DUBAI ROUNDTABLE: Milestone events

Our panel discuss the upgrades of Qatar and UAE by MSCI, the opening of the Saudi exchange and why Ucits is a mark of credibility. Chaired by George Mitton in Dubai.

Dubai roundtable winter14

Mark Friedenthal (chief investment officer, Abu Dhabi Commercial Bank)
Reda Gomma (head of equities, Mashreq Capital)

Bassel Khatoun (head of MENA equities, Franklin Templeton Investments)
Firas Mallah (managing director MENA, BMO Global Asset Management)

William Wells (director, Middle East, Schroders)

Funds Global: To what extent will the opening of the Saudi stock exchange to direct foreign investment, planned for the first half of 2015, bring inflows and investor attention to the MENA region?

Mark Friedenthal, ADCB: The opening of the Saudi equity market to foreign investors is the most significant development in the region in a long time. The Saudi market is close to three times the size of the combined UAE markets. It’s a large, deep and liquid market.

In the context of the investment universe, the MSCI Saudi index has 45 constituents. By comparison the MSCI UAE index has 12 and MSCI Qatar has ten. Saudi Arabia represents a very interesting investment opportunity set. 

In terms of demographics, the country has a population of nearly 30 million people, of which two-thirds are Saudi nationals and 50% are below the age of 25. 

The stock market represents a full spectrum of economic sectors. 

These market characteristics encourage institutional investor participation. The depth and liquidity of the market focuses their attention and prompts further analysis, whereas for a smaller market this may not be the case because the investment opportunity set is narrower.

Bassel Khatoun, Franklin Templeton: It’s a massive step forward for the region. The Saudi market cap is close to $550 billion and Saudi is trading $2.3 billion a day, which is significantly higher than Russia, South Africa and Turkey. The scale and volume of trade for the Saudi market is very likely to gain attention from international investors.

Today, foreign representation represents close to 1% of that market. Opening up the market by 10% creates a $50 billion opportunity for foreign funds to come in. That’s hugely significant. 

Of course, it does also pave the way for the region and Saudi to become part of the MSCI Emerging Markets index. The initial suggestions from MSCI suggest that Saudi would represent about 1.7% of the index, though that will depend on foreign ownership limitations.

In general, the opening-up process elevates the status of the entire region and, in doing so, brings with it a lot of benefits. Saudi is a predominantly retail market today and 90% of volumes are retail driven. 

As you institutionalise the market, you bring a degree of sophistication and maturity that is currently lacking. Indeed, we view this as the most transformative event for our region in a very long time.

Reda Gomma, Mashreq Capital: Saudi opening to foreigners will bring the big tickets to MENA markets. Market capitalisation is big and the market is very liquid and well diversified. This event will support the rally for MENA equities in the medium term because having those inflows, either from passive or active funds, from emerging markets or from developed markets, will increase the influence of MENA and investor appetite. We plan to increase our fund’s weighting to Saudi Arabia. You have to be reactive to this announcement. This is a natural thing.

William Wells, Schroders: It’s a very positive step. Whether Saudi has a weighting of 1.7% or whether it’s potentially 3% or 5% in time, that inclusion in the MSCI Emerging Markets index puts the Middle East on the map. The region becomes a much more important part of the overall emerging market universe and that’s going to bring further asset flows. Many managers here, such as Schroders, already include Saudi stocks in our portfolios but, for others, there are going to be increased levels of interest, which can only be positive for the regional markets.

Firas Mallah, BMO Global Asset Management: This event would allow a lot more investors to access the Saudi market directly instead of via p-notes or other instruments. The economic opportunity will widen. 

Having a more sophisticated market, a deeper market and an institutional market could also encourage more listings, which is something the authorities in Saudi have been pushing for a while. We could see more IPOs [initial public offerings]. When businesses see an opportunity on the demand side, from international institutions, that will unlock that potential. It is a game-changer, in many ways.

