ROUNDTABLE: Following the spring

Stability may be returning to the Mena region after months of political unrest, albeit slowly, but how has this affected the markets and how is investor appetite in the region developing against this backdrop? Edited by Nick Fitzpatrick.

Stewart Adams (head of investors and intermediaries, Mena, Standard Chartered)
Nick Angio (managing director, Apex Fund Services)
Sean Daykin (head of investment funds, Emirates NBD Assest Management)
Fadi Al Said (head of investments and senior fund manager, ING Investment Management)
Eric Swats (head of asset management, Rasmala Investment Bank)
Richard Street (head of securities and fund services Middle East, Citi)
William Wells (head of intermediary, sales, Schroder Investment Management)

Funds Global: What effects have the regional uprisings had on investor sentiment for Mena assets? Also, has there been an impact on the asset allocation of local investors, for example, leading to more diversification?

Eric Swats, Rasmala: While the period of debt restructuring and protest, at least in the Gulf region, appears to be passing and stability is returning, we have yet to see a return of investor interest in this region. This is reflected in brokerage volumes, particularly in the United Arab Emirates where they are at quite low levels.

It can be seen also in international investors’ allocations to the region, which are as low as they’ve been in years, even for dedicated investors who invest in frontier or emerging markets.

On the other hand, things can only improve – but for the time being it seems the difficult operating environment for local investment banks will remain.

Stewart Adams, Standard Chartered: We believe there will be strong growth in Qatar and Saudi Arabia, and the whole region will benefit from higher oil prices and increased production. I think Dubai and Qatar have come out of this as places that people recognise as safe havens.

However, the region is not seeing a huge amount of investment movement and probably less than we expected to see coming into Dubai. People are still deciding on asset allocation and may wait to see if Bahrain settles down first. The bond market here is relatively small compared with Asia, for example, but the growth has been huge and will probably continue due to the safe nature of the investment.

Richard Street, Citi: One area we need to look at carefully is the commitments made by some of the Gulf Co-operation Council (GCC) governments as to how they are going to support their neighbours in the region. For example, Kuwait and Qatar have committed to make significant investments in Egypt, be that into debt markets, equity or other direct investments. That is important and will help move the whole region forward. But these things take time to pull through.

Nick Angio, Apex: The market remains fragile in the short-term and I think asset managers and financial institutions are still adapting to the ‘new normal’, even two to three years post the 2008 crisis.

From a political perspective we may still be in chapter one of the whole Arab Spring story. We’re still seeing a lot of activity in Egypt, Syria and Yemen, and even in Morocco. Overall, I think it’s still too early to say whether the new environment resulting from the uprisings will be positive or negative for the asset management and financial services industry.

Fadi Al Said, ING Investment Management: I’d emphasise three main points. First, when you invest in emerging or frontier markets, the biggest fears are usually political risk and default risk. And over the past three years most of these fears and risks materialised.

Historically, whenever these kinds of risks materialise it means the potential for things to get worse actually declines, so it’s better to deal with the risks and look to the future.

The problem is that to increase investors’ interest in the region we need a really solid fundamental base where earnings improve. The problem for our market is that it is concentrated in long-cycle sectors, like real estate and the bank sector, which is exposed to real estate.

Therefore, the second point is that we need new blood in the market, we need new companies, and governments should do something to support listing. Not of strategic assets but take, for example, Abu Dhabi National Oil Company. It has a lot of sister companies that support the main business of oil exploration. I’m sure I could give a lot of other examples across the region.

New companies would attract new investors and wherever we have a successful IPO (initial public offering) it improves sentiment.

The last point is about outlook. We have been selling the political transformation story – it’s part of the attractiveness of this region. That it is happening unexpectedly and very fast is not necessarily a bad thing. People have developed nice metaphors – some say it’s another Berlin wall falling. If managed well it could be a very positive transformation.

Sean Daykin, Emirates NBD: There are some good things going on in the world, too – certainly in this region. If you look at the bond markets, for example, over the last twelve months bonds are up 10% to 11%. We’ve seen lots of new issuance and much more confidence in that area. We are also seeing interest rates fall here. Eibors (Emirates Interbank Offered Rates) have been dropping fairly substantially over the last few months or so, and I think a lot of confidence is returning to that market.

Then, looking at companies, valuations in this region are pretty cheap, compared to emerging markets or global markets generally. We are seeing signs of improvement in the petrochemical sector; in financials, impairments are beginning to come down.

The macro side is a bit more tricky, but that affects the periphery markets more than the core GCC markets.

