Participants at our Dubai panel discuss plans for a financial free zone in Abu Dhabi, question why some local companies are listing in London instead of the UAE, and warn that confusion among different regulators could cause problems. Edited by George Mitton.
Pieter Hendriks, director of investment services, Middle East and Africa, T Rowe Price
Abdul Kadir Hussain, head of asset management, Mashreq Asset Management
Amer Khan, director, senior fund manager, Shuaa Asset Management
Fadi Al Said, head of investments, Middle East and Africa, ING Investment Management
David Verghese, senior fund manager, Emirates NBD
Funds Global: The UAE stock markets led the Mena region in terms of performance in the past 12 months, giving some stellar performance figures for UAE-focused funds. Will this rally continue?
Abdul Kadir Hussain, Mashreq Asset Management: A lot of indicators around the UAE have been improving for a while. Credit spreads, which indicate financial risk, have come down significantly. The underlying economy in terms of tourism and real estate has improved, and the global backdrop supported equities. There was strong momentum going into the start of the year.
We’ve had a phenomenal run. From our perspective we’ve become more defensive, taken a few chips off the table, but the fundamental story is still intact. There is probably another 5-10% of growth to come this year, and maybe double-digit growth next year. There is still upside to come, though clearly a large part of the catch-up has happened.
Fadi Al Said, ING Investment Management: There has been a solid investment case for the past three years. There were low valuations, high dividend yields – all we needed was a catalyst and the lack of bad news.
This region has had many negative headlines over the past five years. The moment we see any movement there’s a revolution somewhere, or a financial crisis. But now, the global situation is calmer.
The catalyst was the comeback of the real estate sector, helped by low and interesting valuations, and a huge spread in terms of the sovereign risk of Dubai compared with the rest of the world. The first leg has been accomplished. Most of the banks are at book value, or even at premium, Emaar is close to tangible book, and these are the main constituents of the market. The next leg will be focusing on fundamentals.
David Verghese, Emirates NBD Asset Management: Dubai has been one of the world’s leading markets this year and much of that has been supported by fundamental data points. In the first month or two, people were sceptical that the rally would continue. Emerging markets in particular have been quite weak, and there wasn’t a lot of buy-in from local investors. They thought the rally would peter out but, surprisingly, emerging markets have continued to be weak while the UAE and regional markets have been strong. That testifies to real improvement in the economy.
If the US and Europe continue to do well, that will be good for our markets here. We are pegged to the dollar. We have seen weakness in many of the emerging market currencies, while currencies and economies linked to the dollar have benefited. That is one reason why the UAE has performed well.
MSCI has now upgraded the UAE and Qatar to emerging markets. That’s something that’s been in the works for about five years and it shows we have made progress.
Funds Global: Concerning the MSCI upgrades, Deutsche Bank estimated this could lead to more than $400 million of additional inflows into the stock markets of both Qatar and the UAE. Do you all believe that?
Amer Khan, Shuaa Asset Management: The figure is probably higher. That estimate is likely to be just passive ETF [exchange-traded fund] flows coming into the market. In the future, you’ll see a lot of active managers of emerging market funds invest in the UAE economy as well. The total inflow could be significantly more than $400 million.
Speaking more generally, Bric [Brazil, Russia, India and China] markets have underperformed developed markets for almost three years now, and so even from an emerging market positioning perspective the UAE and Qatar markets are headed in the right direction.
On the upgrade, it is notable that the UAE took care to check all the boxes. They made the upgrade a priority and I applaud them for chasing it down and getting there. Qatar was a bit of a surprise, but again, it’s good news for our markets.
Al Said: One interesting thing is that the impact of the upgrades would have been more positive if it didn’t come at a time when frontier markets were doing very well. Everybody is focusing on the gross flows into these markets, but the net flows will be lower. There are some huge funds that invest in the UAE and Qatar as frontier markets, and these will now reposition themselves away from these markets into other markets, such as Africa.
Frontier markets are much bigger than last year. We hear that a lot of frontier funds are soft closing at $1 billion and $2 billion. The last numbers I heard were $17 billion of year-to-date inflows into frontier markets. To what extent this will change the game? These are serious players now, and they look at the UAE and Qatar as frontier markets.
Pieter Hendriks, T Rowe Price: But MSCI has said Morocco will be downgraded from an emerging market to a frontier market, so that will help to balance it out. In general, the upgrades are positive, and not only for asset managers. The upgrades will also benefit service providers, brokers and sell-side research. These have had a few hard years, so these inflows will help them again to reboost their businesses.
A lot of global active managers have taken exposure in the UAE and Qatar in their global emerging markets funds already. They have to research companies, and they have done that maybe out of America, Asia or London, or some of them from here in the Middle East.
Funds Global: Have the markets already anticipated these upgrades?
