ROUNDTABLE: Movers in Mena (part 2)

Industry heads in the Gulf region come together to discuss the major issues facing them and how to best operate in today’s marketplace. (part 2)

Sven-Olaf Vathje
(partner & managing director, The Boston Consulting Group

Amin El Kholy (head of asset management, Arqaam Capital)
Sean Daykin (head of investment funds, Emirates NBD Asset Management)
William Wells (head of intermediary sales, Middle East, Schroders)
Eric Swats (head of asset management,Rasmala Investments)

Funds Global: Are you seeing interest from Asia for investment into the Middle East region? And how are investors here looking at Europe and the US, if at all?

Wells: We’ve seen interest from a number of areas. When we launched our Middle East equity funds, almost three years ago, it was largely on the back of demand from the Asian markets to get access to the high-growth markets of the Middle East. Initially we saw a lot of demand from those markets. The Asian investors saw the growth rates they themselves experienced so they can see the potential there is here. More recently we’ve seen demand from other places as well, like Europe and America.

Daykin: Investors here tend to not go directly into the European or US markets. They don’t buy individual securities but go through funds instead. There are a lot more third-party funds being distributed in the region than there were in the past, so there’s a lot more choice.

Wells: Historically, retail investors in the Middle East have felt a huge affinity with emerging markets. They’ve had some interesting times and great returns in the emerging markets but following 2009’s strong returns they are now starting to think that maybe they should be looking at other markets as well. So you’re seeing more investors looking at the US, which is probably something they haven’t done before. We need to remember that in the UAE, for example, the percentage of foreign investors is very high. Therefore expat investors are going to be aware of what’s happening outside the region and more comfortable investing outside the region as well.

Daykin: There might be more interest in the Eurozone because of the weakness of the currency. From the dollar point of view the region is becoming more interesting.

Vathje: Ultra-high-net-worth individuals increasingly have investment opinions on global markets, which was not the case five years ago. Local investors are beginning to understand that it’s not just about buying and holding US and European assets, but that it is about managing the cycles. Recent crises like in Greece have pushed local investors to form more differentiated opinions about where Europe and the US stand economically. Sophistication from an investment perspective is going to continue to increase.

Daykin: You’re seeing a huge amount of interest in UK property from the Middle Eastern region. We haven’t seen much interest in Europe, but maybe that’s going to change.

Kholy: This raises the question about which channels will be used to access these markets, especially considering that many of the target investors probably already own several UK properties directly.

Daykin: We’re broadening our range of distribution channels quite significantly. We sell through our private banking channels, but most of our growth has been outside of these bank channels – through platforms, like Zurich and Friends Provident. This is where we’re seeing most of our growth in terms of getting assets under management. This constitutes quite a change considering that historically assets grew through the captive channels of the bank.

Wells: That has something to do with education. People are starting to understand that they need to save for the long term because local employers often don’t provide for this. A lot of the life insurance companies are marketing regular saving plans and also many retail banks are setting up their own regular savings plans to allow the long-term planning for people’s futures. Also, as Sean says, there is a lot more business coming through from the IFA [independent financial advisor] market.

Kholy: Globally a big driver of private pension contributions is the tax relief on savings for retirement. Here, there isn’t that tool and it will be interesting to see whether some of the contributions paid by the government on behalf of the population can be diverted towards something people can manage themselves. Even if it’s just a small part of those contributions, it would be seen as the government giving people an incentive to invest. The governments do fund generous pension schemes which they also manage but to help develop that investment culture they might consider schemes which are managed by the individuals themselves. I don’t see any evidence of this happening right now, but it would certainly add something to the markets in the region.

Daykin: We don’t have the 401k [US defined contribution pension plans] structures here, but we launched regular savings vehicles for our clients. We go to companies and in effect put in place a plan that acts like a pension fund. Employees save into our funds or third-party funds on a monthly basis and it’s becoming very popular. It works like a defined contribution scheme and can work with small amounts of money. Rather than putting all your money in one month, where you can have mark-to-market risk, savings over monthly periods is dollar cost averaging.

Funds Global: The targets for these plans are private sector employers. What about state employers? Have you been working on any saving schemes within the public sector?

Daykin: State employees tend to have their own pension strategies, particularly the local nationals. These kinds of developments are mostly for expats in the private sector. Another problem is that there are no big pension funds to supply stability and institutional access to the markets here. They just don’t exist, so there is a big gap in the markets.

Kholy: They exist in some Gulf countries, Kuwait, Oman and Bahrain, for example, and in the wider Mena region in Egypt and Morocco.

Daykin: But there are no UAE pension funds or DB [defined benefit] schemes.

Funds Global: How has the pension system in the Middle East been developing? Have you been asked to consult with companies on their pension requirements?

