Middle East: Fixed income, equity, local and international assets – a demand for all

Product is an exciting field in a state of rapid evolution in the Middle East. Local managers are moving rapidly from country-specific equity funds to a host of other asset classes; internationals are finding appetite for a wide range of their global product book.

For local managers, equities remain the dominant asset class, although that is shrinking somewhat. Looking at the asset allocation of local mutual funds in Saudi Arabia and Kuwait from 2005 to the middle of 2007, the proportion of assets that is in shares was 72% in 2005, before falling with the 2006 stock market crash and hitting 52% in 2007.

These have traditionally been local country funds. Almost every fund manager of any consequence in the Gulf offers one in their home market. The Dubai-based research group Zawya tracks 208 products, and 93 of them are single-country equity funds.

Over time, though, more regional products have appeared. Zawya tracks 23 GCC equity funds and a further 11 MENA funds, and more are appearing. Shahid Hameed, head of asset management for GCC at Global Investment House, says this is the future – even though Global is something of a pioneer in country funds outside its home market, even offering a product focusing on the Palestinian Territories. "What’s currently in demand, and will be, is mainly regional funds," he says. "It’s more challenging to sell specialized country-specific funds. For us it’s Kuwaiti funds [Global’s home base] and regional scope funds like GCC or MENA." This approach is going to be the one that appeals to international capital. "If I want to sell to an international level and tap into the western and Asian markets, it makes a lot of sense to have a geographical spread," he says. "If we look at the GCC as a bloc it starts looking very interesting in terms of its size: there’s a trillion-dollar market capitalization."

There are more under way. "You see a lot more competition," says Hameed. "When I launched my first fund five years ago [then at SICO in Bahrain], we were amongst the very few GCC focused equity funds. Now almost every bank in the region has some sort of GCC fund."

The local view, though, remains exactly that: local. The average investor still wants home exposure. "There are now so many products and funds offering MENA, but only sophisticated or international investors look into these products," says one domestic fund manager. "It’s mostly local-centric." After local equities, money market and real estate are the next most popular, he says.

Be that as it may, change is under way. Several Gulf-based managers have developed sector funds, very rarely seen a few years ago. There are, for example, four regional telecoms funds in the region now: Kuwait Investment Company’s Al Atheer Fund, National Investment Company’s Zajil Services & Telecommunications Fund, the EFG-Hermes Telecom Fund, and another from Saudi Arabia’s Riyad Bank; the National Investor, an Abu Dhabi manager, also plans a telco fund, alongside other sector funds in financials, real estate and industrials.

As befits the oil wealth of the region, there are funds for industrial and petroleum services (from National Investment Company); global energy, petrochemicals and downstream industries (Global Investment House); and industrials (HSBC/SABB in Saudi, which also runs a financial sector fund).

There aren’t, yet, any small cap funds, because the markets simply aren’t deep enough to warrant it. A handful of index funds are sold, among them a global product from Global Investment House and country-specific funds from Industrial and Financial Investments Company (in Kuwait) and Abu Dhabi Commercial Bank (in the UAE). This shortage of index funds is puzzling in a market where many people seem to show an enthusiasm for market exposure without a great deal of discernment between the merits of individual stocks.

A handful of local managers run their own international equity products, notably Global Investment House and Saudi Investment Bank, but generally local managers sell white-labelled products from internationals. There are a number of India funds, though often with underlying stock selections made by people on the ground there; Commercial Bank of Kuwait sells an India fund of funds, and Bahrain’s Al Amin Bank plans a Shariah-compliant Indian stock market fund managed by Kotak Mahindra.

On the debt side, the vast majority of funds in this area are money market products, sometimes referred to locally as trade finance funds, or their Islamic finance equivalent, murabaha. This is the biggest part of the ‘other’ category referred to in the Cerulli chart on Saudi Arabia and Kuwait.

But mainstream fixed income debt funds are rare indeed – 1% of the Kuwait and Saudi markets. They do exist – Global Investment House, Gulf Investment Corporation, Kuwait Investment Company, HSBC and SHUAA Asset Management run bond funds – but they are strangely under-represented.

Some see an opportunity. Algebra is in the process of launching a local currency corporate debt fund for the MENA region, believed to be the first of its kind. Daniel Smaller, managing director of sales and distribution at Algebra, says the corporate debt fund will aim to be highly liquid so local investors can use it in place of cash investments. "They’re getting paid 1 or 2% on their deposits," he says, whereas the yield on a debt fund should be higher. It should also appeal to international investors because of low volatility and high credit ratings for regional debt, plus the benefits that will come if currencies de-peg from the US dollar and revalue upwards. Algebra also plans a sukuk fund – see the Shariah chapter for more on this.

Logically, debt funds ought to have a bright future in the Middle East. "It is estimated that $2 trillion of infrastructure spending is going to be done in the Middle East in the next five to 10 years," says Smaller. "You can’t raise that with equity, and bank lending has its limits. You need an efficient bond market."