William Wells, Schroders: Compared with the international landscape, there are still strong levels of growth in the regional economies. For investors it’s a case of whether there are still good investment opportunities. I think there are, but it depends on risk appetite and there are so many other factors outside the local markets that people are taking note of it, too. Just when risk appetite appears to increase, something happens, whether internationally or locally, and it reduces again. Many investors are still sitting on the sidelines. There has been limited activity, whether it’s in fixed income, equity or other transactions. There is too much going on that has prevented the positive change in sentiment that we’re looking for.

In terms of diversification, there has always been a bias towards the home country, like everywhere else. But we’ve started to see many more investors asking for diversification of their risk. People have started to move from individual country funds to regional funds.

Increasingly, we’re seeing people looking for global diversification as well.

Street: The retail investor has typically focused on their domestic market. Clearly, the reduced activity from retail investors in the local stock markets has reduced liquidity and concurrently contributed to high bank balances. It’s very hard to see what the retail investor is doing with regards to investment funds. One individual or family group may be keen on investing across the Mena region, while another may want diversification through emerging markets exposure or to the western hemisphere.

If you look at the institutional investor, at one end of the scale there are sovereign wealth funds and central banks, which are very mature investors. Central banks traditionally focus on fixed income. This has not changed although we have witnessed an increased interest in the Asian issuers, while the sovereign wealth funds, which tend to have extremely long return horizons, continue to have very balanced portfolios across emerging and mature markets.

Adams: There have been significant bond issues this year which closed out at around $6 billion (€4.34 billion). They were oversubscribed and it seems that investors are keen to get into that type of investment vehicle. In the last month, I’ve had conversations with asset managers looking to set up new Mena funds as they think retail investors want a regional focus.

Al Said: Egypt was a very important chunk of many portfolios – 10% to 20% in some cases. After what happened there equity allocations went to more stable countries such as Saudi Arabia and the UAE especially, and fixed income exposure increased.

I think it’s very important to talk about the prospects of Egypt. Ahmed Heikal, chairman of Citadel Capital [a private equity firm] made a very interesting comment. He said that Egypt within five to ten years could be like Turkey, or it could be like Pakistan in 18 months. I agree with him. There is big potential in Egypt with its very high population, very low GDP per head, and very low penetration rates. To a certain extent there is a will among the young population to bring Egypt to the next level.

However, one risk we have highlighted is that the government is trying to please the people and unfortunately you can’t always please people. Egypt is not Saudi Arabia. Egypt cannot afford to please all its people, they cannot spend billions and billions on subsidies.

We think that there will be a devaluation in the currency if they continue. Egypt must focus on foreign direct investors and arrange all its regulations to help them.

So in asset allocation terms, I think Egypt is going to be the wildcard. In the meantime, everybody is going to focus on the GCC countries.

Daykin: Clients are more risk averse than they were, though it depends on which particular clients. On the retail side, particularly expats, they’re still focused on emerging markets –  gold, Brics (Brazil, Russia, India and China), the normal go-getting sectors.

As for high-net-worth individuals and corporates looking for segregated mandates,  they are much more focused on fixed income and equities and so they’re after more professional management. They had been doing it themselves but now they’re coming back to professional institutions.

Angio: From a fund administrator’s perspective we see what funds are being launched or are upcoming in the market.

In the private equity space there is significant focus on local investments as high-net-worth individuals and family offices have a clear preference towards investing in assets which are tangible and that they understand fully. But it’s different on the listed equity side. We’ve seen a lot of funds targeting peripheral Mena countries such as Iraq. There are a number of peripheral countries that have been targeted in country-specific funds and that gives us the sense that people are looking to diversify and not just hold GCC equities. 

Looking forwards, we expect to see an increased focus on China, Russia and India following the Arab Spring. Many investment managers are asking what is the best way to access those markets and to set up investment products there.

I think, therefore, there may be a shift in asset allocation towards emerging markets.

Street: There are some other technical aspects to think about, if you consider investors from beyond the region looking to return to the region. International investors have reduced or withdrawn due to concerns about the risk; this has affected liquidity. I’m hoping that UAE and Qatar will be admitted to the MSCI Global Emerging Markets Index. This will help raise liquidity and rekindle the interest in, and profile of, the whole region – encouraging the international investment dollars back.

That’s one aspect. Another concerns the packaging of international funds. If Mena equity funds are not ‘flavour of the month’ we need to encourage managers to package funds which include exposure to the Middle East markets. For example, frontier funds or industry-focused funds. We need more than just regional investors to start investing back into the region. Having said that, we should not underestimate the regional public sector investing back into the region. What will happen to those commitments to invest into Egypt and Bahrain? If the GCC invests $10 billion in each of these countries, it should create significant economic stimulus.

Al Said: I doubt the market could take on five new Mena funds. We need new ideas, more creativity. People need to differentiate, to specialise, and I think this is where the opportunities are. We don’t need another Mena equity fund.