Vathje: The idea of a funded pension system for the national population and potentially also expatriates has been discussed for some time. Such changes take time, it is a long-term process. In the short term, local employees will most likely continue to have a government-funded system. In terms of expatriate employees, I wonder whether voluntary pension schemes may be developing. A well-designed corporate pension scheme could be a very effective retention tool for qualified staff; for example, combined with employee copayments. Many employees in this market still find it difficult to access the most adequate products for their savings needs. They roughly know what they need, but the funds and investment product distributors often have difficulty selling to them and communicating with them in the right way. A corporate distribution channel into captive employee bases could – in this context – be a very interesting distribution option for fund providers.

Funds Global: In the past two years growth in Islamic finance has showed signs of slowing, while the sukuk market has continued to draw interest. Are these trends likely to persist and how is fund management affected?

Swats: It’s correct to say that things have slowed down in the Islamic finance market. Innovative techniques to create solutions appropriate for investors wanting to adhere to Islamic tenets have not been as prevalent as they had been in previous years. Part of it may be because in some instances the goals have been reached and so the pace of innovation has decreased.

On the other hand you still have a number of investors who want to invest according to Islamic tenets and the sukuk market, which has developed further over the past couple of years, is a way for them to access such investments. We don’t see a lot of demand for Islamic-oriented investment strategies. If anything we’ve seen funds closing down and people rationalising funds. If managers didn’t have funds that were large enough they decided to wind them up.  So it’s not just that the growth has slowed but there has also been a retrenchment in terms of the number of products available in the marketplace.

Daykin: The banks have been having troubles with lending whether they’re Islamic or not. The Islamic banks have been struggling to attract assets just as much as conventional banks have. In terms of funds, I agree with Eric; we don’t see much demand. We have many Islamic products, but we haven’t seen huge flows going into those products. We have balanced products and recently launched money market and fixed income products to offer less risky assets. Even so, we haven’t seen a huge amount of interest from Islamic investors, although this may come in time. They tend to be very keen on property, real estate funds and private equity, but not so much in listed securities. Hopefully this will change in the future.

Vathje: Even though the numbers have been fluctuating a little bit, the underlying trend is that the Islamic banking industry is going to continue to grow and outgrow the conventional banking industry. The penetration of Islamic banking in general has not reached its full potential yet. This means that from a distribution point of view there will be an increasing number of banks that can technically only distribute Sharia-compliant products. Also, an increasing number of investors will be familiar with Sharia-compliant investments as an asset class. This will continue driving the need for Sharia-compliant fund solutions.

Daykin: We are also seeing interest in Sharia products from the international markets, from platforms and institutional investors in Europe who want to offer their employees Sharia options. The Western or European asset managers tend not to have these products and so it’s quite easy for us to distribute our Sharia-compliant products through the platforms into Europe and Asia.

Kholy: As far as regional equity funds are concerned, the issue is more of a structural one. In aggregate, there were probably sufficient assets under management in Islamic mandates. But when it comes to funds, there is a tendency for every bank or institution to have its own Sharia board and set up its own separate vehicle. So as a fund manager, you get sub-contracted to manage these accounts. You could end up with ten mandates each being pretty small in size. They might have the same investment universe but the reality is they all have slightly different ways of screening the Sharia criteria which require additional analysts. There are solutions emerging to these bottlenecks. There is an increasing tendency for the Sharia service providers [the companies that provide a link between the fund managers and the Sharia board] to be more active and encouraging them to actually do the screening themselves, possibly in collaboration with the benchmark providers.

Wells: In fact, some individual investors will have some Sharia-compliant investments and other investments that are not. They want to do some things the way their principles tell them they should, but they don’t have to necessarily do everything that way.

Kholy: There’s a practical element to it and that’s where the growth will come. The more you can provide something that is Sharia-compliant but doesn’t involve a higher cost to the investor, the more investors will flock to it.

Daykin: We manage Sharia-compliant fund of funds so, for example, with equities we look at many different Sharia equity managers globally, just because the universe of managers is not very big. The universe of managers in conventional investment is probably 100 times greater than that of those who are Sharia-compliant. There are probably around 30 equity funds that are credible in terms of size, and if you look at the track records, they’re not that great. And then there’s the question of fees; because these funds are scarce, they charge a lot more and put performance fees on it as well. Most funds are too small in terms of size, they have no track record and the manager’s investment process is not clear or credible. They’re just not very good products to be honest. Most of these funds don’t have financials or highly indebted companies because of the Sharia screening. But in the last year those are the companies that performed best so most of these Sharia funds underperformed the conventional benchmarks.

Funds Global: Would it be fair to say that there’s more demand for Sharia-compliant products in Saudi Arabia? And do Saudi-based Sharia investors get a better deal vis-a-vis fees and returns and general efficiencies?

Swats: Yes, there is more demand for these types of products in Saudi.

Wells: The investors there probably get a better choice from local institutions because they cater for the local client base. But as Sean said before, when choosing funds does one necessarily want to invest in Saudi-domiciled funds? There might be a broader selection of funds there but it may not be, structurally, exactly what other investors looking for.

Kholy: In Saudi, the way the CMA [Capital Market Authority] specified the rules in relation to charging performance fees was very unclear. Most service providers chose not to include performance fees at all. That may have, accidentally, had a hand in keeping the overall fees down.    

