Our panel discuss Saudi Arabia, the costs of launching Ucits funds and how to fix negligent corporate governance. Chaired by George Mitton in Dubai.
Samer Abdel Kader (Regional head, SEI Investments)
Saleem Khokhar (Head of equities and fund management, National Bank of Abu Dhabi)
David Marshall (Senior executive officer, Emirates NBD Asset Management)
Terry Mellish (Head of MENA and global head of institutional services, Natixis Global Asset Management)
Muhammad Shabbir (Head of equity funds and portfolios, Rasmala)
Funds Global: What will happen when the Saudi stock market opens to direct foreign investment, in terms of investment flows, equity prices and volatility? How can you prepare for this event?
Saleem Khokhar, NBAD: Saudi Arabia is a deep and liquid market worth nearly $600 billion. Currently, foreign access is limited to swaps. Giving owners direct access will help to institutionalise the market. Over time, you will get more research coverage and more international brokers setting up over there.
We saw something similar when the UAE and Qatar joined the MSCI Emerging Market index, when there was a run-up in the equities market. I would expect a similar reaction in Saudi but not to such a great degree. The bigger story will be if Saudi gets upgraded to emerging market status. That’s likely, but not before June 2017.
Samer Abdel Kader, SEI Investments: We have seen a difficult period for the Saudi market because of geopolitical issues in Yemen, but since the Saudi regulator announced a timeline for opening up, we’ve seen a strong rebound. Right now, an estimated 3% of the Saudi market cap is held by foreign investors through P-notes [participatory notes], swaps and other expensive instruments. On average, emerging markets tend to have between 25%-30% foreign holdings. It will help to have a more institutional base to the market but, in the coming months, volatility is likely to tighten.
Terry Mellish, Natixis: It’s notable that the Saudi authorities are opening the market during Ramadan, a period when a lot of people aren’t going to be around. This shows a huge commitment. It will improve liquidity and you’ll get more institutional investors coming in, which will be win-win for them and for investors generally. Our firm has a strong emerging markets presence, we have 26 underlying asset managers, and some of them are already interested in what’s going on.
Muhammad Shabbir, Rasmala: Close to half of our portfolios are already invested in Saudi Arabia. However, we find the market is dominated by local retail investors. Institutions are only 8%. The opening-up may add another 10% for institutions, but it is not going to be a big difference. I don’t think there will be less volatility because foreigners are coming, I think there will be more.
However, the focus of foreign investors will be different. Local investors don’t care too much about valuations. Right now, the average price-to-earnings ratio on the Saudi market is close to 17 or 18 and it is too high for most foreign investors.
The attraction for foreign investors will be in the banking and petrochemicals sectors, both of which are not loved by the locals. But the question will be, is the Saudi economy going to weaken, and have valuations adjusted to the drop in oil prices?
David Marshall, Emirates NBD: On a relative valuation basis, the market may be expensive. For us, however, it’s a positive, because we’ve always run MENA portfolios with higher Saudi weights than most of our peers. We moved our book to Luxembourg last year and found that counterparty limits mean a certain number of peers run money with benchmarks capped in Saudi at 10%, 20% or 30%.
Saudi has been an underperformer in the last 12 months or so, but we’ll look to maintain a weighting of up to 50%. As well as P-notes, which have been mentioned, there’s been a slight opening up in the swap agreements, which are a little bit cheaper than P-notes. We’ve been using those as well.
The big issue is that this puts MENA more on the map. The people who want to be in Saudi equities are already in that space; the bigger thing is the international guys who see it becoming more of a mainstream player.
Funds Global: Investor sentiment towards Gulf equities has been driven by one overwhelming factor this year: the oil price. How have you responded as fund managers? How long will oil dominate local markets?
Abdel Kader: It’s been the biggest factor for the last six months and will likely continue to be the biggest factor. An important question is whether an agreement with Iran is announced on June 30. If you have Iran’s production suddenly on the market, that’s not going to help the oil price recover. There’s been a lot of talk about oil finding a stable level; whether we’re there now after the recent run-up is still debatable.
Khokhar: Rig counts have come down for the US producers but, strangely, production levels have gone up. It’s because there is a fixed-cost element – you’ve already got rigs in place, so you drive them as hard as you can even though oil prices have fallen. However, it’s not a sustainable model. In any normal environment, it is the lowest-cost producers that tend to survive and the highest-cost producers that have to come offline. That says the US shale producers will be the ones to pare back.
I expect 12-18 months of weaker oil prices before they stabilise to $70 or $80 a barrel. I take on the point about Iran. There is low-cost production there but they also need to put some serious infrastructure investment in. It will take a number of years before that comes out.
Marshall: We are concerned about the oil price but we’re also agnostic. We can’t affect the oil price. However, one way we changed our approach is by looking at factors we’d never looked at before – the movement of the ruble with local bourses, for instance. One thing you can do is increase allocations to Egypt, which is in cyclical recovery and is a net oil importer.
