" Mutual funds have limited presence in Gulf"--Interview with MR

August 21, 2011

Article By Gaurav Ghose in Gulf News. you can find here

By comparison with other regions, mutual funds have only a limited presence in the Gulf, owing to a host of factors such as market liquidity and regulation. Clearly, institutional development is needed if this traditional way of diversifying exposure is to make much headway.

With Saudi Arabia, the Gulf's largest economy, and its stock market forming roughly 50 per cent of the combined market capitalisation of the GCC region, it is no surprise that the country leads in locally-domiciled mutual funds with 224 at the end of June, according to Lipper, a Thomson Reuters company. It is followed by 72 in Kuwait and 45 in Bahrain. The UAE lags behind with 17 locally-incorporated funds. Oman and Qatar have eight and five funds respectively. The assets under management (AUM) in locally-domiciled funds for Saudi Arabia-based firms stand at about $21.2 billion (Dh77.8 billion), comprising 76.6 per cent for the region's total AUM, as against $4.6 billion for Kuwait and $1 billion for Bahrain. 
However, in a report on mutual funds issued by National Bank of Abu Dhabi last November, in terms of AUM, money market funds have nonetheless become a force to reckon with, thanks to the impact of the large funds based in Saudi Arabia.

The average size of a GCC equity fund was about $50 million, while the average size of a money market fund was more than $250 million. These funds primarily depend on institutions (pension funds, banks and insurance companies) rather than the general public for their capital. That may say something about attachment to cash and currencies rather than stocks.

The mutual funds industry has been growing rapidly in the last decade, only to slow down in more recent years because of the local stock market meltdown, followed by the global financial crisis.

But the trend is still positive, according to fund managers and researchers. For instance, in Saudi Arabia, between 2006 and 2010 AUM grew by about 12 per cent in aggregate to reach around $25 billion at the end of last year. This has come despite the stock market having declined by around 16 per cent during the same period, highlighting the net flows that the industry has been able to garner during this time.

But as Osama Shaker, Managing Director and head of financial markets, HSBC Saudi Arabia, points out, the money invested through mutual funds is approximately only 8 per cent of the level of banking sector deposits in Saudi Arabia. In developed markets, this ratio can even reach as high as 100 per cent. Clearly, the secular growth story of the fund industry in principle has some way to run yet.

According to a recent Boston Consulting Group global study, three of the six densest millionaire populations (proportion of millionaire households by market) are in Kuwait, Qatar and the UAE. So the market itself has a high-net-worth bias. It's normal that most funds products are designed to cater to that segment, says M.R. Raghu, Senior Vice-President — Research, Kuwait Financial Centre (Markaz).

There are a number of challenges that need to be addressed before the industry matures further. Among the issues cited include the problem surrounding low liquidity, the fragmented nature of the industry and low fees, poor distribution channels, unsatisfactory corporate governance, lack of market breath and depth, and foreign ownership restrictions.

Liquidity is a prime concern when managing risk, says Shakeel Sarwar, head of asset management at Securities and Investment Company (SICO) Bahrain.

Funds generally have minimum liquidity criteria when investing in a stock, so the market impact is minimal when entering or exiting that stock. When a fund is growing, this liquidity threshold goes up. "However, over the past two years, the liquidity of GCC stocks has been on the decline. [That] poses a significant barrier to regional mutual industry growth," he says.

Raghu agrees. "Lack of liquidity and shallow markets hinder the fund manager's choice of investments." There's an important addendum. "Stock market regulation in GCC is still evolving," he notes, "with investors often being cynical about their effectiveness and independence."

Yet the biggest challenge, according to Shaker of HSBC, is distribution, and attracting assets during these turbulent times. The underdeveloped nature of distribution channels acts as a barrier for the regional funds to reach a wider capital resource base.

As to the regulatory environment, Shaker asserts in fact that "the CMA [Capital Markets Authority, the market regulator] has been supportive, and local regulations and oversight should be a source of comfort to investors". "The CMA has been gradually encouraging new types of funds," Shaker notes, and, apart from traditional equity funds, "we have seen real estate funds, ETFs, and recently received approval for a commodity fund that we expect to launch after the Eid".

