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Lately you hear often about the launch of a new Middle East and North Africa focussed fund. These funds are being launched not so much by domestic asset managers in the Mena region, but by some of the big international asset management firms, most of them managing the funds from outside the Mena region.
What this highlights is the rising interest across the globe in the equity markets of the Mena region. 'Mena' has become the new buzzword just like the 'Bric' story (Brazil, Russia, India and China) a couple of years back.
The important question for clients looking to invest in such funds is to consider whether the Mena markets constitute a sector in the equity asset class that is worthy of their attention or just another passing trend.
To answer this question, one has to first look at the definition of an asset class. The Investopedia website defines an asset class as "A specific category of assets or investments, such as stocks, bonds, cash, international securities and real estate. Assets within the same class generally exhibit similar characteristics, behave similarly in the marketplace, and are subject to the same laws and regulations".
Based on the above definition, the Mena region has to exhibit characteristics similar to the other well established regional equity sectors.
Simply put, in order to generate long term global interest, firstly the Mena region has to be able to demonstrate that its capital markets are on par with at least other key emerging markets, especially in terms of its operating and regulatory environment, size and depth, as well as long term sustainability.
Secondly, the region has to differentiate itself in terms of the opportunities it provides global investors that will help them consider the Mena markets as a bigger part of their overall asset allocation. Let me try to evaluate both these points.
Capital market development
Stock markets in the Mena region have been opening up and introducing better systems and processes. Compared with the standards in other emerging markets, published disclosure by public companies in the region is relatively good and is getting better. However, company managements are not easily approachable by investors unless an experienced local presence is available.
The region also suffers from certain misconceptions around the size and liquidity of its fairly young but rapidly developing capital markets. The market capitalisation of the companies listed in the region is roughly around $1.35 trillion, which is as big as India and much larger than say Korea. The estimated daily turnover of stock transactions are quite healthy, ranging between $5 billion to $7 billion.
Another factor to consider is that the region's current representation is only 1.25 per cent of the MSCI Emerging Market index. However, there are strong indications that this is set to change over the coming year. Countries such as South Korea, which carry significant weight in the MSCI Emerging Market index, are expected to be upgraded to the ranks of developed markets and countries such as Kuwait, Qatar and the UAE will be amongst the new entrants to the index. This change will obviously attract significant liquidity to the countries remaining in the emerging markets universe and more importantly to the new additions from the region. It is estimated that around $50 billion of net inflow could find their way into these three markets from several emerging market funds.
This increasing market capitalisation and liquidity, combined with better systems, processes and regulatory environment, has translated into increasing interest, both from local and global investors.
Reasons to invest
Mena, whose economies have been growing substantially over the past few years, is the eighth-largest economic region in the world, according to the International Monetary Fund. The Mena countries have demonstrated robust GDP growth which is expected to continue in the coming years. The region's estimated average real GDP growth is estimated at 6.4 per cent - clearly exhibiting significant out-performance in comparison to the developed markets.
While high fuel prices have undoubtedly boosted growth in many countries in the region, there is also a strong demand for consumer and financial products and the region's young population is expected to drive demand for the real estate sector.
In addition, the regional consumer spending as a percentage of GDP is also low - relative to other emerging markets and the developed world. As spending increases, the economies will grow, benefiting long term investors.
As public markets have grown, so has the variety of sectors represented. Over the years there has been a substantial increase in the contribution from non-oil sectors to the economic growth such as banking and finance, construction, telecommunication and logistics and transportation. Market capitalisation is still relatively low, leaving room for much potential growth.
Valuations tend to be attractive due to strong corporate earnings. Based on the future earnings growth, the regional markets currently offer relatively low valuations as compared with global markets. They are trading at a discount to their historical valuations that we have seen over the last six-to-seven years.
The Mena markets also show little correlation to the markets in the rest of the world. The region is the largest supplier of oil contributing to 33 per cent of the world's total supply of crude. This actually shelters the region against any global economic slowdown as its growth is not really from consumption, population or exports to developed markets like other emerging markets, but from oil revenues it generates, which then gets through the development of the economy. Additionally, correlation between countries within the region is also low offering investors great diversification benefits.
Summary
The capital markets in the Mena region are part of the emerging markets world and in fact most markets in the region are considered to be 'frontier markets'. Therefore, investing in this asset class clearly carries a level of risk that every investor has to take into consideration.
However, given the rapid economic and capital market developments in the region, I believe the Mena funds provide an interesting investment opportunity as well portfolio diversification opportunity for medium to long term investors.
The writer is a Senior Director at Franklin Templeton Investments. The views expressed in the article are his personal opinion.
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