Middle East Asset Management Prepares to Take Place on World Stage

Euromoney, September 2015

For many years, asset management in the Middle East has been something of an afterthought to the global industry. With the biggest markets inaccessible, and the others representing little meaningful scale in any benchmark index, they have been a side-bet, even an indulgence. 

All of that is set to change. The inclusion of Qatar and the United Arab Emirates in MSCI’s Emerging Markets index last year was a sign of things to come. The opening of Saudi Arabia to international capital – with some restrictions – is a true landmark, bringing by far the region’s biggest economy and market into the reach of a whole new group of institutional investors. And now it looks like Iran, cut off from world portfolio flows for years by sanctions, is returning to the fold as well. These are interesting times to be a regional fund manager in the Middle East.

That said, while there are examples of international institutions staffing up in the Gulf, today it remains heavily under-represented by the world’s big active managers, and most of them still talk about a future opportunity rather than a present one. Meanwhile local managers have a chance to attract funds from overseas while the multinationals wait for the right moment to bulk up.

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The Dubai International Financial Centre is supposedly the hub through which multinationals engage with the region, and its tenant list represents the great and the good of global asset management. There’s a catch, though: the majority occupy their small offices with sales and support staff only, with very few conducting active fund management on the ground. It has long been argued that DIFC represents a conduit for money to leave the region, not to enter it; the opening of Saudi and Iran represents the single greatest opportunity to reverse that trend.

There’s not yet evidence of this shift taking place, according to the region’s asset managers who are watching and waiting for the flows to come to them. “People have been preparing for it [Saudi opening], but I don’t think the massive changes have come yet,” says Rehan Pathan, managing partner of Takseem, a Dubai-based firm that takes on the marketing and distribution for a number of regional and international funds. “We have a couple of regional managers on board and it’s not like they’re being overwhelmed with inquiries or RFPs. There will be movements in the long run, but people aren’t rushing in at this point.” He adds: “It’s the middle of summer. There’s not much going on.”

One of the few multinationals to make a sustained effort to build a regional asset management business is Franklin Templeton, which built its critical mass in the region by buying 40% of the Dubai-based boutique Algebra Capital in 2009 and then integrated it into the broader Templeton machine. There’s no question Templeton sees the emergence of Saudi and Iran as deeply significant from an investment perspective, and it meets all the criteria (see previous Euromoney features on the Saudi market opening) to go into that market directly. But it isn’t, yet, doing so.

“While we do have access to the market through promissory notes, we are currently exploring options to enter the market as a qualified foreign investor,” says Bassel Khatoun, CIO for MENA equity at Franklin Templeton Investment (ME). He’s certainly enthusiastic about the investment case – “With a capitalization that exceeds US$550 billion, the Tadawul is the region’s largest, and compares to major emerging markets such as Turkey, South Africa and Russia in scale.” And he is effusive about Iran, while stressing – as all international fund managers do, usually underlining it and putting it in bold in reiterated email confirmations – that it adheres to all government sanctions and won’t go in until it’s unequivocally OK to do so. “The long-awaited announcement that Iran has secured an agreement over its nuclear programme will have positive implications, not only for Iran, but for the wider MENA region.”

But he and Templeton stop short of saying that this changes the way they themselves do business. Templeton stresses that Khatoun’s positivity on both markets as an equity investment team “doesn’t speak to corporate decisions to enter the market as an asset management firm.”

And in this, Templeton is representative of a widespread sense of caution in the Gulf. Schroders is another international name that has built Middle East funds and developed an investment presence on the ground, and is similarly enthusiastic about the investment opportunity presented by what’s happening. “The short answer is it’s very significant,” says Rami Sidani, the key fund manager of the Schroder ISF Middle East and Schroder ISF Frontier Market Funds in Dubai. Saudi opening “is a massive development, not only for Saudi Arabia but the entire Gulf region. It puts Saudi and the Gulf on the radar screen of international investors.”

But he, too, stops short of expressing a desire to increase resources to meet this opportunity. “At the moment we have enough resources to leverage, and the capacity to look at new markets. We’re not in a rush to increase resources,” he says. “We’re directly overlooking about $1.8 billion [the total within frontier market strategies, of which he estimates more than half is in the Gulf] so the economics can easily allow us to increase resources if we want to.”