The other issue I’d raise is that the reason you would hold, say, regional banks actually has nothing to do with the oil price. It is about balance sheet repair, lower provisioning, hopefully no impairments. Those are the kinds of sectors we’re invested in. Of course, if the oil price plummets, those stocks will be affected, but we will simply buy more on the way down.
Shabbir: We saw a big swing due to sentiment but are yet to see a significant impact on fundamentals, barring the petrochemical companies. The correlations are still high with the oil price, but are they going to stay at that level? I don’t think so. Eventually people will get used to the $60-$70 oil price range.
The big impact will be in the second half when you will start hearing about deficits. We are starting to see sensitivities even from the central bankers. They are looking at which banks have more exposure, for example, in the eastern region in Saudi, so they can prepare themselves for what actions to take.
Mellish: To some extent we will see a redistribution of revenue between importing and exporting countries, which could be beneficial. It clearly impacts on inflation, so central banks can be more accommodative in their programmes as a result. We as a group try to look through short-term noise. We’re telling clients not to do irrational things, to take the sentiment out of their decisions. They had to stay the course when oil was $120 a barrel so they should stay the course when it’s $60 or $70.
Funds Global: It is a common complaint that Gulf equity markets are dominated by retail investors and prone to big swings based on sentiment. Do you see any signs of a more institutional attitude emerging?
Marshall: The retail market was dead in the first quarter of this year, so we decided to speak to institutions more than the wholesale market. We saw some net outflows from the retail market and inflows from institutional inflows, which is a positive development. On the debt side, there are a lot more institutional allocators to the MENA region because it’s been resilient versus other emerging market debt strategies.
Abdel Kader: In developed markets, you have institutions like insurance companies and pension funds which prop up the markets – they are almost completely absent here, although there is regulation coming into play on the insurance side. In a young market, it’s typical to see retail dominate. Within another five or 10 years we’ll start to see more institutions play a bigger role in the market. Because it is a young market there are still issues around transparency. The Arabtec scenario last year turned off a lot of foreign investors.
Khokhar: I started off in the MENA region nine years ago, in Saudi Arabia. The change I’ve seen has been tremendous. Back then, when I tried to visit a number of large listed companies, they simply wouldn’t take the meeting. Now, most listed companies are mandated to have investor relations departments.
It’s moving in the right direction. Saudi opening up will bring more institutions in and make firms gear up to provide the information they require.
Mellish: We’re seeing a lot more institutional focus from some of the wholesale buyers we have. We have to go through stringent due diligence on solutions, strategies, products, which is encouraging. Some of their demands in terms of client support, operations and fee scales are moving towards an institutional approach.
Shabbir: No doubt the institutionalisation in the markets has increased in the last five years but it is not uniform across the markets and the test of it comes when the market is under pressure – when there’s sustained selling and nobody is buying. In the last six months, barring Saudi and, to some extent, Qatar, there was little or no support, particularly in the UAE.
The institutions, particularly the local ones, should be taking an interest in the overall healthiness of the market. In the first quarter, foreigners were heavily selling in the UAE, particularly in Dubai, but there was no counter-buying from local institutions because retail investors were largely at the centre of market conditions.
Funds Global: What is your attitude to corporate governance in the UAE and the wider region? Do you agree with a senior lawyer quoted in this magazine, who said corporate governance standards in onshore UAE companies need to be improved by heavy enforcement?
Abdel Kader: Should it be improved? Absolutely, and it has definitely been improved. There are regulations coming on board that will push insurance companies to institutionalise and have better corporate governance. The enforcement period for this is three years. The UAE Companies Law came on board recently too, so there is movement in that direction. Regarding the question of enforcement, it’s not necessarily the best scenario.
Khokhar: Enforcement is probably not the right answer. When you look at Saudi Arabia, for instance, they’re pretty good in terms of their corporate governance structures. The regulators are doing an effective job. There are still mishaps, though, but the regulators are working in an effective manner.
Overall, you want to encourage an environment where corporate governance is ingrained in the culture. From our side of the fence, asset management, there’s a compliance culture, a real corporate governance culture that affects everything that we do.
Mellish: We’ve seen in many markets that to be good corporate citizens, to do well in portfolios, to do well as investors, is a plus point – it’s a positive rather than a negative. It would improve if the regulators were naming and shaming people generally so everybody responds to that. It’s a very young market but we do see clear evidence of it improving.
Shabbir: There has been an improvement in some markets, in others it is very patchy. In the UAE, we had the case of Arabtec. We also found that certain companies in the UAE were allowed to do greenfield IPOs, while others were not allowed even at 30% or 50%. These kinds of preferential treatment give rise to negligent corporate governance.
In the Saudi market, we have seen an improvement; they are quite strict about it. The Qatari market is also more or less all right. The Kuwaiti market mainly has been difficult, and here it is an enforcement problem rather than a case of lacking regulation.
