Unlike its arid surroundings, the Middle East has been anything but dry on liquidity. RAPHAEL WONG looks at investor sentiment post-Arab Spring, and its impact on the current tremulous economic conditions.
The Middle East was a thriving region prior to the global financial crisis that hit in late 2008. At the height of the crisis in early 2009 all sectors, conventional and Islamic, saw their profits shrink and some even saw their businesses come to a grinding halt. The funds industry was not left unscathed. Ernst & Young data reveals that the total Islamic assets under management (AUM) of the four GCC major countries of Saudi Arabia, Kuwait, UAE and Bahrain fell to US$25.4 billion in the first quarter of 2011 from US$34.1 billion in the corresponding quarter of 2010.
In the following years, economic conditions began slowly but surely to improve. Ernst & Young reported that global Islamic fund assets under management grew by 7.6% to US$58 billion in 2010, up from US$ 53.9 billion in 2009. As the industry continued to realign itself, 23 new Islamic funds were launched in 2010 while 46 were liquidated.
However in spring 2011 a wave of political unrest, dubbed the Arab Spring, began in Egypt and spread throughout the Middle East with Bahrain, a regional center for Islamic finance, being one of the most severely affected. The chairman of the Bahrain Chamber of Commerce and Industry is reported as stating that the country had lost up to US$2 billion due to the recent political unrest.
According to a recent report, an enforced closure of the Egyptian stock exchange earlier in the year caused conventional and Islamic equity funds to plunge 25.18% and 20.42%, respectively, by August 2011. Bahrain also saw the total net asset value of its mutual funds, both in the conventional and Islamic space, decline slightly from US$9.17 billion in December 2010 to US$8.74 billion in June 2011, according to data from the Central Bank of Bahrain. The outflow of investments came from its local funds, which dipped by US$480 million.
Ashar Nazim, the MENA head of Islamic financial services at Ernst & Young, points out that aside from Malaysia, a heavy concentration of institutional funds with little focus on retail funds is one of the main issues that the industry faces in all regions, even in the Middle East. Globally, he said, institutional funds continue to grow at a rapid pace and make up 67% of global Islamic funds’ AUM, while retail funds make up just 33%.
He attributes two reasons for this trend. “Firstly, family businesses show a preference towards established institutions. Secondly, people [retail customers] generally perceive their money to be safer in the hands of banks as compared to funds, as funds are usually smaller, more localized or lack the brand awareness that banks have.”
Haissam Arabi, CEO and fund manager at Gulfmena Investments, also says that 2011 has been a very difficult year for asset and fund managers in the region, as a majority of them focus on local markets which have lost their appeal both regionally and internationally. He attributes this factor to a number of reasons including the Arab Spring and the ongoing troubles in the Eurozone.
Pervez Akhtar, a partner at White & Case, in a recent interview said that there has been a reduction of new investment funds in the region over the last 18 months, largely due to the investors’ perception of the lack of quality assets, with asset valuations that were out of sync with the current economic situation.
Despite Asia now being the focus of huge inflows of investments from global investors, Nazim believes that institutional investors are still investing in the Middle East region. “The reasons are not hard to fathom. Firstly, sovereign ratings in the region are stable and may even be improving, leading to risk averse capital inflows. Secondly, Islamic finance is gaining popularity and is becoming a larger part of investment portfolios. GDPs in the region are still growing with Qatar’s growth being in double digits. And finally, a plethora of new infrastructure investment opportunities are presenting themselves as public private partnership is now the preferred mode in this sector.”
However, Arabi does not share Nazim’s view. He says while there are still some foreign institutional money and even a few mandates: “Generally interest has dropped significantly and we have not seen a real pick up yet.”
Asked what asset classes remained popular with the region’s investors, Arabi says Sukuk in particular had retained its appeal, with some investors also going into commodities such as gold for hedging or speculation. He feels that equities remain largely out of favor due to the volatile market conditions.
However, Nazim on the other hand believes that equity investments are still prevalent among investors, with Ernst & Young data showing that they led the AUM of Islamic funds in the region. The other asset classes favored by retail investors were fixed income, commodities, real estate funds and alternative investments.
A total of US$63 billion-worth of Sukuk were issued during the first nine months of 2011, up 90% from issuances during the same period in 2010, according to market data. Malaysia accounted for the bulk of the issuances making up a total of 69%, while the six GCC states issued a combined US$16.1 billion or just 25% of the total. This can be partly attributed to lower issuance levels due to the unrest in many parts of the MENA region.
Arabi is confident however that an increase in issuance in the Middle East will spur investor interest in Sukuk funds. Nazim concurs, saying that Sukuk present a safer opportunity during volatile times; making it the preferred investment option for investors over the next few months. “The Sukuk market has been an outstanding performer in 2010. It had a record year with an issuance of US$50 billion. It has also been doing well in 2011 and will most likely continue to do so next year.”
Nazim points out the UAE and Saudi Arabia are at the forefront of the Islamic funds sector. “In Saudi Arabia, the market is heavily skewed towards Islamic finance and local laws are helping the sector, while the UAE has the best operating environment and a long history in Islamic finance.” Aside from Saudi Arabia, Arabi believes that Qatar is another attractive market for Islamic instruments.
What does the future hold for the Islamic funds industry? Ernst & Young’s report forecasts a bright future for the region. It notes that the addressable universe for Islamic fund managers is in excess of US$500 billion, and is growing by at least 10-15% annually, while in the GCC liquid wealth from Shariah sensitive investors is predicted to add more than US$70 billion to the pool by 2013.
In spite of this, there are analysts and funds managers who feel that without the support of institutional investors – which include sovereign wealth funds, pension funds and Takaful companies – the Islamic funds industry will remain miniscule over the next five years.
Jahangir Aka, a senior executive officer at asset management firm SEI Investments, has even gone to the extent of cautioning the industry that poor sentiment in financial markets and lackluster interest among Islamic institutional investors will probably bring this year’s growth to a grinding halt or even see it decrease. Aka adds that pension and institutional funds in particular will be critical to the industry’s growth as they provide long-term, stable money.
Nazim is on the same page, but suggests that if institutional players such as large conventional fund managers and sovereign wealth funds enter the Islamic funds market, the industry can expect to see a renewed resurgence and sustained growth. He firmly believes that the best opportunities in Islamic finance today are presented by the GCC countries, especially the UAE and Qatar, as well as Egypt.
Arabi is optimistic that the future is bright. He reasons that the investment culture is there to offer the catalyst which the asset management industry needs, as household savings begin to rise and inadvertently boost the GDP per capita.
However, he warns that the Islamic funds industry is in need of major restructuring. “Structural reforms all the way to repositioning our products and services will have to be considered. In other words the industry will have to reinvent itself otherwise it will lose out to international institutions.”
Empirical evidence indicates that things are looking up for the Middle East at last, with the Eurekahedge Middle East/Africa Islamic Index posting an uptrend of 0.21 for September 2011. Though miniscule, it is a sign of a positive future. Fund managers have a long road ahead, but it is essential to lay the groundwork in order to convince the big players to invest in this region, before the industry can truly take off.