As we enter 2016, Mena Fund Manager considers some of the potential trends and themes likely to face asset managers during the next 12 months

After a turbulent 2015, fund managers will be hoping for some return to normality. The macroeconomic headwinds of the previous 12 months are likely to play a role in markets during 2016, however.

Last year proved a major adjustment period as investors and fund managers got used to the idea of weaker oil prices. Lower oil prices have been felt most sharply by the region's largest producers, however the impact has been felt across Mena markets.

Smaller oil revenues look set to remain a feature of the 2016 investment environment with economists from a number of organisations forecasting oil to sit at around $53 to $55 per barrel.

Weaker oil prices have been part of a wider drop-off in commodity prices across the world that has had a disproportionate impact on emerging markets.

The fall in commodity prices was largely driven by fears of a slowdown in Chinese economic growth and have contributed to a flight to safety by many international investors.

The region faced more specific challenges in 2015. Threats to regional stability have continued with the influence of Islamic State and its supporters spreading beyond Iraq and Syria drawing in international actors from further afield, further complicating matters.

However, the prospect of Iran returning to the international fold and the opening up of its market to greater levels of foreign investment has prompted much optimism among the region's fund managers.

Liquidity constraints

The pressure placed on oil producers by the lower price environment has forced finance ministers across the region to rethink their budgets. Subsidies have been withdrawn and 2016 spending plans restructured to factor in lower oil revenues.

Economists and managers have also highlighted its effect on liquidity in the region. Lower oil revenues have impacted the deposit mobilisation process in GCC banks, warned MR Raghu, senior vice president of research at Kuwait-based Markaz in November, where government deposits are significant.

Fall in deposits growth coupled with governments drawing down their savings had led to short-term pressures on the money market, he added.

"I see potential liquidity constraints on the horizon and have heard feedback from banks that their deposit base has been constrained," says Fred Tabbal, regional head of fund services - Middle East at Maples Fund Services.

"The primary sources of liquidity are regional governments and when the revenue base is impacted that will trickle down to institutions. It's something I'm watching closely and may have future implications.

"The theme is consistent throughout the region and if there is no 'dead cat bounce' in oil prices - which I think we are beyond - then it could become difficult for several governments to maintain their current level of spending," he adds.

Strong fundamentals

Despite underwhelming performance by many of the region's markets during 2015, some managers and economists are bullish about the prospects for the region in 2016. IMF GDP growth projections for Mena countries remain robust, with few significant downgrades and predicted growth is at much faster rates than that for developed economies.

Managers have been quick to point out some of the potential opportunities in markets during 2016.

"There is a feeling of real robustness about the UAE, whether there is a new post-sanctions regime in Iran that might benefit the UAE, but it is its position as a regional hub that looks likely to continue to play out positively in 2016," says Nick Tolchard, head of Invesco Middle East.

"Saudi is interesting because the Tadawul broadened its qualified foreign investor scheme in June and there is a lot of positive sentiment towards it."

He adds: "As an asset manager, we are very positive about the opportunities in Saudi Arabia and the headlines are all about oil price and geopolitical risk in the region, but we think there will be a good opportunity there because it's a domestic opportunity.

"There are significant headwinds but they shouldn't overlook some very strong fundamentals in certain countries."

"We've been increasingly more cautious about oil-related economies and looking for where the opportunities are," says Oliver Bell lead portfolio manager and chairman of the investment advisory committee for the T. Rowe Price Middle East & Africa Equity Strategy.

"We're underweight all the countries in the GCC with the exception of the UAE. We think markets have corrected but not enough. We are hiding in the high-quality companies with the potential to grow," he says.

"Even in a country like Saudi Arabia where the fundamentals are deteriorating, there are pockets of growth. Health and education are growing in the budget so we're looking at those companies."

He adds: "We remain constructive on Egypt, probably think there is a small devaluation coming that will unlock the currency and think the interest will rise significantly.

"Morocco continues to be a beneficiary of current environments: Europe getting slowly better and oil prices being low. It's an interesting country but just not that many companies that are interesting to invest in."

Taxing times

As well as macroeconomic challenges, managers will also face regulatory changes during 2016. One area potentially affecting fund managers will be the OECD's common reporting standard (CRS), which will seek to standardise financial reporting.

