November 2008


Gulf governments need foreign investment. ETFs based on local exchanges are a great prize and should help European investors gain exposure, finds Nick Fitzpatrick It might seem that only gravity rather than economics can stop growth in the Gulf – and it would appear even gravity isn’t up to the job. The region continues to build skyscrapers, including a kilometre-high development in Dubai, while the rest of the world struggles to save their banks from ruin. 

But the reality is that the Gulf area’s stock markets have been affected by the credit crunch, and even the opulence seen in recent years has had its levelling flipside, namely large-scale joblessness.

Countries in the Arab world have the highest rates of youth unemployment and under-employment of any region on the planet – even higher than sub-Saharan Africa. At least 100m new jobs need to be created in the Middle East and North Africa (Mena) region over the coming 20 years. This is more than has been created in the last 50.

In the Gulf states – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – plans to increase the rate of employment mean investors from abroad are now needed more than ever, particularly if homegrown sovereign wealth funds look to diversify internationally. 

The Gulf Co-operation Council (GCC) will take comfort, therefore, in the finding by Lyxor Asset Management that half of the UK’s institutional investors plan to increase their investment exposure to the Gulf region over the next three years. Also, nearly 45% of them believe stock market returns in the Gulf will be excellent or good over the next five years. Ten per cent  expect returns to be poor.

One investment manager channeling money into the region’s capital markets is HSBC Global Asset Management, which was due by the end of October to launch a Mena fund, a flagship part of its global investment funds domiciled in Luxembourg and available for sale in more than 35 countries. Managed by Halbis, HSBC’s active specialist, the firm also has a 45% exposure to the Gulf states and broader Mena region through its institutional-focused New Frontiers fund.

Investment drivers
Sustained high commodity prices, infrastructure development and undiscovered companies are what drive investors in Mena and the Gulf at present. Inflation and unemployment are the other side of the coin. So too is a lack of liquidity but exchange-traded
funds (ETFs) based on Gulf stock market indices are set to play a bigger role in providing investors with relatively simple and liquid access to the region.

FTSE Group and Dow Jones Indexes, two major index groups, have already licensed Gulf indices to ETF providers. The Dow Jones GCC Titans 40 Index serves as the basis for a New York-listed ETF that measures the performance of 40 stocks traded in five of the GCC member states, including Bahrain and Kuwait. Licensed to Van Eck Global, a US money manger, Dow Jones says this is the first time that a pure GCC index has been licensed for an ETF.

In July, Lyxor and Coast Investment & Development Company, a financial institution in the Gulf region, launched a London-listed ETF based on the FTSE Coast Kuwait 40 index. It was the first to focus solely on Kuwait. At the end of June 2008, its year-to-date performance was positive at 3.43% when the FTSE 100 was down by 12%. Since inception (February 2007), the index had returned 30.71% to the end of June.

But GCC stock markets have belatedly followed their European and American counterparts downwards. As at 21 October, the Dow Jones ETF stood at -28.83% year to date.

Interest in the region will likely be sustained though. Standard & Poor’s, another index provider, is currently talking with institutional providers to launch a GCC-based ETF, says Rodney Fernandes, vice president of business development.

So far, ETFs based on Gulf markets are listed in the US or UK. They also appear to attract interest from largely non-Gulf investors. Sophisticated Gulf-based investors are more likely to invest directly into equities or seek ETFs that focus on international markets. Less sophisticated Gulf investors who wish to stay locally invested are more likely to invest directly or dedicate large sums to real estate and private equity.

This could change when ETFs are actually listed on Gulf stock exchanges. Fernandes says: “There is no local ETF provider in the Gulf area yet because there are no regulations in place, although Abu Dhabi hopes to launch by end of the year.”

Alan Bainbridge, a private equity partner at City Law firm Norton Rose, says: “There are not any ETFs listed in the Gulf yet, but if Abu Dhabi and Bahrain are on track there could be in the first quarter of 2009.”

Fernandes says Abu Dhabi is the most liquid of the Gulf stock exchanges. Liquidity is crucial for ETFs, whether locally listed or not. Although ETFs are baskets of stocks that trade as a single share, liquidity in the underlying stocks is still important. Stocks in the Dow
Jones ETF, for example, must have an average daily trading volume of US$1m to be qualified for the index.

Creating liquidity
Tony O’Brien, head of ETF products at BNY Mellon Asset Servicing, says: “There’s a lot of exchanges in the Gulf that would like ETFs to be listed there because they feel it would bring liquidity to the markets. An ETF would mean a basket of Gulf stocks would have to be built and that would create liquidity. Exchanges in the Gulf have a history of volatility and there is limited free-float in the markets so liquidity would be a good thing. Middle Eastern investors are historically very much buy-and-hold investors.”

O’Brien’s job is to service the operational aspect for ETF providers, and so he recognises the challenges of having Gulf products listed elsewhere, along with the administration.

“The traditional challenge for a Gulf ETF listed outside of the region is the Islamic working week. If the administration is in Ireland but the ETF underlying is traded within the Islamic working week, this can be a problem as exchanges in the region are open on Saturdays, potentially on Sundays, while closed on Fridays.”

iShares, the large ETF provider of Barclays Global Investors, is one of those international players that is exploring the GCC area. Andrea Morresi, head of sales for Europe, said that if there was demand to list ETFs in the Gulf, it would be considered as long as liquidity could be counted on.

“If there is demand to list outside of the five main European stock markets then we would, but there would have to be liquidity. Historically, although these countries have had great GDP growth they have invested money in real estate or private equity, while those institutions that will invest in public equities do so using direct investment rather that through products like ETFs.”

But local markets, in their bid to attract foreign investors, are evolving. Imogen Dillon-Hatcher, managing director for the EMEA region at FTSE Group, says: “There is a lot of competition between the states, both for international investors and local investors. All
the exchanges in the GCC are building new financial abilities, developing new strategies and enhancing existing ones. They are defining the regulatory framework that will allow international players to take part.”

Great claims are made for ETFs, but perhaps the greatest is that they could reform Gulf stock markets. “It’s considered quite a coup to get an ETF listed on your market in the Gulf,” says Dillon-Hatcher.

An even greater claim would be to solve the region’s youth unemployment problem, which is not as unlikely as it might seem. FTSE is working with a Qatari organisation called Silatech, funded by Sheikha Mozah Bint Nasser Al Missned of Qatar, wife of the Emir of Qatar, to develop indices led by small firms that lead the way in youth employment. ©2008 funds europe

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