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Special Report

Impact investing


Briefing, Investment: Gulf in expectations

Many of the countries of the Persian Gulf  – the wealthiest part of the Middle East – have several of those characteristics most cherished by long-term investors, including economic strength, growing domestic markets and some well-managed companies. However, the stock markets are also prone to extreme volatility and irrationality. 

The virtues and vices of these markets are summarised by Oliver Bell, London-based manager of the T Rowe Price Africa & Middle East Fund: “These are nascent economies, so the market cycles get more exaggerated, with more upside risk and more downside risk.”

It is hard not to be struck by some highly impressive numbers. Because of its oil production, Saudi Arabia has a current-account surplus of 18%, with Qatar’s surplus even higher at 31%, according to recent figures from their central banks. These and other Gulf states with abundant oil reserves are, therefore, immune to the fears of draining global liquidity that have bedevilled many frontier and emerging markets with current-account deficits. 

The oil basis of their economies also gives their markets some attractive characteristics. Oliver Kettlewell, senior investment research analyst at Morningstar OBSR, the investment research and consultancy in London, notes their lack of correlation with emerging market stocks. For example, the Saudi Tadawul All Share TASI index kept rising in the first few months of this year, while many emerging markets were taking a hit. 

“If you look at the countries in emerging market indices, many of them, such as South Africa and South Korea, are net oil importers,” explains Kettlewell.

 The Gulf governments that control this oil revenue have been, moreover, putting more money in the pockets of their citizens since the outbreak of the Arab Spring four years ago. An example is the generous increase in pay that public-sector workers in Qatar, who account for the majority of the country’s employed citizens, have received. 

Saudi Arabia, which has also acted to increase income, is probably the Gulf country in which investors have the greatest interest. 

“What makes this market so unique is that it not only has the characteristics of frontier markets, most notably high growth at both the macro and company levels, but is also very liquid,” says Asha Mehta, lead portfolio manager for frontier market equity strategy at Acadian Asset Management. 

Most frontier markets are quite illiquid, but the $550bn Saudi market, the biggest in the region, has more than twice the liquidity of the other frontier markets combined, Mehta notes. With up to $3bn in daily turnover, it is more liquid than the South African market. 

In particular, Mehta feels that the Saudi telecoms sector benefits from two broad-based themes common to the oil-rich Gulf states: rising consumer income and growing internet adoption, resulting revenue per customer as well as increasing customer numbers. 

“It’s not uncommon to see people with four or five cellphones in these countries,” she says. “This is not so surprising, given that mobile technology in frontier markets is leapfrogging mobile technology in developed markets.” She cites mobile finance as an example of this leapfrogging.

Acadian also likes the Saudi petrochemicals sector – the nearest that equity investors can get to the oil sector, which is government-owned and unlisted.

Bell also sees promise in the UAE’s stock markets. He acknowledges that the economy and market went through a big correction after the 2009 property bust, leaving its  banks looking like “basket cases”. But he also notes that the Arab Spring had one intriguing outcome: the turmoil in the region made wealthy investors across the Arab world park their money in UAE property as a safe haven. That brought the property market – and the banks that had funded it – back to life. His fund has a holding in the UAE’s First Gulf Bank, as well as in Saudi Arabia’s Saudi Fransi Bank. 

However, the UAE has seen perhaps the most notorious case of market irrationality (at best) or skulduggery (at worst) in the Gulf – the case of Dubai-based Arabtec, the Gulf’s largest construction company by market cap. In July the Dubai stock exchange suspended trading in Arabtec amid rumours of price manipulation, after its share price experienced a two-month rollercoaster ride. 

Kettlewell of Morningstar OBSR suggests that these kinds of wild movements may be caused by the dominance of retail investors in local stock markets. Over the past three years the standard deviation of returns for the oil-rich Gulf countries has been almost double that of the MSCI Emerging Markets index. 

The hope is that newly-arriving institutional investors will bring a little more rationality to these markets.

“With more institutional and international investors in the market, replacing the 95% retail investor base, we are likely to see some of the longer-term themes take hold – replacing emotionally driven investing,” Mehta suggests.

For Saudi Arabia the great catalyst for this could come next year, when foreign investors are, for the first time, allowed to buy and sell Saudi shares directly, rather than entering into a form of swaps contract – known as a P Note – with a local broker that holds the stock in their name, as they do now. The exact date of the opening has not been announced. 

Acadian, T Rowe Price and some other foreign investors are prepared to use the P Note system, but they are not keen on it. Mehta of Acadian cites the counterparty risk: if your broker goes bust or does not honour the swaps contract for some reason, the investor loses indirect quasi-ownership of the stock. She adds that the high transaction costs of investing in Saudi stocks are likely to fall, too, with direct ownership.

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