Funds Global: Now that the UAE and Qatar have enjoyed MSCI emerging market status for several months, can you say what the benefits have been in terms of inflows and investor interest in these markets?

Khatoun: The upgrade of both markets is a milestone event for the region. The GCC has seen $4.4 billion of net inflows in the first nine months of this year, compared with $3.7 billion for the entire 2013. Of this year’s inflows, Qatar represents $2 billion and the UAE represents $1.6 billion. Looking at the month of May specifically, that month saw record inflows for the UAE and Qatar, and that was the month that preceded their elevation into the MSCI Emerging Markets index.

Overall, what you’ve seen this year is a 65% increase in volumes traded in the market. 

That, to me, suggests that both local and international investors are taking note of the opportunities in this region. That’s validated by the performance. The Dubai Financial Market (DFM) is up about 39% so far this year and the Qatari market is up 32% as of the end October.

Wells: The latest flows are encouraging, but the real benefits will be seen in the long term. The increase in foreign participation, from companies including Schroders, Franklin Templeton and other international players, will lead to better levels of transparency and improved levels of corporate governance. That’s going to be positive for the market, as more of this money becomes long term rather than short-term money.

The other thing that we’ve seen is the increase in IPOs, which is something that’s sprung up over the last few months on the DFM here in the UAE, as well as in other parts of the region.

Friedenthal: Improved volumes are important but the upgrades also bring more efficiency to the market. Institutional investors are more systematic, more data driven, more practical in their investment decision-making process, whereas retail investors are more prone to rumour and speculation. The presence of an institutional investor mentality in the market will bring greater stability and lower volatility.

We did indeed see substantial inflows at the time of index inclusion, however, if UAE equities hadn’t experienced a 250% plus gain in the 24 months leading up to the index inclusion date, we could’ve seen a far greater volume of inflow. 

Active managers, because valuations had become stretched, were not participating to the level we would’ve expected them to. Nevertheless, they are data driven. When they do see valuation improvements, their participation levels will improve.

Gomma: Mark is right that the benefits are in the more sophisticated investment approach. As proof of that, if you look at the UAE and Qatar, they are the best performing markets in MENA this year to date which proves the point of increasing inflows into these two markets. Plus, the market now is starting to reward the good companies and punish the bad companies. The stars of Dubai and Qatar have been stable and outperforming the market. 

Meanwhile, the more retail driven and speculative stocks have been hammered when the market corrected.

This means the level of sophistication has increased in both markets, and that’s a great benefit for institutional investors like us. In addition, the retail investor has started to think a bit differently now. 

These markets are not about hit and run money. You have to have an investment strategy and be careful in your selection.

Mallah: We see a lot more traffic from our emerging and frontier market people in the region. We used to have portfolio managers passing through so we could do investor meetings. Now, portfolio management teams are passing through to do their own company due diligence. 

We find a lot more local engagement, which is part of why the authorities are upgrading those markets and institutionalising them.

Funds Global: MENA countries have a large weight in frontier market indices – Kuwait is the largest single entry in the MSCI Frontier Market index. How has the popularity of frontier market investing benefited MENA? And are there risks these assets could be overvalued?

Wells: It’s interesting. Six months ago at another Funds Global MENA roundtable, all we talked about was MENA funds, whereas at Schroders, we were talking about global frontier funds.It’s great that the question is now coming to frontiers and thinking of MENA as part of those frontier markets, because it makes them more attractive to clients. 

One of the reasons is that many investors from outside the region worry about instability in places like Iraq and Syria, as opposed to the strength that you see in some of the Gulf economies.

With regards to Kuwait being a larger part of the MSCI Frontier Markets index, one thing about frontier market investors is they tend to be less benchmark-aware than investors in either developed or even emerging markets. 

The increased weight of Kuwait doesn’t necessarily lead to more money pouring in. 

