors – like Eric said about them having a pot of conservative money in Switzerland, and a local pot that’s invested more aggressively – I think you tend to see investors in the region are either very low risk or very high risk and there is nothing in the middle.

Over the last three to five years there were a lot of structured products coming into the market offering capital guarantees, alongside emerging market equity funds. Clearly the problems with Lehman Brothers and some other investment banks have meant that people are slightly more nervous about structured products and understanding what the risks are.

This means though that we are able to highlight to clients about the benefits of investing in mutual funds and the fact that the assets are ringfenced from others.

We encourage investors to build a diversified portfolio of growth assets and in fact we have started seeing investors looking more at corporate bonds, whether it be local names or international corporate bonds. There is also interest in convertible bonds as well, where risk is slightly higher.

But over the last couple of months there’s been renewed interest in equities. What’s important here is to remember that the Gulf is part of the so-called ‘frontier’ markets, meaning they have not graduated to become  emerging markets yet. The point is that people here often think of the high growth rates that markets like these have offered in the past and expect similar high returns in the future.

JAN: On the institutional side the two main concerns are liquidity and credit worthiness. When we were at the height of the financial crisis, investors wanted to keep their cash closer to home but that was much easier said than done so they bought US TBills at 0.15%.

What’s not working today for investors? We are not seeing demand for private equity or real estate yet, in fact, there are quite a few investors looking to exit from investments made in 2007 and 2008 and go into cash despite the likelihood of booking a major loss.  This is in the more developed economies but there are deals still being done in selective emerging market countries as well as GCC and Mena.

I think the hedge fund space is mixed but there are some strategies attracting attention and very specifically, credit.  This is a market that suffered serious damage in 2008 where everything from high yield to high grade suffered major losses. We saw capital markets opening up again in the last 3 months and as that happened, credit spreads reacted very positively and a few large investors are looking very seriously at the sector with a view to profit from the rebound. I’m not sure these strategies actually fit the hedge fund description as most of credit plays will be long only ones.

Today, the majority of institutions in this region, and I’m talking more about the cash-rich ones like sovereign wealth fund, pension funds etc allocate the lions share of their AUMs, 80-85%, to the traditional asset management space so global equity, fixed income and money market.

Funds Global: But Eric, for high-net-worth individuals, is it more about returning to domestic markets?

ES: You know, in Mexico they like to buy their bonds from the Mexican power suppliers. It’s the same in the Philippines. Well, we’ve had the opportunity here to do this recently because of a number of issues that were very, very overbought by international investors for a host of different reasons, which then were oversold by the same sorts of investors, that created opportunities to pick up mid-teen returns on credits that are investment-grade names, that provide the electricity and the water around here.

Some of those opportunities still exist, although the equity market and the fixed-income markets in this region have improved substantially and the yields have come down dramatically over the course of the past several months, but with clients who are risk averse still getting rather meagre returns on their deposits, they’re still looking for a pick-up in those yields, and maybe some of them are coming back into the equity markets now.

But there’s still an amount of money that is still rather conservative. Maybe they’ve lost and they don’t want to come back, or this was money that was always on deposit and now that the deposit yield is coming down, other fixed-interest-like alternatives are of interest.

Funds Europe: We’ve heard that local people do not invest heavily in Gulf markets. Nevertheless, where their equity investments are concerned, are they too concentrated on the Gulf?

JAN: Regional infrastructure has become a pretty popular theme of late, something that really was much less interesting to large investors two or three years ago. I can think of two regional infrastructure funds that are very well backed. Mubadala with Credit Suisse and GE have launched a GCC fund, as have the Abu Dhabi Investment Company and UBS. These are all names you expect will still be around in this region in years to come and as we see this region develop, more and more infrastructure investment opportunities will emerge.

Infrastructure investments are very long term in nature. They tend to be in the ten-plus years category with returns expectations much lower than those you would expect in private equity and real estate.  Still, investors recognise the relative safety of these assets.

WW: The other side is to do with what infrastructure impacts, and that’s the demand for commodities. This is where we are seeing another big, big demand, whether it’s from institutional investors, the high net worths, or retail investors.

JAN: International hedge funds for Middle East money will remain important. Obviously there was a huge amount of redemption on the private wealth side, and in some cases that is still continuing because of gates that have been imposed. It’s going to take a while to come out of this.

The hedge fund universe has shrunk quite substantially and I think overall people now understand how much money can be lost. It’s a case where investors have never gone through something like this before with hedge funds, other than LTCM and that was a one-off situation at that time. But to have the whole industry go through this to the point where if you lost 10% you did pretty well, all of a sudden people understand that this is not really a hedge at all and that you could lose half of your money just like you would lose half of your money in a long-only equity situation.

Demand today is much less from institutions. When I talk about institutions on the hedge fund side, I look at probably about 50 sizeable ones. When I talk about institutions on the private equity side, we’re probably looking at ten – ten substantial investors. There are of course more but we’re talking about the top tier here.