"The CRS is intended to establish a new global standard for information exchange and, as at 30 October 2015, 74 countries had agreed to its adoption," says Will Smith, partner at global law firm Sidley Austin. "Importantly, such countries include those where managers would typically consider locating fund arrangements, for example the Cayman Islands, Luxembourg and the Channel Islands.

"The majority of fund managers will need to consider the impact of CRS on their fund arrangements, and will need to work with both legal counsel and their local administrators in order to ensure that they are, and remain, CRS compliant through 2016 and beyond," he adds.

Another issue on the agenda for 2016 includes the OECD's initiative to counter BEPS or Base Erosion and Profit Shifting tax planning strategies which see little or no tax paid by corporates.

"Much has already been written about the impact of the BEPS initiative, and the issues which may arise for fund managers," says Smith.

The Sidley Austin partner says BEPS will force managers to have to consider a number of issues including bids to curtail the use of 'hybrid investments' and targeting of arrangements intended to avoid the creation of a 'permanent establishment'. The OECD will also target arrangements which seek to abuse treaty provisions (Article 6), says Smith, "in essence seeking to make it more difficult for certain types of intermediate entities to benefit from treaty reliefs".

"Through 2016, it will be essential for fund managers, particularly those with more illiquid strategies, to continue to monitor the development of these issues," he adds. "In particular, it is important to note that the OECD will launch a further consultation in the early part of 2016 to further consider the application of Article 6, with focus on the basis on which unregulated funds should be entitled to access treaty benefits.

Changing appetites

Increased volatility for the region's markets has contributed to a more uncertain investment environment for retail investors.

"Markets are very volatile, people's appetite for risk is changing. Their investment goals don't change too much but you're not going to achieve them if you don't make short-term focused decisions," says Terry Mellish, head of global institutional services at Natixis Global Asset Management.

"There is turmoil globally and the Middle East is not immune from that

Oil prices impact much of the region, if you're producing oil like Saudi Arabia at $50 per barrel you're not making any money, you're losing it. It is unlikely you are making any profit.

"We're seeing all of these trends changing the dynamics of markets like the Middle East," he adds. "It's forcing people to look at their investments and what they are doing in their portfolios with a long-term view and a focus on risk, in order to build portfolios better suited to investors' goals in complex modern markets."

Invesco's Nick Tolchard says investors have been making changes to asset allocations during the past year to adapt to new market conditions.

"Institutions have gone very much into alternative asset classes and we don't see that changing very much going into next year given the low yield environment," he says.

"Private investors have moved more towards core equity investing. One of the trends we saw amongst expatriate investors was to increase their local investment in 2015 and more interest in IPOs local bond issuance.

"It will be interesting to see whether that [trend] continues to be attractive because we have seen in 2015 a softening in asset prices in the region."

He adds: "I would say that retail investors are more cautious than they were in 2015 and potentially looking more at developed markets again."

Investors and managers had been very optimistic about the opening up of the Tadawul earlier in 2015 and the potential growth of the market ahead of expected inclusion in the MSCI Emerging Markets Index in 2017. However, as oil revenues have shrunk and investors have become more cautious, Saudi firms have been reluctant to list on the country's exchange.

There was a big drop-off in the number of IPOs in Saudi Arabia and the wider region during 2015, yet interest in new Tadawul listings has been sustained throughout the year, says Charbel Azzi, head of Middle East, Africa & CIS at S&P Dow Jones Indices.

Other managers in the region have sought new benchmarks better suited to the current market environment, he adds. Smart beta and low volatility indices were in greater demand during 2015. "Clients wanted something new: typical standard market cap indices were not really doing it for them," explains Azzi. "Discussions about smart beta started a couple of years ago and today we've started seeing some interest because they want to tackle volatility and different themes."

Winners and losers

While many of the macroeconomic themes of 2015 will continue to play out in 2016, there will also be a number of other developments that fund managers will need to be aware of. One of the key factors behind emerging market woes during 2015 was uncertainty surrounding the timing of interest rate hikes.

"The issue for the industry next year is whether the headwinds are seen as short-term difficulties within overall strategic movement towards the market or whether they could cause policymakers to do things differently," says Tolchard.

"There is also continued uncertainty about the Fed and the interest rate cycle and that's been particularly tough on emerging markets, including the Middle East. What we're seeing is the sense that within emerging markets there will be winners and losers."

"If the US Fed raises rates then the banking systems across the GCC with dollar pegs benefit; they will get wider margins if rates go up," adds T. Rowe Price's Bell.

© MENA Fund Manager 2016