Adams: Yes, managers are going through the process of back testing just now and I think the majority of them are trying to do something a bit different. After all, why go to someone new when you can go to someone with a track record?

Swats: But while the operating environment is difficult, I think the investment environment is still quite appealing and you can play a number of interesting global themes in the region very well. You can play energy, you can play infrastructure and you can play growth in domestic demand very well. The Mena region has high GDP growth; some of the highest levels around the world.

Sectors where we are focused include materials, capital goods, energy, retail and insurance. These are industries where we can exploit different themes and this has us very overweight Saudi Arabia, very overweight Qatar, with small nominal investments in Kuwait, the Emirates, Oman and Egypt – though very little in Egypt. We’ve been underweight in Egypt for a long time because the macro scenario has been quite dismal for a period of time. This strategy has helped us to earn nearly flattish returns year to date when the markets are down around 7%. Our onshore team in Egypt managing money for local, institutional clients still has 25% in cash and these are to be fully invested equity portfolios. We remain concerned about the economic environment with respect to the way the government’s managing the situation at this moment.

Al Said: One aspect of the infrastructure spend, which I think is around $500 billion to $600 billion, is the multipliers. For example, when China decides to spend $500 billion on its infrastructure, the multipliers are substantially higher than for a regional sovereign fund spending on infrastructure here. This is because in the China case, the workers will be Chinese, the goods Chinese, so a figure like $5 billion, say,  is multiplied into billions and billions.

When Saudi Arabia decides to spend $500 billion the workers are expatriate, the contractor most likely is Hyundai or Samsung. Most of the raw materials are imported, so we don’t see a major ripple effect.

I think the best infrastructure fund to have in the region is perhaps a Korean fund with some exposure to some local contracting companies. We don’t have really good infrastructure companies in the region, we have commodity producers with no pricing power, we have contractors that are actually overwhelmed with money that they earned but did not get. So the problem, if you want to play these themes, is very challenging.

We know the consumer story: it’s growing. So what are your options? A couple of names are trading at 16 or 17 times earnings because everybody likes them. Why the hell buy them? This is the problem that we are challenged with, that’s why we need new blood in the market, and by new blood I don’t mean an exit strategy. We need companies that are priced to perform well, this will create momentum.

We totally agree with Eric’s views about the themes. The problem is that it’s overcrowded. That’s why we went the other way, to illiquid names in some cases, focusing on very niche sectors.

Swats: I think it’s misplaced to expect governments to step up and list more companies, to provide more money for asset managers, and for that to be the hope that gets everything going. I think the environment has to be understood and for innovative ideas and good strategies to emerge from it. There are stocks in this region that are worth owning and there are companies which are competitive on a global basis as well, and which play to these macro themes.

Fixed income is another area where you can make good money for clients. Our fixed income fund is up over 4% year to date, which is quite attractive. It was up over 10% last year.

There are investment opportunities in fixed income securities from regional issuers. I think that waiting for local governments to be the catalyst for a better operating and investment environment will be a long wait.

Daykin: We are certainly positive on some of the countries in the region, such as Qatar, Saudi Arabia and the United Arab Emirates. We have overweight positions in those countries, focused energy stocks, fertiliser stocks, construction companies. The fiscal stimulus in Saudi Arabia and Qatar is going to really benefit these companies over the next five to ten years, so we’re taking a longer-term view that they should do very well in terms of earnings growth. They may be a bit more expensive but over the long term we think they’re going to grow into those valuations and do well.

Funds Global: What type of investment returns do clients expect, and how realistic are they?

Al Said: Expectations, usually, are a function of last year’s returns. Because 2008 was bad, people thought 2009 would be, but it wasn’t. In 2005 the expectations by investors in the UAE for 2006 were 50% to 60% returns after a major jump in the market.

Daykin: It’s going to be tough to repeat some of the returns we’ve seen. In fixed income, for example, yields were 10% over the last twelve months, but that has pushed yields right down to 5% or 6% now. It’s unlikely those positive double-digit returns will be repeated over the next twelve months. We’re typically talking to clients, saying that 6% to 8% is what we can expect on equities, and we doubt whether 10% to 15% returns over the next couple of years are achievable. We’re trying to bring down the expectations of clients generally.

Funds Global: How do you see growth in retail funds and what products in that sector are coming to market?

Daykin: One theme would certainly focus on income yields coming down across the board. People want to go into income products and so we’re looking to launch some income orientated global products that will obviously give our clients income generation on a quarterly basis. The other area that we’re beginning to focus on more is the Islamic side of things. That’s been a relatively unsuccessful market generally over the past couple of years but we’re hoping that some areas that have not been penetrated well before, such as in the alternative space or in the emerging market space, can begin to see some growth there. So we’re hoping that that area, which has been successful in the past, can become a bigger growth area going forward. So, sort of niches, but hopefully some successful stuff there.

