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Magazine Issues » September 2020

MENA roundtable: Dimensions of diversification

Funds Global Mena – What are the top three risks to investors in the Mena region and how are you mitigating these? 

Duke – What I have seen, bizarrely, over the last couple of months, particularly through the banks, is a lot of demand for individual securities. It does centre a lot around tech and the stocks that benefit from the work-at-home environment. That is fine, provided it is done within moderation. However, it seems to be taking over from more of a balanced approach to equity investing through a mutual fund, which is potentially a risk in due course. Technology is a crowded trade and if that unwinds, similar to fixed income and leverage, investors can get caught on the wrong side of that.

Back to income, it’s chasing the highest yield and buying that in the expectation that if you have a high yield and can leverage it, that’s a safe and secure investment. Simple lessons, but even sophisticated investors don’t always heed previous warnings. 

Grist – From a retail investor perspective, it’s a lack of diversification, chasing yield and income for sure and tactical investments rather than long-term, goal-based financial planning. The broad needs such as retirement planning are not very different here to anywhere else in the world – you’re saving for significant life events. But with uncertainty around job markets and certain sectors that are heavily impacted by Covid-19, such as tourism, oil and gas, in this region particularly, the level of uncertainty that goes with that will influence people’s investing and saving habits. Potentially they’ll favour shorter-term cash investments rather than long-term financial planning, and of course that means inflation risk, compounded by a low rate environment, and a future risk by not investing for long-term goals.

Talhaoui – Let’s look at it from an institutional angle. Why would you invest in the region and what are the risks? There is a question mark on the global economic outlook for the region, which is a problem that everybody has, but in addition to that, there has been a lot of overthinking around the trajectory of the oil price. We have seen numerous research pieces being very creative about oil at ten, 20 and 30, and it’s complicated because the issues around oil prices go beyond just this volatility that came with the Covid-19 crisis. It’s a geopolitical game, it’s complicated, but it’s very important that this is kept under control because eventually the credit quality – and the ability of the region to attract capital – is going to depend on the stability of the oil markets until the economies are diversified away from oil.

This leads me to the second point, which is an opportunity, but also a risk. The region has done a good job in outlining a bold agenda about economic reform and growing the financial sector and around financial education. It’s very transparent, you have the 2030 plan in the UAE and Saudi Arabia, and it’s very important that the authorities in charge stick to this agenda and give a strong message to investors – that this is an ambitious agenda that might have been a bit distracted because of the current volatility, but it is a firm agenda that is on track. This would send a very strong message for international investors.

Finally, it’s a bit of a chicken-and-egg situation. If you want more capital in the region, you need to attract capital first. It’s a bit of an acceleration and as a result, any initiative that can attract transparent, diversified investing from the international community is going to have a leverage effect, a positive one in terms of attracting more capital. The MSCI inclusion for Saudi Arabia was a very significant event and it drove a lot of flows in our ETF platforms and our competitors’. Again, it goes both ways – if you have a lack of traction or some sort of disinvestment from the region, it’s going to make international investors more sceptical. The bottom line is that there is a global competition for capital, there are a lot of attractive regions that are also undergoing reforms and it’s very important that the region stays competitive.

Mallah – There’s always this discussion about secular trends in energy, and that is an inherent part of, or one main element of risk in this part of the world. Obviously, the oil price has a massive impact on the appetite, asset prices and general economic activity in the region. We are a very long way from having oil become a secondary source of energy. There is transition into new sources, but there will still be adoption rates globally that will not make oil obsolete in the next few decades. There are still countries using coal today, but we are already looking at solar now. So, the transition is a long one and it’s not going to be a binary one, and that’s going to give plenty of time for countries here to adapt. We see solar plants already in Saudi and the UAE, we see nuclear energy plants, so they’re adapting, they’re diversifying their dependence, they’re also diversifying their sources of income by deregulating, opening foreign ownership. So, I think oil price decline has an immediate impact today, but I don’t think it’s an existential threat on the region in the future as the region is gradually adapting and diversifying.

What I’m more worried about is something that has nothing to do with the economy – it’s the geopolitical risk, because the minute something happens everybody wants to stay on standstill. We have seen some families with abundant amounts of cash, but still they would rather stay on the sidelines because they never know what the impact of the geopolitical uncertainty will be. With the evolution of their business going forward, they want to keep their dry powder so they are able to support and reinvest in the business. That has nothing to do with global trends or the global economy, it’s very much a regional geopolitical risk.

For us, we see an important headwind, which is that valuations tend to have this lag time in this part of the world to converge with reality. Valuations still want to cling to the pre-Covid or pre-oil correction prices. A lot of those deals come to a standstill because of valuation at the last minute, but there’s just unrealistic expectations sometimes because of how misaligned the investor expectations are with the seller expectations. I would call it the cultural risk, not just the valuation risk.

Stull – I definitely agree. We have seen a lot of people saying: ‘Now is not the right time to come into the region,’ and they have been saying that since the Arab Spring. The geopolitical element certainly has an effect and still makes some people a little bit skittish.

On the deal execution, it’s cultural but also legal. We tend to see deals drag out and take a lot longer here. There are certain asset classes my colleagues here on the roundtable mentioned earlier, such as credit and private credit in the Middle East. From a legal perspective, it’s so difficult to structure from a regulatory and enforcement standpoint. There are certain deals and asset classes that are done in Europe or Asia, and here we scratch our heads and say: ‘How can we structure this to comply with the regulatory framework? How can we structure this to give confidence about enforcement?’ We come up with solutions, but often these are too complicated and so the deal will be passed on. 

Dickinson – There’s a fairly gloomy mix coming out of this scenario where, if the Covid-19 situation involves second and third waves and possibly no vaccine, this is going to have a depressing impact on the oil price – I think that’s an absolute given. It may not be as dramatic as some of the price movements that we saw earlier this year, but it very much comes down to the backdrop of geopolitical stability of the region.

Why is that important? Investment sentiment is very much driven by optimism and the optimistic aspect in this part of the world comes from the governmental level. Despite some of the challenges that we have faced of late, the general governmental stance still looks to be optimistic. They are going to be driving the private sector and the region in the short to mid-term – I don’t see it coming from external investors alone, who will look to take advantage of commercial or investment benefits that they generate.