Equity investment in the MENA region has lost some of its luster, especially after the 2008 financial crisis. Despite the recovery experienced in the past few years, the shock of the economic downturn has prevented investors from pouring money into regional equity funds, breeding caution in the same measure as the zeal responsible for the booms of 2007 and earlier.
However, looking at the global and regional financial landscape, equities seem poised to make a return to many investors' portfolios and garner a higher allocation in those they are already a part of.
With global interest rates at record low levels and yields on bonds and sukuk having steadily dropped over the past few years, the current differential between yields on bonds and those offered by equity dividends is at the highest level since 2005. It is likely that investors looking for yield will push up equity valuations further.
At this stage, as focus returns to equity markets, it is worth noting that there are a host of developments supporting regional equity fundamentals and value. Some of these advancements are naturally progressive while others are hastened by the competitive pressures induced by the financial crisis.
Among these include initiatives toward greater transparency and disclosure by listed companies and asset managers, as well as a prime focus on liquidity and market breadth, which are likely to draw further interest from foreign investors.
Quest for transparency and disclosure
Transparency in the region has long been a consistent high ranker on foreign investors' and regional fund managers' gripe sheets. Although transparency is a broad standard that companies should aspire to adopt, it is a goal yet to be fully achieved.
Disclosure and transparency on the part of listed companies has improved sharply as a function of demand by institutional and sophisticated high-net-worth (HNW) investors. Significantly more companies today are acutely aware of investor needs and interests and address them regularly - and more importantly recognize this as a part of business regardless of industry.
As an example, in 2008 the author contacted a Saudi Arabian company for disclosure on their capacities and was quite unceremoniously informed that they were under no obligation to provide it. Fast forward four years later and the very same company's very competent investor relations (IR) director makes disclosure in line with any other emerging markets company (their stock, unsurprisingly, has performed admirably through the period in question).
As another example, investor conferences today are bigger, better organized and well attended - again a clear nod to greater disclosure and the importance placed on it by senior managements.
From a fund perspective, regional asset managers today are generally more transparent than they were in 2008. Of course there are cultural issues which have yet to be tackled by the industry such as the reluctance of regional investors to embrace funds domiciled abroad.
However, the consequence of the fiercely competitive landscape, which emerged after redemptions began to soar in 2009, has been apparent in asset managers' focus towards client service and transparency. Investment processes are more readily shared, product structures clearly discussed, client calls more frequently made and fees more clearly explained.
As with company disclosure, there is little doubt that the industry has a long way to go, but client focus emerging as a preferred, even necessary way to conduct business was overdue in the region and bodes well for both the investors' interests as well as the industry's future growth.
Furthermore, an extremely important benefit of client service and focus is that after the most dramatic shrinking of investors' time horizons in half a century, such practice backed by consistent performance is poised to reward these asset managers with a clientele that is more tolerant and understanding of short-term volatility, but appreciates long-term performance and gains.
Better liquidity and market breadth
Although undemanding valuations have generally been enough to keep new issuers firmly away from the market, or focused on fixed income issuance for financing needs, recent equity market interest has proven particularly supportive of new IPOs.
For example, Saudi Arabia, a market which has made steady progress in the past three years towards openness and accessibility to foreign investors, has seen a spate of very successful IPOs in 2012. This year also promises to be a bumper year for the kingdom's IPO market.
Such new issues, particularly in sectors other than petro-chemicals and banking (both of which dominate the Saudi market) increase not only the liquidity of the market but also its breadth - a key draw for sophisticated investors.
Progress in the rest of the region has been rather slow, particularly in the UAE where valuations remained stubbornly in the doldrums until early 2012. However, last year's valuations finally began to reflect economic fundamentals that are on the ground. As a result, it is likely that a number of businesses already looking to list may do so soon.
As an early indication of this, NMC Healthcare, the UAE's largest private healthcare provider, successfully listed its shares in London last year. Further listings in various sectors (such as real estate and banking, which are dominant in UAE indices), will also increase liquidity and offer investors broader investment opportunities.
Lastly, UAE and Qatar are likely to be added to the MSCI Emerging Markets Index, an upgrade long in the works and one that could boost liquidity significantly and attract passive and active emerging market fund managers to these Gulf countries.
In conclusion, there is no doubt that MENA market fundamentals remain solid and valuations attractive, but investors - current and prospective - should take further comfort in the knowledge that the developments taking place are poised to make the case for regional equities even more compelling.
While the markets are, and will likely remain dominated by retail investors, efforts by companies to adopt transparency and disclosure, as well as asset managers' emphasis on client focus, increasing liquidity and accessing regional markets will eventually draw more institutional capital, especially foreign capital. This, in turn, will lead to a maturity of the regional markets.
Amer Khan is a Dubai-based fund manager at Shuaa Asset Management Ltd. He manages the firm's flagship, Pan MENA, Arab Gateway Fund, the UAE focused Emirates Gateway Fund and multiple discretionary client portfolios.
© Zawya 2013
