Investing in Iran: Not Such a Far Frontier

Financial Times, March 11 2013

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Last week this blog looked at the investment case for Iraq under the headline: “A frontier too far?” So we were struck by a new report today on neighbouring Iran with the opening line: “Iran is beyond the final frontier for portfolio investors.”

One can quibble about which frontier is further but in truth investment in Iran is not so outlandish. The nuclear deal struck between Iran and several world powers in November prompted a renewed look at the investment case for Iran, as has been the case for other markets that have come in from the cold after international isolation, most recently Burma. But in fact, even in isolation, Iran’s capital markets have grown just fine.

Tuesday’s report from Renaissance Capital’s main visionary thinker Charles Robertson follows a research visit there that led him to believe Iran will become investable, at least to frontier funds, within the next six to 18 months. This is a country, Robertson says, whose well-educated 78m-strong population is roughly the same size as Turkey’s, “with official per capita GDP of around $5,600, but which feels to us like $8,000-10,000. Tehran feels like Ankara did in 2004.”

Iran not only has a broad manufacturing base but 9 per cent of the world’s oil reserves (the Iranian & Foreign Joint Venture Investment Association reckons 11 per cent) and a large current account surplus. “Most interesting of all, there is a dynamic reform team now in charge of the government and central bank, which is undertaking the classic monetary and fiscal reforms EM investors usually like. This looks to us like a potential re-rating play that could – in an investable scenario – attract those investors who have recently invested in Saudi Arabia, like those who invested in Turkey after 2001 and Russia since the 1990s.”

When it does become investable – which will involve a combination of the removal of US sanctions and a growth in investor confidence around repatriation of funds – investors will find a mature market waiting for them. The market cap of the country’s stock markets at $170bn is, as Robertson says, similar to Poland’s, following privatisations over the past decade. The free float is around $30bn, more than the MSCI free floats of Kuwait and Nigeria, so if it were to enter the MSCI frontier index, it would account for about a quarter of it if all companies qualified for inclusion. Its daily trading volumes of around $150m are about five times those of Nigeria last year, Robertson says.

Others point to Iran’s favourable location between the Middle East, Asia and Europe, a staging point for the growing Central Asia/Caucuses region of 300m people and a lot of natural resources.

So, what’s the case against? First, there’s getting access in the first place. Robertson says there is a consensus in Iran that a deal on sanctions will take place with the US, possibly even later this year.

Once in, investors will not find everything to their liking: Robertson compares the banking sector to Russia’s in the 1990s. “We doubt the official NPL ratio of around 18 per cent is telling us the whole story.” The bond market is somewhat weird, with securities able to be sold back to the guaranteeing bank at any time and trading, if trading is the right word, at par. And many companies are owned by quasi-government funds or the Revolutionary Guard.

There are ethical questions around treatment of women, attitudes to Israel and general human rights – though there is a strong case to be made that Iran does better than Saudi Arabia on at least two of these metrics – and questions about the environment for legal redress, through there is new investment legislation in place intended to protect foreigners. A natural question arises about safety but many who go there frequently report no problem.

Some are in there already. Canton Hermidas Private Equity has launched a technology start-up private equity fund for Iran. Swicorp, a private equity and investment banking group headquartered in Switzerland, launched an open ended private equity fund focused on Iran, Algeria and Sudan back in 2005.

There are many steps to take before Iran can be considered fully linked back into the global economy and its portfolio flows, but when those steps are taken, investment in Iran is not going to look any more peculiar than many other countries that today receive frontier funds. As Robertson says, “if the situation with sanctions is resolved, it could be a serious market to consider in the coming years.”