I would also point out that since the upgrades, the weight of the Middle East has actually come down in the frontier market index and other regional weights, like Africa, have increased. So, singly, Kuwait might have benefited but the region as a whole has become a smaller part, which is potentially going to impact the local market as well.

Mallah: Frontier market funds are great products but there is a problem of capacity in frontier. We have capped our frontier market portfolio to $1 billion. Regarding this region, we do look at it, but we consider this region “less frontier” than others if we can say so. In other words, its markets are deeper and more developed than other countries in the frontier index. We give it a lesser weight compared to the benchmark. If you compare MENA to Africa or places in South America or places in Asia, these are much shallower markets, but they are more frontier. There is, obviously, the MSCI classification, which we all respect but, in our minds, some markets are already emerging markets, whether MSCI puts them there or not. This is one of those cases.

Khatoun: Frontier markets are an attractive asset class for which Franklin Templeton has seen a strong appetite. The attraction of frontier markets is that they represent the next generation of emerging markets. However, the emerging market universe is a much more broadly followed index. We saw the visibility of UAE and Qatar increase dramatically when they moved into emerging markets, whereas the foreign participation or visibility of Kuwait has not changed drastically now it’s a larger component of the frontier markets index. The interesting transition is the move from frontier to emerging. The way we view the MENA region is in a state of transition towards becoming a distinctly identifiable subset of the emerging market universe, in a similar way to Latin America, Southeast Asia or emerging Europe.

Friedenthal: The inclusion of any market in a recognisable and reputable index brings the right calibre of investor. Index inclusion ultimately leads to more efficient price discovery. Index inclusion, however, does not necessarily result in overvaluation. The MSCI Frontier Markets index has a market cap of around $650 billion, whereas the MSCI Emerging Markets index is close to $8 trillion in market cap. So the emerging market space is a vastly larger market. While attractive for investors with specific risk appetite, the frontier markets are perhaps small enough for many institutional investors to overlook. 

Large institutional investors will question whether the costs and complications of local settlement processes and procedures are sufficiently rewarded. A passive manager may accept a small tracking error and stay out.

Funds Global: Launching Luxembourg or Ireland-domiciled funds under the Ucits brand is seen as a mark of credibility in asset management. What are the main challenges involved with launching these kinds of product?

Friedenthal: We’ve just concluded such a project ourselves. The most important consideration is cost. Luxembourg is not a cheap jurisdiction to domicile a fund in. If you don’t have critical mass, if you don’t have assets under management in excess of around $50 million, Ucits is not feasible. 

For smaller funds the large fixed costs inherent in a Ucits fund will result in prohibitively large TERs [total expense ratios]. So cost becomes a big issue.

Luxembourg local substance requirements are also challenging. Ucits have to be managed by entities with on-the-ground presence in Luxembourg. 

There are solutions to this problem, but these introduce additional costs. This is often achieved through the use of a third party management company in Luxembourg that can fulfil the regulatory substance requirements.

As a Luxembourg domiciled entity investing back into the GCC markets, we are no longer considered a local entity and will encounter certain foreign ownership restrictions. 

Whereas we have unrestricted market access for our locally domiciled funds, the Ucits fund has a reduced universe of companies that we can trade. Some of the regulatory, collateral and diversification rules are also challenging when investing into narrow markets. 

One of the consequences of redomiciling our UAE equity fund to Luxembourg was the need for a customised UAE benchmark which complies with these Ucits diversification rules.

Gomma: We have had more than five years of experience of running an Ireland fund. I agree with Mark about the cost issue, but on the positive side, institutional investor clients appreciate that fund compared to funds domiciled in Bahrain or the UAE. 

They look with more respect to an Ireland fund compared to the others, especially those ones who are looking for a long-term return, such as pension funds or insurance companies.

Wells: Ucits is a stamp of credibility and that’s why we’re seeing an increase in Ucits funds available in the region. Also, it allows local asset managers to sell into other markets more easily. Schroders have three different fund companies in Luxembourg. Two of them are Ucits with multiple sub funds, and that allows us to distribute in many different markets, as well as here in the Middle East.