Khan: To some extent, yes. However, there may well be more fund managers that will look to position themselves in the latter half of this year or early part of next year ahead of the upgrades’ effective date in May 2014. That fits with what Abdul Kadir said about the expected upside from current levels.
Also, a large part of the money that’s coming in is more sophisticated institutional money, at least in terms of the active funds. These guys naturally tend to pay significant attention to valuations.
In contrast, this market has historically been either panic or euphoria-driven because it was largely retail dominated. You’ll likely start seeing those types of huge swings get a little more muted because you have professional investors involved.
Al Said: The attitude also changes. When foreign investors used to come to the region, especially emerging market managers, they viewed the region as an off-benchmark bet. So the exposure came when the market was doing well. When any negative headline hit the market, they were the first to jump, because they didn’t want to be caught with off-benchmark exposure that would hurt them. Now, they don’t have to rush out. They can hold on to their position and ride downswings in the market, because it’s part of the universe.
Verghese: Investors should pay quite a bit of attention to the frontier index, because the movement out by Qatar and the UAE is going to create about a 30% gap in the frontier markets. Part of that could be filled by Morocco, but it is going to be a huge gap, and you could see, for example, an outsized movement into Kuwait, which would be the dominant market left in the frontier market index.
The second thing that’s worth pointing out is the biggest market in the region, Saudi Arabia. There is a lot of noise about Saudi Arabia potentially opening up to foreigners.
Will that happen this year? That’s still a question mark.
If and when that does happen, Saudi Arabia will become a frontier market, but the question then becomes how quickly could it progress to the emerging market index? Saudi Arabia in the emerging market index is going to be a much more meaningful size than UAE or Qatar, and that, for the region, could be a game changer.
Al Said: I’m fortunate enough to read Arabic, so I was reading a lot of articles in the Saudi newspapers after the MSCI upgrade. Many Saudi writers are increasing the pressure on the authorities after the upgrades as the Saudi market is left behind, because it is not open yet for foreign investment. Perhaps the upgrades of the UAE and Qatar will stir Saudi Arabia into action and finally open up the market.
Funds Global: Were you surprised by the decree to establish the Abu Dhabi World Securities Market as a free zone under the same law that created the Dubai International Financial Centre (DIFC)? How do you expect the new zone to affect asset management in the UAE?
Hendriks: The short-term impact on the DIFC will not be significant, I expect. The DIFC celebrates its ten-year history this year. It has a proven track record. They have all the facilities and a solid infrastructure for asset managers in the Gulf. I don’t see a big move in the short term from the DIFC to Abu Dhabi. There could be an incentive for companies to make that move, but not in the short term.
The main thing driving change is regulation. In the UAE, more than 80% of the mutual fund flows are taken by insurance companies, which are not under the regulation of the SCA [Securities and Commodities Authority]. If you look at these flows, it’s a winner-takes-all strategy. There are about five to seven asset management companies that take 80% of the flows, and in the DIFC, there are 150 asset management companies. So if six companies will have to be more regulated because of their insurance products’ distribution strategy, it will affect six out of 150 in the short term.
Hussain: Was I surprised by the announcement? No. That’s typically been the pattern here. You build a port here, you have to build a port there. You build a free zone here, you build a free zone there.
As an entity that has a fund registered in the DIFC with the DFSA [Dubai Financial Services Authority], one of the few not passported in, the issue is transparency of regulation. We need to understand what rules apply, how they apply across different jurisdictions and how they will develop, once other jurisdictions come along. As a fund manager the last thing you want is different rules for different people.
If you’re a DIFC fund, you have a different set of rules than if you are an Irish or a Luxembourg fund. The issue is in the level playing field.
You can establish as many financial centres as you want, but if you don’t have clear, transparent, efficient regulation across all of those centres you’re not going to create a business-friendly environment.
People eventually will decide this isn’t the right place to domicile products. Yes, they will have an office and an asset management window here, but the actual fund and infrastructure will be somewhere else.
Funds Global: What about potential incentives for companies to set up in Abu Dhabi?
Hussain: You might have incentives, such as Qatar does, where you get help to set up your asset management business. For every dollar you bring in, they put in a certain percentage to match, to get your AUMs up, which is obviously a big incentive for a lot of asset managers.
Hendriks: In Europe, asset managers have multiple offices, in Luxembourg, France, Spain, Italy etc. That is justified because the markets themselves are big enough. But in the smaller GCC markets it will be difficult to have an office for a global asset manager in every country. From a cost point of view, that’s not realistic.
If regulation is different in different jurisdictions, it’s going to be a challenge. The majority of asset management companies will have a business model where they are based in one regional office and service the larger investors for bespoke solutions with global solutions, it’s a more viable strategy.