There are probably two reasons that fund managers aren’t rushing to bulk up. One is the sense that the biggest change in institutional investment attitudes towards Saudi Arabia doesn’t come with the opening of the market, but the moment when it is included in international benchmarks, and then cannot be avoided. “There has been more interest in the region from international investors because of Qatar and the UAE entering the MSCI index, but it’s not as high as it will be when Saudi is added,” says Akber Khan, director of the asset management group at Qatar’s Al Rayan Investment. “At present the UAE and Qatar represent about 1% of the index each; when Saudi is added, the region will represent at least 5%. A fund manager can overlook one or two per cent of an index but when it’s 5%, and with Saudi as big as liquid as it is, it’s a different beast.” Indeed, it is different in every respect: where the UAE and Qatar combined have less than 15 companies that trade more than $7 million a day, Saudi has 50; the Saudi market’s daily volumes are always a significant multiple of the UAE and Qatar combined; and Saudi has considerably greater depth for stock selection alongside its liquidity.

But Saudi, barring some unusual accommodation with MSCI, can’t enter that index until 2017 at the earliest, and that’s more likely to be the landmark moment for foreign portfolio flows. “In my opinion, the real inflows of international investment into the Saudi market will happen then,” says Sidani at Schroders. “Inclusion in the MSCI EM index will attract massive inflows into the market.”

The other reason may be that Saudi’s opening, and the positive news on Iran, have both coincided with a very low oil price (indeed, Iran’s opening is another reason for the oil price to remain low, since logically it should increase supply of oil to world markets). “The oil price has, at the very least, affected sentiment; and at worst it has actually dented earnings,” says Khan. “For SABIC or other petrochemical companies it has had a real impact on revenues and profits.” That’s not the case in the many other sectors represented in the Gulf (fund managers tend to like consumer and healthcare in particular, and in truth direct exposure to oil is not that easy to get in the Gulf), but that doesn’t necessarily make a difference to distant investor sentiment. “A number of companies continue to have excellent medium-term fundamentals. Yet share prices of many of these have weakened because top-down asset allocation decisions are being taken thousands of miles away to reduce exposure to oil exporting countries, in some cases to reallocate to oil importers.” Local asset managers don’t think this way – Al Rayan, like many in the region, takes a bottom-up, stock specific approach, and Khan says “patient investors can pick up some fantastic bargains in our region” – but it does affect the ebb and flow of international capital which might otherwise be coming here.

Nevertheless, there are some examples of multinationals who see this as the right time to build.

One clear example is Ashmore, which opened an office in Riyadh late last year through a new locally-licensed subsidiary called Ashmore Investment Saudi Arabia, with initial plans to launch funds that would give both onshore and offshore investors the option to buy Saudi, GCC, global equity and debt products. It is marketing its combination of local and global expertise directly to institutions, family offices and high net worth individuals.

Why choose Saudi over Dubai or the others? “Saudi Arabia is the biggest economy in the region, accounts for nearly 50% of its collective GDP and has the largest population in the GCC,” says John Sfakianakis, Middle East director for Ashmore Group. “With a very high purchasing power, it makes for a compelling story to be in Riyadh now.”

“Also,” he says, “one is appreciated far more by being physically present by investors, businessmen and ordinary people than shuttling back and forth. Moreover, one gets a far better understanding of the intricacies by being in Riyadh rather than flying in to Riyadh.” He compares it to China: it’s good to be in Hong Kong, but to understand it, you need to be on the Mainland too.

Ashmore’s Saudi office will serve the whole region, “but that doesn’t preclude us from opening more nimble offices in other parts of the Gulf,” he says. So far three funds have been launched: a Saudi equity fund, a GCC fund and a Shariah IPO fund.

Clearly, Saudi’s new openness was crucial to Ashmore’s decision to launch here. “Institutional investors will only invest in open markets,” he says. Being locally domiciled, Ashmore is already able to invest directly.

Another example was Lazard Asset Management’s decision to poach the Middle East asset management team of ING Investment Management, led by Farah Foustok, a long-standing fixture of Gulf asset management who also used to run that division at Emirates NBD and is now managing director and CEO for the Middle East at Lazard. Lazard had been running assets in the region out of a Bahrain office, but the poaching of the six-person ING team in February 2014 was a clear statement of intent.

“We have an investment team based in the Middle East doing Middle East equities, we are marketing the international strategies of Lazard into the region, and we are marketing the Middle East externally,” explains Foustok. “It’s a three-pronged model.”

Plenty of other international houses, though, are content to continuing running their Gulf investments – insofar as there are any – out of London. And in the meantime, local managers sense an opportunity.

