Euromoney GCC asset management guide: product

This article is one of seven that makes up the Euromoney Guide to Asset Management in the GCC, distributed with Euromoney magazine in June 2008

Product is an exciting field in a state of rapid evolution in the Middle East. Local managers are moving rapidly from country-specific equity funds to a host of other asset classes; internationals are finding appetite for a wide range of their global product book.

For local managers, equities remain the dominant asset classes, although that dominance is shrinking somewhat. The attached chart shows the asset allocation of local mutual funds in Saudi Arabia and Kuwait from 2005 to the middle of 2007. The proportion of assets that are in shares was 72% in 2005, before falling with the 2006 stock market crash and hitting 52% in 2007.

These have traditionally been local country funds. Almost every fund manager of any consequence in the Gulf offers one in their home market. The Dubai-based research group Zawya tracks 208 products, and 93 of them are single country equity funds.

Over time, though, more and more regional products have appeared. Zawya tracks 23 GCC equity funds and a further 11 MENA funds, and more are appearing all the time. Shahid Hameed, head of asset management for GCC at Global Investment House, says this is the future – even though Global is something of a pioneer in country funds outside its home market, even offering a product focusing on the Palestinian Territories. “What’s currently in demand, and will be, is mainly regional funds,” he says. “It’s getting more and more difficult to sell country specific funds. For us it’s Kuwaiti funds [Global’s home base] and regional scope funds like GCC or MENA.” In particular this approach is going to be the one that appeals to international capital. “If I want to sell to an international level and tap into the western and Asian markets, it makes a lot of sense to have a geographical spread,” he says. “If I look at it as a block it starts to become of interest in terms of its size: there’s a trillion dollar market capitalisation for GCC markets.”

There are more underway. “You see a lot more competition,” says Hameed. “When I launched my first fund five years ago [then at SICO in Bahrain], we were amongst the very few GCC focused equity funds. Now almost every bank in the region has some sort of GCC fund.”

The local view, though, remains exactly that: local. The average investor still wants home exposure. “There are now so many products and funds offering MENA, but only sophisticated or international investors look into these products,” says one domestic fund manager. “It’s mostly local-centric.” After local equities, money market and real estate are the next most popular, he says.

Be that as it may, change is underway. Several Gulf-based managers have developed sector funds, very rarely seen a few years ago. There are, for example, four regional telecoms funds in the region now: Kuwait Investment Company’s Al Atheer Fund, National Investment Company’s Zajil Services & Telecommunications Fund, the EFG-Hermes Telecom Fund, and another from Saudi Arabia’s Riyad Bank; the National Investor, an Abu Dhabi manager, also plans a telco fund, alongside other sector funds in financials, real estate and industrials.

As befits the oil wealth of the region, there are funds for industrial and petroleum services (from National Investment Company); global energy, petrochemicals and downstream industries (Global Investment House); and industrials (HSBC/SABB in Saudi, which also runs a financials sector fund).

There aren’t, yet, any small cap funds, because the markets simply aren’t deep enough to warrant it. A handful of index funds are sold, among them a global product from Global Investment House and country-specific funds from Industrial and Financial Investments Company (in Kuwait) and Abu Dhabi Commercial Bank (in the UAE). This shortage of index funds is puzzling in a market where many people seem to show an enthusiasm for market exposure without a great deal of discernment between the merits of individual stocks.

A handful of local managers run their own international equity products, notably Global Investment House and Saudi Investment Bank, but generally local managers sell white labelled products from internationals. There are a number of India funds, though often with underlying stock selections made by people on the ground there; Commercial Bank of Kuwait sells an India fund of funds, and Bahrain’s Al Amin Bank plans a Shariah-compliant Indian stock market fund to be managed by Kotak Mahindra.

On the debt side, the vast majority of funds in this area are money market products, sometimes referred to locally as trade finance funds, or their Islamic finance equivalent, murabaha. This is the biggest part of the ‘other’ category referred to in the Cerulli chart on Saudi Arabia and Kuwait.

But as that chart also shows, mainstream fixed income debt funds are rare indeed – 1% of the Kuwait and Saudi markets. They do exist – Global Investment House, Gulf Investment Corporation, Kuwait Investment Company, HSBC and SHUAA Asset Management run bond funds – but they are strangely under-represented.

