Our regional asset management panel talked about distribution, âcumbersomeâ regulation, and why regional fund managers have had their model wrong for years. Chaired by George Mitton.
Amin El-Kholy, managing director, asset management (Arqaam Capital), Emmanuel Laurina, managing director (State Street Global Advisors, Dubai)
David Marshall, senior executive officer (Emirates NBD Asset Management), Muhammad Shabbir, head of equity funds and portfolios (EIIB-Rasmala)
William Wells, director, Middle East (Schroders)
Funds Global: Which countries and sectors in the MENA region are most interesting in terms of equity investment?
Amin El-Kholy, Arqaam Capital: Qatar and the UAE come to mind and not only because they will soon be included in the MSCI emerging market index; but rather the attractiveness of twin surpluses in strongly dollar-pegged currencies makes these and other GCC countries attractive in the emerging market space.
Attention is also being paid to Saudi Arabia because the dynamics are similar. Does it open up, does it not open up, do active investors need to wait for it to be in the index or can they go off-benchmark and invest now?
We consider Turkey part of the MENA region but it is harder to say if it will continue to perform well. Should things go particularly well in Egypt on the reform front, it will provide interesting opportunities, but question marks remain. The concerns in both Turkey and Egypt apply to most emerging markets where the reform agenda has slowed down mainly for political reasons.
Muhammad Shabbir, Rasmala: The UAE and Qatar had a number of catalysts in the past year, but what is different with Saudi Arabia is it is the only country undertaking reform at the lower level, such as the crackdown on unlicensed labour.
Regarding the UAE and Qatar upgrades, regional investors must be prepared if they are to benefit from this influx. The money that flows in is not just there for reasons of loyalty. Foreign investors are there to make money and once the money is made, they ought to leave. So there will be consistent pressure.
Emmanuel Laurina, State Street Global Advisors: Qatar and the UAE are going to get a lot more attention simply because institutional index clients are constrained to be invested in all the markets of the MSCI index. Big index asset managers will automatically rebalance into those countries at the end of May. Surveys estimate in the region of $1 billion flowing into the markets but those figures are understated.
The fact that MSCI has decided to upgrade those two countries from frontier to emerging is a sign that liquidity in the market has improved. Hopefully, foreign ownership limits will evolve because, as and when capital flows into the region, those ownership limits may to be increased.
William Wells, Schroders: Some of our emerging market mandates are constrained, meaning clients can’t yet look at the UAE and Qatar, but a lot of the mandates are unconstrained and already investing. Some of the flows that we are expecting, whether it’s $1 billion or $2 billion, have already started to come in. Active strategies have exposure and will continue to have more exposure to UAE, Qatar and some of the other frontier markets as the dynamics are more attractive than in some of the emerging markets.
David Marshall, Emirates NBD: There has been huge growth in regional stock exchange volumes in the past year, and we’ve seen some regional investors trimming their positions, but we haven’t seen international allocators taking their money off the table. In terms of fundamentals, some of the problems that are seen in emerging markets aren’t there in the GCC. So, to take the money off the table now would be too early even if the difference in valuations between emerging markets and MENA countries, which was a great story two years ago, no longer holds true. MENA has effectively moved from a “value” story to a “growth” one.
Funds Global: Do you think emerging market assets are ready for a rebound? Which MENA markets are best poised to benefit if this happens?
El-Kholy: Emerging markets will perform well where there is an indication that there is a genuine intention to reform, for example in Mexico and subject to elections possibly in India.
The commodity boom has subsided somewhat so it comes down to which countries can do the hard work of structural reforms and which can’t, which goes back to the issue of why the GCC is attractive. On an earnings multiple, the discount to the broader emerging markets universe has closed, but price-to-book ratios are still comparable with strong earnings growth potential.
However, it is important to be selective within the GCC, some stocks have seen spikes in prices when their margins are weak and some have problems in delivering the kind of growth which is now in the price. The difference between the quality stocks favoured by professional long-term investors and the liquidity driven retail favourites will show when the market corrects sometime in 2014.
Marshall: Some emerging market valuations are becoming so cheap they will attract investors. Russia, with its single-digit price-to-earnings ratios, is an obvious example. At some point that will pop, probably ahead of any reforms, just because it is so cheap people will start taking positions in it. But if you think about an active manager looking at these structural problems in emerging markets, the MENA countries can be a nice hedge. This would apply to the GCC countries in terms of stability and, on the valuation side, probably Egypt and Turkey.
Wells: Valuations are starting to look very attractive in the emerging markets as a whole but there are still many headwinds out there, such as the politics, deficits, the dollar strength. That’s where the Middle East markets are differentiated because none of those factors impact the GCC markets. There are still good opportunities in the region, while emerging markets are starting to look more attractive in the long term.