“There’s certainly a great deal of home country bias where regional institutional investors would rather give money to a domestic manager because of familiarity and perhaps other relationships that already exist, especially if the asset manager is part of a bank,” says Khan. “As far as internationals are concerned, a few have presence on the ground with varying success. With some exceptions, most have failed, and I’m not sure why: in theory, the combination of having global distribution marketing local production should be far superior to what local managers can muster. But that doesn’t seem to be the case.”

Should locals, then, be selling their product internationally? Some are. After many years of planning, Saudi Arabia’s NCB Capital, the country’s biggest fund manager through its Al Ahli range, launched Saudi’s first locally-run UCITS funds from Dublin in December 2012; two funds, the NCB Capital Saudi Arabian Equity Fund and its GCC Equity counterpart, can be bought internationally under the regulation of the Central Bank of Ireland. Both are Shariah-compliant. In July, Kuwait’s Asiya Investments and Trium Capital said they would jointly launch a UCITS fund (although this first fund is an emerging Asia one, not Middle East); there is already a UCITS registered MENA fund run by The National Investor, another Kuwaiti fund manager. Other funds under the UCITS framework from local managers include products from Dubai’s Al Masah Capital, a MENA bond fund from National Bank of Abu Dhabi, and Duet MENA, which is a Dubai-based arm of the London-headquartered global group and launched a UCITs version of its global Horizon strategy in Luxembourg earlier this year. Egypt’s EFG-Hermes Asset Management also has UCITS products.

It’s a fairly modest list, but then again, we should perhaps not read too much in to that. “Within the region, you don’t typically need a fund structure like UCITS,” says Rehan Pathan at Takseem. “Asset managers like NCBC and Jadwa have raised several billion riyals in local Saudi equity funds and mandates. UCITS funds are set up for international investors looking to access the GCC region, but if they aren’t ready to buy the underlying market, there’s a question mark over the need for them in that format.” Big investors who might have considered going through a UCITS fund are more likely to invest directly anyway, as they have done through P-note structures in Saudi. “If I’m an international institutional investor I might say I’m better off running my own book on Saudi, because if I take a bet on 15 companies – SABIC alone is 15% of the market, plus Al Rajhi and a couple of other big ones – I’ve got my allocation.”

The opening of Saudi in particular could be a boon for those locations that seek to be a hub for regional asset management. In truth, there’s hardly anywhere in the Middle East that doesn’t think it is a regional asset management hub, but in practice Dubai’s DIFC probably has the most to gain.

DIFC itself is, like pretty much everyone else, guardedly optimistic. “In a way, Dubai and DIFC will stand to gain from it,” says Chirag Shah, chief strategy and business development officer at DIFC. “The expected inflow of funds to the Saudi bourse will have a positive impact on the entire region. I am sure some funds will also make its way to the DFM [Dubai Financial Market]. And I expect at least some of the fund houses which already have offices in DIFC to expand their workforce and service the Saudi market from here.”

He has Dubai’s streamlined processes on his side. “We’re based in Dubai because of regulation, ease of doing business, ease of hiring staff, and logistically being able to fly in and out of any of these countries in the same day,” says Foustok at Lazard. Equally, though, Ashmore’s move may suggest that more people will simply go straight to where the money is and open directly in Saudi, though that brings with it a number of logistical challenges, as well as the fact that it is harder to attract international staff to Riyadh than it is to Dubai.

Incidentally, Euromoney understands that of all the international asset managers that might qualify for direct access in Saudi Arabia, HSBC is (as of the time of writing in mid-August) the only one that is actually doing so, with six further filings pending approval. Lazard, for example, has opted to stay in its existing structure, investing through P-notes, due to the current Capital Markets Authority rules which do not allow access except through either P-notes or direct. “It is clearly important to understand all the legal implications, and we will be visiting the CMA,” says Foustok.

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If Saudi is an easily quantifiable opportunity, and the effects of UAE and Qatari MSCI inclusion can already be measured (positive but modest), then Iran is a little harder to consider. It is, though, a source of some excitement in the region.

“It is, to me, the most exciting economy in the world and the most exciting investment destination in the world right now. No other country comes close,” says Khan at Al Rayan. “It’s the combination of extraordinary natural resources – and not just oil and gas – a large and well educated population, very significant opportunities for tourism, its geographic position from a trade perspective, and the massive, massive unmet demand in every single sector of the Iranian economy from industrial to finance to real estate to aviation to the consumer. Assuming western sanctions are successfully lifted, investors are going to be, and some have already started, falling over themselves to figure out how to get a piece of the action.”