Some see an opportunity. Algebra is in the process of launching a local currency corporate debt fund for the MENA region, believed to be the first of its kind. Daniel Smaller, managing director of sales and distribution at Algebra, says the corporate debt fund will aim to be highly liquid so local investors can use it in place of cash investments. “They’re getting paid 1 or 2% on their deposits,” he says, whereas the yield on a debt fund should be higher. It should also appeal to international investors because of low volatility and high credit ratings for regional debt, plus the benefits that will come if currencies de-peg from the US dollar and revalue upwards. Algebra also plans a sukuk fund – see the Shariah section for more on this.

Logically, debt funds ought to have a bright future in the Middle East. “It is estimated that $2 trillion of infrastructure spending is going to be done in the Middle East in the next five to 10 years,” says Smaller. “You can’t raise that with equity, and bank lending has its limits. You need an efficient bond market.”

Two asset classes are mentioned constantly by local and global managers when asked what is popular: real estate and private equity. Direct investment in real estate is as popular as local stocks in the Gulf; it stands to reason that real estate funds, offered locally by several managers, should be popular too. This is despite the fact that the real estate investment trust market has not yet developed strongly, although legislation was passed in 2006 for the Dubai International Financial Centre to create domestic and international REITs.

Private equity is a huge area of interest; the Gulf Venture Capital Association believed there to be about US$25 billion invested in private equity funds in the Middle East by the end of 2007. Private equity fits the Gulf very well: stock markets are young and have a relatively small number of stocks listed on them, so there is a great opportunity in smaller companies that are not yet listed and can benefit from private equity investment. Another important element of this appeal is the passing of businesses from one generation to another. Abraaj Capital is the best known private equity manager in the Gulf; it has US$5 billion under management.

Alternatives generally are in increasing demand, including hedge funds and infrastructure. UBS has  formed a joint venture with Abu Dhabi Investment Co to launch a MENA infrastructure fund, where ADIC does the screening and UBS manages the infrastructure. The fund will sell in Asia, in Europe and the Gulf itself, with Asia expected to be a particular source of appetite. Among hedge funds, there are some local products – two prominent examples are the Alternative Strategies Fund sold by Gulf Investment Corporation in Kuwait, and a fund of funds sold by EIS, the asset management arm of Emirates Bank, in the UAE – while the most prominent international manager to have built a presence in the region is Man Investments.

Foreign fund managers are only now beginning to launch Middle East products of their own, and generally do so by subcontracting the investment process rather than trying to do it themselves. Schroders, for example, has a Middle East fund (interestingly, it can’t be sold in the UAE because it includes Israeli stocks) but runs it from London rather than its DIFC office, with most of the management handled by Algebra Capital on a sub-advisory basis. Algebra is part owned by Franklin Templeton, and represents a manufacturing or sub-advisory base for the Middle East for the US group (the two recently launched a Middle East fund in Korea in this way, for example). JP Morgan has a Middle East Equity Fund which had US$756 million in it in early April.

It used to be that structured products were particularly popular in the Middle East.  “When I first started going to the Middle East,” recalls Nick Tolchard at Invesco, “mutual fund sales were quite restricted and there were a lot of capital guaranteed products on the market. In the last few years people have increased their revenue from mutual fund sales.” Volatile markets – the UAE stock market dropped over 70% from its peak between mid 2006 and early 2007 – do tend to make capital protected products more appealing for investors, although Tolchard says: “we would argue that mutual funds remain a good long term opportunity and we would encourage investors not to automatically swing back into capital guaranteed structures like we used to see.” Nevertheless structured products do remain areas of strength for foreign houses such as SG, BNP Paribas, Deutsche Bank, ABN Amro and UBS, generally coming out of their investment banking divisions rather than the asset management teams.

So there is plenty of activity in Gulf product manufacturing, but the level of penetration is still reasonably weak. “A lot is happening,” says Shahid Hameed at Global. “But if you look at assets under management in the industry overall and compare that with the deposit base we have, it remains at the early stage of development.”