But, even if you have that Ucits brand, when you come to the UAE, you have different regulations and costs for registering foreign funds compared to local funds. 

According to the SCA [Securities and Commodities Association], the UAE regulator, the number of local investment funds that have been registered is 18. The number of registered foreign funds is 525, of which the vast majority would be Ucits.

Khatoun: Ucits is held in high regard because of its stringent criteria on the way the funds are managed, structured and governed. But there are challenges around passporting funds through various states of the EU. Because of local regulatory requirements, registering a fund in individual countries can be time-consuming and costly. In addition, you have to adapt to local nuances, which means having the fact sheets and the local marketing material in the language of that country, which again increases the cost of the fund. Ucits funds have advantages but they also come with challenges.

Mallah: For a foreign manager, there are really two ways to sell funds into this region. One is to register the funds and have them properly licensed. The other is to work with a local partner to set up their own offshore Ucits funds for us to manage for them. That’s the route we’ve taken, successfully so. We do understand the complexities of this but, on the other side, we understand the credibility of Ucits. We’ve done a massive exercise of bringing all our other offshore funds into Ucits platforms in Ireland and Luxembourg, and we have about four platforms between the two countries. There is a drive from local entities to have their own Ucits funds and our role, as foreign managers, is to help grow that and transfer our expertise.

Funds Global: For the regional players, what are the challenges with building a brand outside the region, and how can they be overcome? For the international players, what’s the best way to market your brand in the MENA region?

Friedenthal: The biggest challenge for a small manager is the same as with establishing Ucits: cost. For international firms with a wide global presence the exercise is far easier. These firms have the luxury of time and the benefit of frequent face-to-face engagements with prospects. For a smaller regional manager, with a limited team, we need to prioritise and focus on specific markets where the demand is tangible. We also need to overcome issues around language and marketing collateral when the target is not an English-speaking country. 

The first quick win is to get on to the life insurance platforms and business-to-business platforms such as Allfunds Bank, where we can achieve a global distribution reach through a single point of contact. But, even through this model, you need to have some presence. You still need to have a dedicated person or team of people who can get on a plane and meet with a big client, if it’s necessary.

Gomma: It’s a long-term thing. We are working hard on it and we are expecting more inflows to come in the near future. 

I would also say that some firms are trying to team up with international names, to market their funds or to build their brand internationally. In some cases, the internationals team up with local players here to promote their products into the UAE, especially the mutual funds. That has happened in a couple of cases. 

We are facing a lot of challenges, but we have been in the distribution lists for some international insurance companies. We’re starting to get inflows and the ticket sizes are improving and the number of tickets is increasing, compared to last year.

Wells: For us as an international player, it’s important to know that there are many different channels for distributing your products. As well as the insurance channel, there are the retail banks, private banks and direct sales to institutions and family offices. For the intermediary part, it’s all about building partnerships with distributors. We’re very fortunate that we have a lot of strong global relationships with the major private banks and consumer banks, as well as excellent relationships with local banks built through our presence on the ground.

Mallah: This is a difficult market. As an international player, you’ve got to compete against local institutions, foreign institutions based here, and the guys who fly in. 

Also, most of the institutions here have their own reach. They can go find their own products in New York or London if they wish.

If you focus on what you can do well, you can have some quick wins and then build on that. 

Some players have started like that and grown to sizeable amounts of investment in the region, but you have to pick the right battles and, whatever you pick, invest accordingly. 

The days of coming to the region with the mentality of “I’m going to maximise my return for minimum investment” are gone. The regulatory environment has changed and the way the markets here expect you to behave is different now. There are no more suitcase bankers. If people think that is the case, it’ll stop being the case quickly because, if you look at the regulations and the written word, it’s basically not even doable.

©2014 funds global mena

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