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"Undiscovered" MENA opening to the world

09 Jun 2010

"Undiscovered" MENA opening to the world
By Mohammed Al Hashemi, head of asset management at Invest AD

Equities markets in the Middle East and North Africa (MENA) are in a rare sweet spot, offering strong earnings growth and attractive valuations.

The long-term fundamentals are equally positive. A youthful population – some two thirds of the region’s people are under the age of 30 – is spurring consumerism, which is already benefitting a raft of industries. Just look at how cell phone service subscriptions in Saudi Arabia more than tripled in the last five years – to more than one per person.

And accumulated hydrocarbon revenues, bolstered by the rebound in oil prices in the last year, are allowing governments to continue to invest in infrastructure. This immediately stimulates economic activity, softening the effects of the global economic crisis, but importantly also provides the basis for diversification away from oil in the long run.

But the MENA growth story is only just seeping through to global investors, who have taken risk off the table en masse since the global economic crisis unfolded in late 2008. The vast majority have either no exposure or very little to the region, though any asset manager prepared to do their on-the-ground research will enthuse about the gems to be found among fast growing pharmaceutical firms, petrochemical plants, budget airlines and even dairies.

MENA accounts for about 6 percent of emerging markets gross domestic product and market capitalization, but commands only a 1 percent weighting on the MSCI emerging markets index – a key determinant of investment allocations.

However, with deleveraging continuing to suppress economic growth in developing economies, a rebalancing of portfolios towards emerging markets is most definitely on the cards. And as that happens, investors are likely to have more time for MENA markets.

Because Brazil, Russia, India and China equities markets bounced back with between 50 and 90 percent gains in 2009, some fund managers are already looking elsewhere for value.

MENA, forecast by the International Monetary Fund to notch up over 4 percent economic growth in 2010, has very similar economic characteristics to the BRIC countries. And after modest gains last year, the bulk of the region’s stocks are trading at around 12 to 13 times forecast earnings, compared to the early twenties for China and India.

Even a small rebalancing of portfolios in favour of MENA, and an influx of global institutional investors, would make a difference in markets that are only worth a combined $900 billion – under two percent of global market capitalization.

Bouncing back -- GDP growth forecasts (IMF)


Youthful population fuels consumption


Historically low correlations with global markets


MENA accounts for…


With improved liquidity, even more investors would be attracted, ushering in a virtuous cycle.

Across the region, market regulators are starting to do their part to encourage inward investment. Oman has decided to base its regulatory regime on the United Kingdom’s Financial Services Authority rather than reinvent the wheel. Morocco and Egypt have also developed advanced regulatory frameworks thanks to the inclusion of their markets in the MSCI Emerging Markets Index. Traditionally cautious Saudi Arabia opened its equities market to Gulf Cooperation Council investors in 2007, and introduced swaps in 2008 to allow other foreign investors to access the economic benefits of holding Saudi stocks, if not to full ownership rights.

However, to attract institutional investment, companies across the region need to show that they take corporate governance and transparency seriously. Improvement will be gradual.

As in much of the developing world, the MENA corporate landscape is dominated by family businesses -- with some estimates attributing as much as 70 percent of economic activity to them. While this has engendered a high degree of entrepreneurialism, business transactions have traditionally been based on personal connections, and the close nexus between ownership and management has influenced decision making and public disclosure.

Nevertheless, change is underway, spurred on by the greater role public markets have played in corporate finance – MENA’s market capitalization has jumped to around 70 percent of GDP from 20 percent eight years ago.

Management teams are making themselves more accessible to portfolio managers. For example, companies in Egypt are leading the way in building a proper investor relations function, and the trend is spreading across the region.

Companies are also improving the composition of boards, in a region where it has been common for the same names to be on three or four boards because of the prestige attached. Increasingly, director appointments are based on the need to focus time and resources to properly oversee a company’s development, and potential conflicts of interest are taken into account. Regulators have been properly defining what they mean by "independent director" -- an important step as these board members are key in upholding the rights of minority shareholders in markets characterized by low free floats.

While the Dubai World debt issues hit investor sentiment in the region last year, it also gave the corporate landscape a jolt – and improved management, governance and regulation will be the lasting legacy. Even as debt restructuring continues, companies are emerging from the crisis with rational and prudent expansion plans.

The UAE has tightened its requirements for banks to disclose information on their loan books and financial liabilities, while plans are afoot to set up a federal-level credit bureau to provide lenders with better information on individuals and companies.

The MENA markets may be taking some very basic steps, but it is important to remember that, despite the outward modernity and economic vibrancy of cities across the region, capital markets are still in their early stages of development.

And therein lies the opportunity for investors – it is better to be strapped in as the markets lift-off than risk missing the ride altogether.