Investors turning to the Middle East to find untapped opportunities

It’s a similar story across the Middle East and parts of North Africa (MENA) — governments that once shunned the outside world are now opening their borders to more visitors. This means more work for citizens, an increase in infrastructure initiatives and, whether the more hard-line governments like it or not, more western-style capitalism.

Throw in multibillion dollar oil projects and other commodity-related ventures, and you have one of the ripest areas for foreign investment, a fact not lost on a number of fund companies that have started offering MENA funds to retail investors.

Niket Patankar, CEO of Adventity — a financial services research firm with an office in Dubai — says that people have been looking at the region for some time, though it’s only recently that MENA has really come into focus.

He says a number of thing have contributed to the ramp-up of interest in the area, including stronger economies and fiscal surpluses. “In some cases we’re seeing double-digit growth,” he says. “Qatar’s real GDP [growth] is 14%, while other regions are posting between 7% and 10% growth rates.”

Between 2002 and 2007, Middle East countries have seen $900 billion in surpluses — largely derived from soaring oil prices — and they’re using most of the extra cash for domestic development. “A lot of the money is being redeployed to increase the size of the domestic economy, so these regions are attracting people from all over the world to settle and migrate there,” says Patankar. “They’re accounting for a significant stimulus for population and economic growth.”

Patankar points to Dubai as an “icon” for the region, with other countries trying to mirror the city’s success. “They’ve managed to attract a diverse pool of talent that’s being used to develop the region,” he explains. “Step one is surpluses, then attract human capital from all over the world to start building infrastructure and invest in real estate and all the allied sectors. Then start spending to make it an attractive destination.”

All of this development in the region has already attracted millions of dollars in foreign investment. Franklin Templeton’s MENA Fund — which will be the first of its kind in Canada when it is made available in the near future — launched in Korea and Luxembourg in June of this year and has already gathered $64.7 million in assets, while Lebanon-based MENA Capital’s fund is at $100 million after two and a half years on the market.

Returns are strong as well. While the tumultuous global markets have wiped out stock gains in the region, Khaled Abdel Majeed, a managing partner at MENA Capital, says that in 2007, his fund was up 33%. This year returns are expected to be flat, despite a drop of 22% for the MSCI Arabian Markets Index, which is the most representative of the indices that track the region.

Until September, Franklin Templeton’s MENA fund was seeing 10% returns.

“We need to wait until the debacle is over,” says Majeed, referring to the credit crisis. “Everything is hitting down with not much trading, but there are still plenty of opportunities.”

Those opportunities lie mainly with infrastructure development, which started ramping up in 2004 after 15 years of underinvestment. Like many parts of the emerging markets, a big part of the increase in spending is due to soaring population growth. Majeed says the birth rate in the region is growing by 2.5%, while millions of foreign workers moving to the area have made it nearly impossible to maintain living standards without improving conditions.

“Infrastructure is under pressure,” he says. “They need more roads, schools, hospitals, power generation, more housing, you name it.”

“Almost all of these countries are making significant strides in terms of legal infrastructure, building infrastructure and job creation,” adds Dino Kronfol, managing director at Algebra Capital, a Dubai-based fund management company partly owned by Franklin Templeton, and which will run the company’s Canadian MENA fund. “With an increase in the price of oil, and budget surpluses, all of these different elements are fairly conducive to strong economic growth and strong financial market performance.”

While domestic activity might be busier in places like the United Arab Emirates or Qatar, Saudi Arabia has enormous potential to become the next great investment spot. Not only is it the region’s largest country in terms of both population and GDP, buts it’s projected to increase its oil output from nine million to 12 million barrels a day by 2012.

But Saudi Arabia has its problems. Its markets are still tough to maneuver for foreign investors — though it is getting easier.

For Majeed’s fund, Qatar represents the largest geographical weighting, despite being able to choose between only 43 stocks. But with only 300,000 residents, 700,000 foreign workers and an oil industry that will churn out six million barrels of oil a day by 2012, “on a per capita basis there’s no contest in terms of who is going to be richer,” he says.

The fund manager adds that investors can buy pretty much the same industries they can get anywhere — big banks, insurance companies, transportation, real estate developers — the only thing you won’t find, he says, is auto manufacturers.

There are plenty of other countries — Oman and Egypt to name two — that have growth potential, but not every country in the Middle East is included in a MENA fund. Israel, for one, is not considered part of this investing region.

“It’s always taken separately, because it’s a completely different market,” says Patankar. “It’s aligned with the West and there are issues with the Palestinians, so it’s always been valued differently.”

“Israel has a lot of companies on international exchanges, and they have access to capital,” adds Kronfol. “They operate on a different platform.”

Politics can also influence where people invest in the region. Not surprisingly, Iraq is not a country where many MENA fund managers want to invest. “Iraq has been a basket case,” says Majeed.

Iran is another country many managers avoid. Majeed says the threat of an Israeli or U.S. attack on the country is scaring investors away. “Iranians won’t take that lying down,” he says. “If Iran is attacked, then oil prices are going to spike up really sharply, so oil importers will hurt financially.”

Fortunately for investors, the war in Iraq hasn’t had a major impact on the region, though it does make things “complicated,” says Patankar. “There’s a lot in the Middle East that happens, but things are kept separately enough. We saw that with a large country like Iraq. It didn’t affect the region as much as we thought.”

Rudy Luukko, investment funds editor at Morningstar Canada, says there are other issues besides politics that investors should be concerned about. He says the region is an “exceedingly small segment” of the world’s stock market capitalization, and advisors should ask themselves, “why would they want to invest in a product that has such a narrow mandate?”

“If this area happened to be doing fine, then that would be great, I suppose,” he adds. “But I think our preference would be in favour of broader mandates within the emerging market space to give managers more flexibility.

“Undoubtedly this would be among the more inefficient global markets. It’s less liquid, less widely followed. That does create potential opportunities, but with a higher risk associated with it.”

Luukko does admit that most markets around the world have been discovered, so it might be necessary to look at smaller areas for new investment opportunities, despite the risk.

If your client is willing to take a chance, however, it seems like a MENA fund could be the way to go. Most MENA fund managers suggest investing a small part of the portfolio in the region, along with other emerging market options and domestic funds, but there is no question that the region is growing exponentially.

“There’s a compelling story here,” says Kronfol. “Valuations are typically more attractive than the rest of BRIC, it doesn’t cost as much to invest here and the MENA region has all the compelling features that you’d want in an investment.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(10/17/08)