Another thing to note is that the emerging market headlines are all about net redemptions, but these are from retail investors. If you look at the investments coming into emerging markets from institutional investors, the net flows remain very strong.
Laurina: ETF flows into emerging market equities have been in line with equity returns this past quarter, which have been flat. But the caveat is that the vast majority of our clients are institutional clients. They have policy benchmarks they have to stick to and emerging markets are part of that.
Shabbir: Emerging markets will remain a macro play to the extent that investors are satisfied with the macroeconomic structure of the currencies and the deficits. It will be selective. The GCC will benefit because it doesn’t have structural weaknesses. When institutional money comes to the region, it will try more to grab and get hold of the businesses operating here. We might get some sticky flows into the region.
Funds Global: Are you seeing appetite for MENA funds among institutional investors in Europe or the US? Which types of investor in which countries are interested in the region?
Wells: We first set up a Middle East fund in 2007 and were one of the first to have a team on the ground managing MENA assets. Initially demand for the product was driven by Asian retail investors, who could see the long-term growth opportunities in the Middle East. In the last couple of years we’ve seen more interest from European investors, mainly on the retail side, particularly during the course of this year.
The biggest trend, though, is for investment in global frontier markets, in which the Middle East is 60% of the MSCI index. Frontier markets have many benefits such as demographics, low labour costs and natural resources, but it’s not just in the Middle East region, there are also opportunities in African, Asian and European frontier countries. We’ve seen phenomenal sales of frontier funds as well as increased interest in the Middle East.
Marshall: On our institutional, managed account business, we have had some success from Europe, not the US. Last year our mandates were almost exclusively on the debt side, this year they’ve been almost exclusively on the equity side. In terms of equity, assets have gone up from just more than $200 million to about half a billion. That’s good growth and that’s long-term allocation. There’s no doubt attitudes have changed. In 2011, we were in Europe speaking to investors just after the Arab spring but we raised no new money. We had had a great story but it was just too much personal and business risk. It was off benchmark, there were too many headwinds.
Now, certain countries are on benchmark. You still get a good pick-up with countries or pseudo sovereigns that have very strong financial positions. People weren’t ready three years ago. I think they are now.
El-Kholy: Although we haven’t been actively marketing in Europe, we have been approached by European funds of hedge funds seeking to allocate money to regional specialists and they have invested with us.
On a related point, what we’ve found with global institutions who have been allocating managed account mandates is that, although they do help grow your asset base, they are priced at very low margins. Due to the nature of our products, which are limited in capacity and able to deliver higher returns, we are able to charge both management and performance fees. The priority when rolling out our offering was to grow that side of the business until we got to a solid AUM base. At half a billion dollars in alternatives, we are now ready to handle managed accounts at lower margins.
Laurina: We’ve seen pockets of interest for GCC specific mandates but the bigger interest has been for broad emerging market mandates that are managed away from traditional cap-weighted replication.
We’ve noticed clients digging deeper and trying to find ways to capture risk premia within emerging market equities in alternative ways. It can take the shape of factor investing, it can take the shape of actively managed portfolios that include factor-based investing and stock and country selection.
Funds Global: Do you have concerns about regulatory changes in the UAE and elsewhere in the region that will affect the funds industry?
El-Kholy: The biggest factor is clarity to ensure where we can do business and on what terms in relation to asset raising.
There’s a sense occasionally that the lobbying process skews new regulation in favour of established players, but that ends up being modified with time for a more level playing field.
Wells: Regulation regarding distribution within the UAE has changed significantly over the last three years.
In the long term, that will be good for the market, but it’s caused some distributors difficulties while they learn to understand the regulations.
There’s been a lot of interaction between asset managers and the Securities and Commodities Authority (SCA) here to ensure an appropriate process to register funds for sale.
Those discussions will hopefully lead to changes in the process and also in the fees. It’s important that fees are in line with the expectations for the size and growth of the market.
Marshall: The problem is the number of regulators and the sometimes contradictory regulation that appears to be in place. In our world, we have the DFSA [Dubai Financial Services Authority], the JFSC [Jersey Financial Services Commission], the CSSF [Commission de Surveillance du Secteur Financier] in Luxembourg and the SCA when we try to distribute onshore in the UAE.
If you go to insurance brokers, you’ve got the Insurance Authority. If you’ve got a transfer agent, they may deem the UAE high risk.
We’re now getting discretionary funds from Singapore, so we’ve got to comply with the Monetary Authority of Singapore.
We’re not the size of a global player but the compliance function is now every bit as key as investment and risk management and this can increase the cost of doing business significantly. It makes doing business very difficult.
Shabbir: With the issuance of new SCA regulation regarding mutual funds last year, the running of boutique-sized asset management businesses has become a little cumbersome. Distributors are reluctant to take products on to their platforms until they get clarity on the fees, the process and who is responsible for what.