Swats: We had a successful launch recently in Luxembourg with the Rasmala Palestine Equity Fund, a fund dedicated to investing in securities listed on the Palestine Stock Exchange. We’ve seen a lot of interest, particularly among the wealthy Palestinian community around the Gulf. And in the other Arab markets, but also in Chile and Europe. We think there are still opportunities in the region for niche areas that are not crowded.

Angio: I think we can expect new products that are coming to market to be smaller and more focused. A few years ago managers would not have even considered launching funds of the size they are today. The fund market has fundamentally changed that way. There are very few blockbuster funds being launched today and raising $30 million for a focused strategy in Mena is considered a success. At Apex, we spend significant time advising managers on structuring funds adapted to the current environment, which is challenging for capital raising.

As a result of lower assets under management and lower fees, investment managers across the board are becoming leaner, focusing their resources on their front office and are considering outsourcing their middle and back office functions in order to reduce cost.

Funds Europe: How are regulatory developments likely to impact the industry over the next twelve months?

Daykin: We see regulation definitely increasing to some degree. We don’t know how it’s going to play out, but we do think that quality fund managers with the right structures and the right registration, the right domiciles and good governance will be the ultimate winners in this.

Wells: The key thing to consider is the aim of the regulators. It’s about consumer protection, and if there’s greater protection for the consumer that’s good for all of us. We must work with the regulators to help them understand the fund management industry as a whole so that they’re able to incorporate what we do and our normal practices – including what we would see as international best practices – into the local region.

A very positive step is that Emirates Securities and Commodities Authority (Esca) has been listening. There have been discussions between the fund industry, Esca and other regulators to ensure that there’s a level playing field for all asset managers whether they’re local
or international.

Street: If you’re going to be successful in this industry, you’ve got to look forward. Five or six years ago many fund managers would never have used a custodian, for example. Previously, they would have held assets with brokers. We are now seeing regulation which has implied all investors must use a custodian in the United Arab Emirates.

Whatever comes to pass, it’s the right directional movement and if you get a new fund launch that doesn’t have a custodian and an independent administrator they’re not going to get on very well with international investors.

The question for me is about whether the Middle East regional domiciles in the region are absolutely necessary? Does the industry really need them? What’s wrong with Luxembourg and Dublin, or the Caribbean and the Channel Islands, or the UK? Provided the regulations ensure appropriate distribution without too much red tape for the fund management organisations who distribute them, these domiciles remain great options. If there is a unique selling point for a fund domicile, it will be successful. If not, then the current domiciles will prevail. Too many domiciles without critical mass is inefficient. As an industry we need to push for more clarity so we can apply our energy and investment in the right place.

Going back to the ripple effect, if a country has its own exchange and its own fund domicile, it will aim to build up an asset management community. But in order to be a success and obtain a level of critical mass, there needs to be real economic drivers such as a pension system that demands it, a unique selling point that provides an advantage to funds domiciles ithin it. We’ve seen it laid out in front of us in the Dubai International Financial Centre (DIFC) and I think that despite all of the ‘infrastructure’ being in place, it hasn’t succeeded to the extent that it should have because those drivers have not materialised. Until they do, managers will continue to prefer domiciles which they’re familiar and comfortable with; despite the best efforts of the DIFC.

Angio: Egypt has recently implemented regulation whereby independent administrators are required for funds, so that’s definitely a step in the right direction. The Central Bank of Bahrain has just rolled out its regulation for fund administrators and service providers to the fund industry. These are positive developments for Mena as it removes barriers for institutional investors looking to invest in Mena and who perform due diligence on these aspects prior to allocating. Having set up an administration company in Saudi Arabia, we believe that it is just a question of time before the less regulated markets in Mena update their regulatory requirements decreasing instances where investment managers act as the administrator and custodian to the funds they manage. This will be very positive for the industry. 

Adams: Regulation may increase costs but as asset service providers we’ve got to be ready and comply with the changes. This allows our clients to continue with their core business without the stress of looking towards regulations and information technology investment. It is not one united front here, which makes regulation even more complex when you go across different countries.

Al Said: You have to understand that these markets are still young markets and it’s an evolution process. I think the best thing is to learn from others’ mistakes and to start from where the others ended.

Things are not progressing as we had hoped but I think things are improving. Compare the markets now with five years ago when even asking for a quarterly report was considered to be inside information about a company.

I agree that the desire for each jurisdiction to have its own financial sector with all the major companies there is not happening. However, I think the Qataris, because they own the money, are now actually going one step further to support their financial centre by looking into seeding some funds to attract international asset managers. But I don’t think the DIFC can do this currently. We had an experience of domiciling there and launched the first [NBD] DIFC fund. They told us the process would be fast, but it took a long time.

©2011 funds global

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