Dubai’s probably the natural place for this to happen: it’s already effectively the trading hub for Iran, both formally and informally, and is both close and well connected with flights through FlyDubai (as is Qatar, which covers five Iranian cities). That said, once Iran’s truly open, will an entrepot even be required? “There’s no reason that, in a couple of years, the money wouldn’t just come here directly,” says one banker in Tehran.

There is, though, a slight catch for Gulf asset managers considering Iran: uneasy geopolitics, in particular as they relate to Saudi-Iranian relations, which were terrible even before Saudi’s engagement in Yemen (Saudi believes Iran is involved in that conflict on the opposite side) and are now considerably worse. “You know, if I was to have this conversation with my senior management and talk about the opportunity in Iran, I’m not sure they’d even want to do business,” says another local asset manager. “The regional politics are too complicated.” This person argues it will actually be easier for western asset managers to go into Iranian investment than it will be for those in the Gulf, because those regional complexities don’t apply.

As Euromoney reported last month, some first movers have already launched investment products for Iran but, with the sanctions regime still in place for the moment, are doing so through promissory note synthetic structures similar to those that have existed over the years from India to Saudi Arabia. Direct investment will have to wait until sanctions are formally lifted, probably early next year, and in particular until Iran re-enters the SWIFT network. Then, it will be a fairly easy matter to invest: regulators in Iran aren’t particularly restrictive on foreign ownership and, even if the snap-back provisions were to be implemented to put sanctions back in place (see main article on Iran), it would be relatively simple to sell out since liquidity in Iran is surprisingly deep even without foreign capital.

Fund managers in the region note that Iran is a quite different prospect from Saudi. “Iran has a long way to go: less developed internal capital markets, there may be issues of transparency or corporate governance – I would be wary as an institutional investor,” says Pathan. “I don’t know anything about the companies that are listed there, or anyone who’s writing research on them. Is it worth the risk, when so many emerging market opportunities are out there in so many asset classes? Saudi has the best law firms, best audit firms and best consulting firms in the world operating there and they all have a track record now, with audited financials from E&Y or PWC. Saudi is not the same thing as Iran, for sure.”

BOX: The debt case

Saudi Arabia and Iran have been presented chiefly as an opportunity on the equity side, but both markets are attracting interest from the fixed income community as well.

Saudi Arabia as a sovereign had been inactive in the debt markets since 2007 until this year, but the falling oil price, and an apparent unwillingness to dip (or to dip any further) into reserves, has prompted a rethink. In July Fahad al-Mubarak, governor of the Saudi Arabian Monetary Agency, said it had issued US$4 billion equivalent in local bonds, and in August it was reported that the country planned to raise a total of $27 billion by the end of the year, with issuance of about SR20 billion (US$5.3 billion) a month in five, seven and 10-year paper until the end of the year.

That caused a lot of ears to prick up in the international investment community, although some were disappointed to find that the $27 billion headlines masked the fact that little, if any, is likely to be in dollars. “We would be particularly interested in dollar-denominated paper to start off with,” says Abbas Ameli-Renani, global emerging markets strategist at Amundi, which has over $1 trillion in assets under management. “That would be true for most emerging market-dedicated investors. To take risk in local emerging market bond markets, you need local custodians, local infrastructure, and also a currency angle: with the Saudi currency pegged to the dollar there isn’t much of a local currency angle there.”

Still, local currency paper will be of interest to regional fund managers, and even if Saudi doesn’t go for dollars, there are other sovereigns in the region – from Bahrain to UAE government entities to Iraq – that are active, and attracting interest.

Ameli-Renani says Iran could also be an interesting market for the future. “On the fixed income side the initial opportunity would be in external debt,” he says. “The Iranian government has never issued in dollars in a meaningful way – it mandated a dollar deal a decade ago but never came to the market – and if it sought to issue in dollars, that would be quite interesting to investors,” assuming that sanctions had been lifted by then.  “Iran would need to give a much higher premium than Saudi and that would be attractive for foreign investors, especially since it’s a country where people are familiar with the opportunities that exist and want to be part of the story.” As our main Iran story points out, the snap-back provisions in the nuclear sanction deal could be prohibitive, but to Ameli-Renani, that’s a question of price. “At the margin that would be a risk, but that’s part of the reason Iran would have to pay a higher premium.”