So there was a large group of people investing in hedge funds on the institutional side and that’s probably shrunk by more than 50%, simply because a lot of these players were banks who were effectively supplementing their returns with hedge fund returns, and enjoying it for many years. But when you get a shock like this, the boards of these banks look at them and asks why are they, as commercial banks, running this type of risk rather than doing what banks are supposed to do and lend money.
My guess is banks are out of the market for a while and focusing on their core businesses. It’s unfortunate. Most banks were buying for proprietary capital and again, had been doing so for many years.

WW: If the money does come back where’s it going to go to? Was it a problem with their own due diligence? Are they going to move more to funds of funds rather than picking a single strategy?

I think probably the two key areas they are going to want to see in the hedge fund arena are greater transparency and greater liquidity.

ES: Many investors have learned the hard way that it’s not just a case of looking at a hedge fund and saying: ‘How did you do in this particular month? Ah, you went up, you must be really good.’ There were a lot of other risks that investors were taking, which they were frankly naive to take.

But they are quite wise to them now, and my sense is that people will come back, but they will expect much higher returns.

Hedge fund investors who bought funds of funds rather than bonds, expecting cash plus 4% with a low volatility and seeing a very high Sharpe ratio – I think many of those people will not come back, they’d rather sit in bonds.

On the other hand, for those who look at these as risky investments and compare them to equity funds and other risky opportunities that they have, there are certainly many managers who are very, very skilled who will be able to offer reasonable returns.

But I think people are going to be much more selective in the managers that they choose and cognisant about these other risks and bucket them, not on the fixed-income side, but bucket them as a part of their equity investments.

Hedge funds investing in the region face a number of limitations that prohibit a long-short strategy to be implemented in any sizeable or effective way, and the securities or the exchanges do not allow for short-selling, so there’s little you can do. There is an over-the-counter market and you can at times find stock to sell short. But it’s often very expensive. It trades by appointment, so that the fund managers who have presented themselves as Mena hedge funds are really more ‘absolute return’ in their orientation.

There are a few more alternatives available at this point in time with some of the convertible bonds, other fixed-income securities, as well as possibly cheap equity markets. I think it’s a market that probably grows and matures as the exchanges evolve and become more sophisticated in the type of transactions that they allow. But at this point in time, hedge funds that come in are really looking for market exposure, they’re looking for market performance, they’re looking for things that are going to pop as part of their emerging-market portfolio or they are local managers who are specialist on this region.

Funds Global: Eric, you said that there’s a trading mentality in the region. Do you think there’s a positive outlook for ETF’s?

ES: We have used ETF’s from time to time in our global equity strategies. I think local investors will approach ETFs as a local fund, and they’ll have a similar appetite for that as they would for a Mena equity fund from a local manager, and as such they’d probably rather play around with the few stocks that they think they know well.

Funds Global: Rather than a whole index?

ES: Yes, rather than a whole index. That’s my sense.

Client satisfaction
Funds Global: How content are distributors and end clients with the level of service provided by fund managers? This includes returns, levels of client reporting and fees. Is there any fundamental change necessary for fund managers to obtain success in the region?

ES: In terms of client reporting, I think most of the banks and other distributors probably report very well. The reports that I see from the local asset managers are fine, I don’t think there’s a deficiency in what clients are receiving from the asset managers or their banks here in this region.

But there is one thing of note: fees. The fees of local asset managers are high. Many of them charge performance fees on top of relatively high management fees. Very often these performance fees do not come with a best-in-class performance fee calculation methodology, including equalisation and high water marks. So, I would expect to see fees in the region come down such that they approximate emerging-market fees globally.

WW: Schroders, as an international asset manager, brings international fees, international products and international standards of reporting to the Gulf markets. Feedback we hear is that it is in line with expectations certainly.

Our international fees would tend to be lower than the local fees, or the fees that local fund management companies are charging, so we would deem them to be appropriate and perhaps that other fees might be a bit higher. You might see other fees coming down rather than Schroders increasing our fees.

JAN: I think fees are very high here, in the sense that you’re getting long-only management and stock selection. The number of actual local stocks you need to follow are much, much fewer than those in a single-country stock market in the more developed economies.

It became a very contentious issue in 2008. If you look at GCC equity markets, they were probably down around 55% collectively and yet investors were still paying asset managers fees of 1.5% to 2%.   

The asset management industry is developing and I think it’s going to develop and progress more, but my main issue with it is the standard and quality of people managing assets today.  It needs to improve drastically. I don’t think this is going to happen organically if we want to make fast progress, so I would much rather see asset management companies in this region employing seasoned professionals from outside the region while at the same time setting goals to bring through local talent over a realistic time horizon.

At the same time I think regulations need to be brought into line with international standards.  We have seen unbelievable amounts of progress in this area in a very short space of time but I believe we need to continue to do more.

©2009 funds global

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