Marshall: For me, it’s not about regulation. More regulation doesn’t necessarily mean better regulation. We’ve seen it here. Some of the regulation that’s come out is fantastic, some of it, from a practitioner’s point of view, is much less constructive.
Better corporate governance has to come and opening up the markets will help. The movement of capital, people relying more on direct foreign investment, are good for the markets. But remember, this has changed probably beyond all recognition in the last nine or 10 years. It’s got a long way to go in the next 10 years.
Funds Global: If you want to attract European investors, is it necessary to have Europe-domiciled funds, such as Ucits and AIFMD funds? Do the potential gains outweigh the costs of launching and marketing such products?
Shabbir: For marketability, it’s certainly worth the effort. You enter into a better governance framework and investors are more receptive if you are running a Ucits product. The disadvantage is on the cost side – not only lawyer fees, but administrator fees, custodian fees, brokerage, commissions.
Marshall: You don’t have a choice. If you want to attract overseas capital, you need to have a Ucits structure. Having run Ucits money for 18 months and in parallel run non-Ucits money, there are additional controls, and I would say 30% of those additional controls have real intrinsic value, 70% are ‘nice to have’.
A good example: we had to pay someone to do risk management, even though we were doing risk management ourselves. I understand the need to segregate duties, but who ultimately pays? The investors in the funds. I don’t perceive any real value there but I know that if I go to a private bank in Singapore without the Ucits label, I won’t get through the door.
Khokhar: We at NBAD have a Ucits platform. We found that the investor base, particularly in Europe, does not fully understand the MENA region, so it gives them comfort if they’re on a platform which they do understand. Our funds are domiciled in Ireland and we have seen strong growth in assets under management, but it can be cumbersome. There are new regulations coming out all the time, for instance the Emir [European Market Infrastructure Regulation] rules on reporting derivatives and swaps – all things which you have to pay money for. Ultimately, do the potential gains outweigh the costs? Yes. However, you have to think hard before you launch a fund, because you need to reach a minimum size to make it effective.
Abdel Kader: We have a sizeable administration platform and one of the services we offer is helping fund managers administer Ucits funds. There is so much demand, we’re not able to onboard anyone for a number of months.
Funds Global: For locally based firms, what are the hurdles to building a brand in Europe and elsewhere? For international firms, what are the barriers to promoting MENA funds to investors outside this region?
Shabbir: It takes a lot of effort to show yourself to the institutional investor landscape. It is a long road and there are no short answers, even within the region. If you are doing something in developed markets where investors are used to sophisticated pitches and asking questions about the nitty-gritty of your organisation, you have to do a lot of preparation.
Khokhar: There are certain areas where NBAD is well known, and others where it’s not. When we go to Europe, for example, to compete effectively in the asset management space, we try to bring out products which are different to the mainstream, to carve out our own niche so we can go in there and present ourselves as specialists, whether that be in MENA or frontier market investing.
Marshall: NBAD and Emirates NBD have a structure that allows us to play on the balance sheet strength of the shareholder and that makes people feel comfortable. At a brand level, we’re not going to compete with international players on global equities and global debt. Instead, we go for a relatively niche asset class which is interesting from a macro perspective and position ourselves as an expert. In global terms, we’re a boutique manager, but our performance numbers stack up credibly.
Mellish: We have international products which we sell into this region, we don’t have MENA products we sell outside. We nonetheless have a brand fight, just as we do in every market. We own over 20 affiliates globally. Clients may not have heard of Natixis, but when you explain we own, say, Loomis Sayles, Harris and so on, it does open their eyes.
Funds Global: How important is Islamic finance in your product offering? Is there a risk that Asian domiciles, such as Malaysia and Indonesia, will outstrip Gulf markets as hubs for sharia-compliant investment?
Khokhar: Islamic products are becoming incredibly important to the region and beyond and we at NBAD are making a push into Islamic finance. We are looking at setting up operations in Asia and Malaysia is an option.
In terms of competition, attitudes to Islamic finance are different in Malaysia from, for example, the UAE. It doesn’t necessarily translate. There are different views on what is sharia-compliant and what is not.
Marshall: Islamic assets are about 35% of our book, so a little over a billion dollars. We are also looking to expand our distribution capability to Singapore and most likely Malaysia. Common sense tells me that should be a market in which we can perhaps participate.
Abdel Kader: SEI was one of the first of the global asset managers to launch sharia-compliant funds. We probably jumped the gun. We launched them around 2010, when the market hadn’t developed enough – there wasn’t enough breadth and depth. The likes of Emirates NBD and NBAD are perhaps more natural sources of investments because they are more focused on the region.
Mellish: We just won an Islamic bond client, which we were told about yesterday. We are doing Islamic finance selectively. Though it is not suitable for most of our affiliates, it’s important for a firm like Natixis to have a strong suite of both conventional products and Islamic products.
Shabbir: Islamic finance is an important area for us in the Middle East and we take it seriously. Most of our recent products are all on the Islamic side because this is what investors want.
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