For these sorts of issues, the operator’s perspective has not changed despite the passage of almost one year.
Laurina: As an international asset manager we deal with pretty much all the regulators you can imagine, by virtue of the domiciles of our funds and the locations of our offices.
The general cost of execution has gone up and will continue to go up in line with the increasingly complex and time-consuming regulatory requirements our industry is facing.
It seems international asset managers are being forced to be a little more selective about where they domicile their funds and where they choose to register their funds for sale.
Funds Global: With the exception of Saudi Arabia, the retail funds market in this region is small. What is needed for the development of a sizeable retail funds market?
Wells: Some will say you need more regulations, others will say you need less regulations, certainly clarity would help. It’s also important to understand what the market is.
The population of GCC nationals is small and there isn’t a huge requirement for saving.
Where there’s been an increase is in the expatriate market. We’re starting to see international and local banks cater to that client base in other GCC markets besides the UAE.
It’s a segmented market with lots of small channels to work through. The key is working through all those channels in a cost-efficient manner.
One positive step that we have seen over the last few years is the number of local banks offering wealth management products to their client base rather than just selling brokerage.
To some extent that has been delayed by distribution regulations, but over time that will be positive for the market.
Marshall: Many regional fund managers have had their model wrong for years.
They’ve tried to distribute through banks, not realising that banks mainly sell two things: securities and insurance products. Instead, you need to work with players like Zurich, Royal Skandia and MetLife
Alico who have expanded regionally, and find out who the distributors are.
This strategy has helped our retail business, outside of Emirates NBD, to raise some $250 million.
Shabbir: The key is to understand how business is done and getting to know the segmented market. Asset managers need to understand how the private banks operate, how to get close to them and how they get the money. But there are no straight answers.
In the UAE, there are a lot of players, different ways of working, a mixed playing field, and for a number of institutions it’s a difficult task to penetrate.
Funds Global: How significant is your managed account business, if you have one? Is it fair to say the managed accounts business in the region is more significant than the funds business?
El-Kholy: Not yet for us but I expect it to be significant eventually. For us this makes sense because even in our funds we only have a handful of clients and as such they’re not mass distribution funds, so for us they’re almost interchangeable with managed accounts.
Marshall: It’s about 40% of our book and it is growing in significance. In a sense, the funds are a shop window. We’ve seen mandates from Abu Dhabi and Saudi Arabia and we’re now getting business from Singapore. The one caveat is that the managed account business is expensive to operate.
The work you do on a managed account is the same as a fund but you’re probably trading through the client’s custodian, with different settlement practices, different trade mechanisms and trade routes.
We could afford to be more flexible 12 months ago but now we’ve got a 10% rule. If the assets are less than 10% of the fund, they go in the fund.
It’s a point of efficiency and is actually better for clients at the end of the day, and that’s the most important aspect.
Wells: That’s been the issue in the past. Too many asset managers were taking on too many small mandates. People want a discretionary account because that’s what they’re used to, but it may not be as efficient or cost-effective for their providers.
Shabbir: For small asset managers the only way to go is to have more managed accounts but again it is constrained by what you can deliver and what kind of service you can offer.
For a normal institution which has its own distribution channels, its own private bank, people often have more or less equal money between managed account and funds.
Laurina: Our managed account business is pretty significant and typically it’s all about scalability, size and the level of sophistication of the client.
Tailor-made factor based investing, is important to clients, and all that goes in the direction of managed accounts, but as we said it’s all about scale.
Funds Global: Are you seeing any trends among the sovereign wealth funds in the region in terms of the kinds of mandates they’re awarding, investment policies or their willingness to outsource?
El-Kholy: Before 2008 you would have been hard pressed to find a sovereign wealth fund allocated to the GCC. Some had a MENA portion of emerging markets, but nobody was willing to allocate except in their own country for specific reasons.
Between them and the large endowments in the region, there is now a willingness to allocate in to MENA markets. We’re looking to expand further to frontier markets and there’s definite interest there.
Laurina: These institutions are looking for partnerships with people who can solve their problems, people who can help look at their asset allocation from a holistic standpoint and try to find ways to deliver specific outcomes for them. It takes a lot of time to build up that kind of relationship but it’s very rewarding over the long term.
On a more general basis, a recent survey suggested sovereign wealth funds will grow to $10 trillion by 2020 which is almost double what they represent today.
There is definitely scope for growth in the number of them because new ones are being born all the time.
We talked about regulation and risk management. That’s an area that sovereign wealth funds are definitely looking at; some way to harness the risks they have, not just operational risk but also political risk and manager risk.
Wells: Each sovereign wealth fund is different but you do see some who are developing their internal teams as well as investing with external managers.
One trend is that there’s less closet benchmarking and the desire that, when you’re hiring active managers, you get alpha returns to justify your fees. That’s where the opportunities lie for all the asset managers in this room.
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