But corporate governance and legal issues remain a sore point. Additional improvement in this area, particularly in company disclosures, would cause more global investors to look at investing in this area, says David Varghese, Fund Manager, Emirates NBD Asset Management.

For example, institutional investors and individuals alike are sometimes at the mercy of a major shareholder when they make key strategic decisions, with regards to its operations or capital structure, says Sarwar of SICO in Bahrain. "Capital market regulations in the GCC have to improve a lot more to protect the rights of minority shareholders. In addition, the legal framework applicable to financial markets have significant room for development."

With regard to Kuwait, their CMA is in the process of drafting new laws. New regulations like a cap on fund management fees, sales commission, etc. will change the way industry works. The asset management industry should be prepared for changes that the CMA might enforce, says Raghu.

That the regional markets lack breadth in terms of asset classes is a familiar refrain. The fixed-income market has still a long way to go, both in terms of market size and liquidity, says Sarwar. Trading in derivatives is non-existent. If present, these instruments would have complemented conventional equities and debt markets, he adds.

In all, the GCC fund management industry is small compared to that of developed markets, besides being fragmented so that no single fund has AUM of more than $1 billion.

Despite that, regional fund managers are being pressured to lower their fees in line with the mutual funds in developed markets. Doing so might push the monetary value of fees to unsustainable levels, says Sarwar. "Their problems have been compounded by the fact that regional equity market returns have been very low compared to the rest of the world, and there have been no performance fees earned."

And there's more — not least among concerns are a lack of professionally qualified human resources, as well as low institutional participation and information asymmetry.

It seems it may be some time before mutual funds, serving the cause of diversified stock market investment, and the industry's practitioners themselves, make serious headway in this region.

Mixed performance 
There was a feeling of relief at the end of the first half of the year when it comes to the performance of the GCC domestic mutual fund industry. The hope was that the second half would be better, with the political situation stabilising — though recent turbulence has perhaps dampened expectations.

The funds originating and domiciled in the region and managed by domestic fund managers lost a mere 0.67 per cent, according to data provided by Lipper Reuters — see charts on the opposite page.

This was despite all GCC regional markets closing negatively at the end of June amid unprecedented political unrest in Mena, doubts about global recovery, inflationary pressures from emerging countries and nervousness associated with sovereign debt in Europe and the United States — which was in fact about to impact imminently.

The relatively small decline was mainly due to strong performance outside the GCC frontier, and mainly in Europe, where investors took advantage of the appreciation of the euro against the dollar, said Paris-based Dunny Moonesawmy, head of Fund Research, Western Europe, Middle East and Africa, Thomson Reuters.

"It is clear that even faced with a deep crisis in the Eurozone, the euro showed strong resistance. GCC investors gained from the 7 per cent decline of the US dollar against the euro over the first half, reflected mainly in bond funds as the European equity markets were mainly in negative territory," he noted.

"When currency appreciation is disregarded, stock investments have been in the red in most regions and sectors."

When it comes to equity funds, Lipper data show that the Equity GCC category resisted better than the Mena category, the former decreasing 2.65 per cent against the latter's decline of 3.52 per cent.

"The consequence of political unrest on economic activity is important, but at the same time GCC countries are fundamentally strong with either good revenue streams, such as Saudi Arabia and Qatar, or a diversified economy, as is the case with Bahrain," said Moonesawmy.

Similar performance reviews over three and five years show that investors took advantage of their emerging markets investments over the long run. The Equity Asia Pacific ex-Japan category posted 16.4 per cent performance over three years. Conversely, the Equity GCC category lost 37.3 per cent.

Considering all equity funds registered for sale in the GCC, both domestic and foreign funds, they were almost flat during first half of 2011, gaining 0.3 per cent.

Bonds funds managed by local fund managers performed well during the first half in most bond categories.

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