Khan: A lot of investors would like to see more integration of the financial services industry in the UAE. Currently, within 100-odd kilometres of each other we have three separate exchanges. For financial services companies looking to maintain offices in Dubai and Abu Dhabi the natural question to ask would be, is there enough for everybody to go round?
The exchanges would be much stronger if there were some sort of integration, some sort of unification. Certainly, as the UAE grows, there should be more than enough business for companies based in different jurisdictions, but that doesn’t take away from the fact that integration and unification would make the UAE a stronger marketplace.
Funds Global: How have the UAE’s rules on investment funds affected distribution of your products to retail and institutional investors?
Hussain: We might be unique because we have funds in three different jurisdictions. We have a couple of seven or eight-year-old funds that were established under the Bahraini jurisdiction, and there have been no issues with them. We have an Ireland fund, which has had no problems. And we have a DIFC fund, which has had major issues. There’s just no clarity.
Is the minimum investment a million dollars or $10,000? It’s not clear. This issue has taken a long time, going back and forth with the regulator.
It would be helpful if we had better communication between the DFSA and the SCA. That’s a major issue, because one side doesn’t know what the other side is doing. They are only 100 kilometres down the road, so they should be able to talk to each other and figure it out.
Al Said: For us, we’re not focused on retail, our fund is domiciled in Luxembourg, and most of the mandates are discretionary mandates. Maybe this question of regulation is more relevant if you have retail distribution channels. I don’t receive complaints from our salespeople saying there’s a problem.
Hussain: But that’s an important point. This regulatory regime forces your strategy to be based on institutional, discretionary accounts. You essentially use your funds only to establish a track record, because there are too many hoops to jump through to get that fund to behave like a real, actual fund, where it’s distributed across various platforms, to various types of investor. What you’re going after are the discretionary institutional mandates, because those are easier to deal with, due to the lack of regulatory transference.
Funds Global: What developments in the region do you think will give the biggest boost to the asset management sector?
Al Said: Saudi opening up, or MSCI upgrades; these are quick fixes. The main problem we face as investors in these markets is that we are in deep cyclical businesses. We don’t have enough diversity. We don’t have businesses that are scalable, such as creative industries. We have capacity constrained, capex intensive, subsidised industries.
We need to see more companies listed, more liquidity and more depth in the market. We need regulation to support that. There are two UAE-based healthcare companies the market desperately needs that went and listed in London because of regulations. We need to attract companies to list, not push them away.
Khan: For any jurisdiction, two additional key factors that would attract companies looking to list would be a diversified and broad investor base, which one can argue the UAE already has, or will have shortly, and ease of listing and compliance. Obviously, we don’t have that ease of listing or compliance as evidenced by the choice of listing in London, rather than on the Dubai Financial Market or the Abu Dhabi Securities Exchange, by UAE companies for their IPOs in the past few months.
Al Said: The problem is the structure that the current regulations force companies to go through to list. For instance, as an owner of a company I am forced to sell more than 50%, if I want to list. Also, I am forced to sell it at par value. As an owner of the company, I am encouraged to creatively structure the IPO in a way that makes investors believe they are buying it at par and without any premium which creates structures that result in companies being overcapitalised. Until now, they’ve not generated enough return on invested capital.
Hussain: The other thing I would like is deeper institutional money on the demand side. But we also need to see where they get the money from. There is a lack of private pension schemes. I would love to see a single model, a CPF or a 401K type, which could replace the end-of-service benefits that we have today. Right now, companies don’t really account for these benefits. When the guy leaves, it shows up as an expense. But if you create a fund to pay out those end-of-service benefits gradually, you create sources of assets for fund managers to invest.
Hendriks: One idea is to give employees their end-of-service benefit payments every quarter and let them invest them in mutual funds, in a life-cycle product, for example. If one works in a company for about five years, one would have the growth of the market over long-term.
For people that work for companies that don’t do anything with their benefits currently, the employees would just get cash in the end. There would be no enhanced return. And it’s a delayed pension payout, so you need growth on the asset. I would welcome it if the government stimulated a pension system that benefited the investor and local equity and bond markets.
Verghese: The major item that will improve things from the asset management industry is increased assets under management.
It’s still a small industry, relative to GDP, for the kind of output these economies produce, so there is clearly an under served component here, in terms of the asset management industry.
Unlike a lot of developed markets, there is a culture of saving here but, unfortunately, a lot of that saving is being sent, almost immediately, outside of the region.
A key aim is to get some portion of that money to stay in the region. Even if we were to make some incremental progress towards that, the flows to the asset management industry would be significant.
In terms of the capital markets themselves, an increase in the number of listings here would be a big deal.
We’re encouraged by what we hear on the UAE side that there could be some large deals coming to list here in the second half of the year. If that were to happen, especially if they were family conglomerates, or government related companies, we would see it as a positive sign.
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