Crisis alters investor landscape across the Middle East

17 May 2011

Asset devaluation and the collapse of well-known financial institutions have changed the private banking landscape and behaviour of wealthy clients in the region

In numbers

30-40 per cent

Wealth lost by high net-worth individuals in the region in the financial crisis

$1-1.2 trillion

Estimated total liquid wealth in the region

Source: Booz & Co

The past two and a half years have been challenging for the Middle East and North Africa region’s sizeable band of high net-worth individuals (HNWIs).

Investor confidence took a knock during the global downturn, with revenue pools linked to the performance of underlying equity markets.

According to research from US consultancy Booz & Co, it was the mid-range HNWIs with investable assets of $1m-50m that were hardest hit. Many had adopted aggressive investment strategies with subpar management and paid a steep price, losing 30-40 per cent of their wealth and in some cases much more.

Ultra-HNWIs - those holding in excess of $50m - lost an average of 10-20 per cent of total investable wealth during the crisis.

Confidence erodes

The financial crisis shook clients’ relationships with private banks, forcing many to consider new ways of managing their wealth. Conservatism, already the defining feature of the investment strategies of many Gulf HNWIs, has taken an even greater hold, with heightened risk aversion influencing asset allocation decisions. Fixed-income products and real estate have become the preferred avenues in the post-crisis world.

The ebb and flow of the crisis, with the Gulf at first seeming insulated from the worst of the recession, only then for Dubai to reveal massive debts at its state entities, has led to sharp shifts in asset allocation strategies. The outbreak of political unrest in 2011 has aggravated that trend.

Some HNWIs opted to move assets out of global institutions affected by the crisis back onshore. Yet with the region facing renewed political stress, appetite for going offshore may be rising once more.

“You need to build trust and create appropriate solutions, rather than walk in with a product”

James Fleming, RBS Coutts

“It’s always been a combination of the economic and the political,” says Muwaffak Bibi, regional head of the US’ Citi Private Bank. “Once it was favourable to invest in the local markets, be it the Saudi stock market or Dubai real estate, and you saw a lot of that wealth being kept inside the region. But once those real estate and equities markets were affected by the crisis, you started seeing a re-allocation to the global [market]. In the past few months, the region’s political instability may have triggered even more of this. ”

The crisis will have positive effects too, with allocation preferences shifting towards less risky and less complex products.

“Before the crisis, it was a challenging market for anyone wanting to sell products because clients had been very performance-oriented,” says Daniel Diemers, principal at Booz & Co. “Many just wanted to know how much double-digit performance they would make with a specific product.

“It has been a high-octane product selling environment and that made it difficult for private banks and advisers as there are no products able to show 30 per cent annual performance over a consecutive number of years. Those that were, turned out to be Ponzi schemes, as in the case of Bernie Madoff.”

The changed economic environment has forced many clients to diversify their adviser base. Most clients from business families would generally have three or four international banks working for them.

“Post-financial crisis one of the key things that came out was the importance of diversifying counter-party risk,” says James Fleming, Middle East head at RBS Coutts, the private banking arm of the UK’s RBS Group. “Widening the adviser base can only be a good thing.”

HNWIs in the Middle East have learnt the hard way that there is no reward without risk. Many investments were highly leveraged or put into derivative structures that were falling apart. This has awakened interest among wealthy individuals about what products they were buying and the associated risks. Banks too are acquiring a keener appreciation of where their clients’ risk tolerance lies.

The recent financial troubles present an opportunity, as well as a challenge to private banks. Despite the erosion of HNWI assets in the downturn, the long-term economic fundamentals of the past 10 years have been positive for the overall wealth pool.

Wealth pool

Booz & Co estimates the total liquid wealth in the region at $1 trillion-1.2 trillion, with most of that wealth in the hands of local families. Saudi Arabia and the UAE are the largest wealth markets, with $500bn-550bn and $260bn-280bn, respectively.

This provides a globally significant amount of wealth to manage, prompting major international banks to expand their private advisory services in the region.

The longer-established private banks will have been through down cycles in the past and are ready to help clients place their assets around the world. The current situation presents an opportunity for some of the big names to regain client’s trust.

“Middle-sized players stand to benefit from a more client-centric, relationship-driven approach with more focus on personal touch,” says Diemers. RBS Coutts is planning to double its business in the region.