Wells: When we used to manage a Sharia-compliant fund for a bank in Saudi with a fantastic long-term track record, it used to have a performance fee. Since the CMA regulations came into force, this performance fee was removed, for whatever reason. The question is whether this is good for clients in the long term. If it is and if it increases the level of interest in funds from Saudi investors then that’s fantastic.

Kholy: There seems to be a certain amount of confusion around regulation. Regulators do have a role to play that is to everyone’s benefit, but clients need better understanding. The fact is that a lot of the products that were being sold in the region five years ago wouldn’t be touched with a barge pole elsewhere, but because they were coming from European- or US-based houses they were bought by some regional investors.

Daykin: It’s not just the Gulf region though. In Switzerland there were many private banks that were invested in poorly performing hedge funds and these funds locked up their clients’ assets. You saw huge redemptions in hedge funds for Swiss banks. And we saw the same thing here with private banks who lost significant assets through poor selection of individual hedge funds.

Swats: That stresses the point that it’s really in these hedge funds where you’ve seen a lot of dislocation and dissatisfaction. There were no significant blow-ups in other products that had market-like returns.

Funds Global: Should Gulf private banks and institutions be more selective about the robustness and integrity of their potential fund management partners after the financial crisis?

Wells: Reputation is hugely important. It’s vital that clients are happy with who they’re dealing with. We have been very fortunate in that we’ve had stable ownership, management and a stable balance sheet, which saw us through the difficult times. So we’re still in a very strong position. But some managers and their reputation will have suffered significantly. Picking up on what Eric said about hedge funds, the issues there were very much around access and whether clients or private banks could get their capital back. We’re now seeing demand changing in this area. Clients seem to be moving away from individual manager selection and more towards a fund of funds approach on the hedge fund side. They’re also possibly moving away from traditional hedge funds and more towards Ucits III-type products where you can have greater liquidity, regulation and transparency. Liquidity and transparency are becoming more important for high-net-worth individuals and family offices.

Swats: We have seen a heightened interest in the financial strength of regional institutions as providers of asset management services. Largely because balance sheets may have been jeopardised or income statements are looking poor or there have been regulatory issues related to some providers. These institutions have been a greater focus of those looking to select managers or providers.

Daykin: There’s a much greater focus on due diligence and risk management when looking at funds. Historically maybe that wasn’t as strong as it should have been. Now it’s certainly a lot more important.

To the point about Ucits; we’re now considering Ucits vehicles listed in Dublin or Luxembourg that are traded daily, instead of looking at the Cayman Islands, Bermuda or the British Virgin Islands. We don’t look at those regions any more.

Wells: Crisis or no crisis, standards have had to improve. We’ve seen internal procedures within a number of local institutions improve. The advent of international managers bringing international standards to the local markets will have pushed the local players to up their standards. We have to step up to the plate and make sure that whatever we’re producing, whether it’s for international investors or for local investors, is of the highest quality.

Kholy: If you as a fund manager have a good process you’ll eventually get a good outcome, not necessarily immediately, but definitely in the long term. International investors who came into the region in late 2007 and early 2008, have got long enough experience now to start appraising managers. They can go back and find out what went right and what went wrong, some managers stuck to the process and others didn’t. Some had a process which was not suited to the environment having been developed in a bull market.

The due diligence being done now is going to get even more rigorous. Any issues that were glossed over during due diligence in the past would have been exposed by the markets in the crisis.

In terms of manager selection, the track record and statistics are important, but that’s not enough. Being open and transparent about what you do is going to be a lot more important in the future.

Vathje: The drive to improve processes is also strongly supported by the fact that an increasing number of high-net-worth individuals are now using some kind of intermediary – like a family office structure or a dedicated investment team – to make their investment decisions. This raises the bar for fund providers.

Funds Global: Would any one like to make a few closing remarks?

Wells: The Middle East remains a place of trust; it remains a place in which you need to be close to the clients. You have to give something to the Middle East if you want to get something out of it, and this is very important from an international perspective – for those coming here to compete alongside local asset managers. Having a local presence is important. You need to be there, on the ground, working with the local players; whether it’s the retail banks, the private banks or the family offices. Also, most of the distribution channels available need good servicing and hopefully people can bring high levels of servicing to the market. This additional training and servicing can be hugely important to developing the fund management industry successfully in the Middle East.  Furthermore, education of the investor base here is also crucial.

Vathje: I would add that the growth of the industry is also going to strongly depend on the amount of investable assets available over the next couple of years. Earlier we mentioned the challenges of a region that is very cash heavy. It doesn’t have the natural drivers to create capital markets, which are normally led by the strong financing needs of corporations and governments. Today, we see many companies with little free float and little corporate transparency. Vibrant capital markets in general would require a larger number of companies to be listed, more free float, and better transparency of investable companies. Since all the drivers are moving in that direction, the fund industry should benefit and see good growth in the next couple of years.

©2010 funds global

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