The wealth-management divisions of the UK’s HSBC, Goldman Sachs and JP Morgan of the US, and Switzerland’s UBS, have all boosted hiring in the Middle East. Meanwhile, local banks have invested in developing private banking franchises, sensing that now is an opportune moment to grab market share via ramped up wealth-management services. The UAE’s Dubai Bank and Emirates NBD have in the past few months launched wealth-management services targeting royal families.

RBS Coutts has embarked on an ambitious international expansion strategy that has strong Middle Eastern focus. “I have a mandate to grow our business significantly over three to four years,” says Fleming. “Today, we have 20 private bankers dedicated to the Middle East through London, Geneva and local offices in the Gulf and this will grow to a minimum 50 bankers in the next three years.”

Market entrants seeking to establish relationships will need patience. Suitcasing - turning up in the Gulf armed with pre-packaged product offerings - is likely to meet with a tepid response from local HNWIs.

Tailored solutions

The Gulf is not a product-led private banking environment, say experts. “For us, it’s all about taking time to invest time in getting to know the client’s needs, circumstances and time horizons,” says Fleming. “You need to build trust and create appropriate solutions, rather than walk in with a product.”

Middle Eastern HNWIs retain an affinity for the big private banking brands, such as UBS and Julius Baer with their associations to Switzerland, and others that have a strong global footprint. Clients are careful about where they place their money and brand-related investments are becoming increasingly important.

In terms of asset allocation preferences, offshore retains a strong appeal to Middle Eastern HNWIs. The share of GCC investable assets that are offshore is among the highest in the world, estimated at 50-60 per cent by Booz & Co.

Switzerland remains the most popular destination for Middle Eastern assets, especially for Saudi investors, followed closely by London, the Channel Islands, Isle of Man, and, to a lesser extent, Singapore.

“Wealthy people in the GCC will always tend to hold a significant part of their wealth offshore and the last few months have been a good illustration of the need to diversify your risk,” says Diemers. “Anyone owning upwards of $5m needs to spread their wealth across geographies, to maybe one or two offshore centres.”

Gulf business families tend to have a high proportion of wealth invested in their own business, which is where they take a higher level of risk. The remainder, that is held in more liquid form, tends to be allocated between fixed-income and long-term equities.

Fixed income is now the most attractive investment class as investors try to strike a balance between security and performance, says Booz & Co. Cash and time deposits also remain an attractive asset class. Real estate is popular due to a perceived low correlation with financial markets and expected price increases in the region.

Fleming notes an increasing appetite for real estate, with a flow of funds into the UK to be invested primarily in the London property market. “There’s been a pronounced activity in terms of diversifying not just into a second apartment, but a portfolio of properties and in the case of more substantial families, the acquisition of commercial property,” he says.

“Although the Gulf states are planning massive infrastructure developments over the next five years, there’s only so much you can build and the continuing liquidity generated from natural resources requires a safe and sound home. Bricks and mortar in major capitals represents that safe and sound home, and London in particular, has been quite buoyant.”

Alternative investments - mainly private equity plays and hedge funds - are regaining momentum again. “During the financial crisis, people were shying away from anything to do with hedge funds or private equity,” says Diemers. “But bit-by-bit they are coming back to alternative investments and seeing the advantages of these products at a time when markets are going sideways.”

Succession planning

As risk appetite strengthens, experts say complex, highly leveraged and high-margin products will regain popularity as investors seek double-digit returns.

HNWIs are dominated by the Gulf merchant families that account for 90 per cent of the region’s private sector and have multiple businesses and overlapping needs ranging from corporate banking to personal wealth management.

The increasingly comprehensive offerings sought by HNWIs have put pressure on private banks to extend the range of services provided to family businesses. The sensitive issue of succession planning creates an opportunity for private banks with a rich understanding of the succession process.

This is particularly the case at the lower end of the HNWI segment, up to $10m. “At that size they tend not to have their own family office and may have a relationship manager, who may have another 100 other clients in the same bracket,” says Fleming.

Citi’s trust business handles billions of dollars out of the offshore jurisdictions of the Cayman Islands and Jersey, where families want to ensure that their assets are booked in a tax-efficient way for the next generation to invest. “We get the planning in place to minimise disruption when wealth moves from one generation to the other,” says Bibi.

There is a growing trend for HNWIs to invest in a sharia-compliant manner. Many international private banks now carry Islamic products as part of their suite of offerings.

As investor sophistication grows in the region, so too will demand for stronger service offerings from private banks.

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