Fund managers promoting investment opportunities in the Middle East have found the going tough in recent months. Of four regional funds announced since late 1994, two have closed their initial offering with commitments well below expectations, the third has raised only $2 million and the fourth has been postponed indefinitely. Events have conspired to ensure less than favourable marketing conditions.
In the region, a faltering peace process, political violence and uncertainty about Iraq have unsettled cautious investors. And if that were not enough, the collapse of Mexican stocks and the ensuing capital flight from emerging markets around the world have further undermined confidence in the Middle East.
Yet in spite of this inauspicious beginning, fund managers continue to be optimistic about investment prospects in the region. Most of the markets being targeted are undergoing wide-ranging economic reform programmes. They also offer investors the opportunity to diversify emerging market portfolios and many of the shares on offer are still undervalued, fund managers say.
The first regional fund to be launched was the US-listed Foreign & Colonial Emerging Middle East Fund. Originally planned to raise $60 million, the issue closed at the end of October 1994 at only $42 million. In the weeks prior to the close, Iraqi troops were deployed on the Kuwaiti border, raising tensions in the Gulf, and the Palestinian-Israeli peace talks showed growing signs of stalemate.
Nevertheless, the fund’s managers plan to have fully invested by the end of March 1995, with 65 per cent headed for the core markets of Jordan, Morocco, Oman and Tunisia, and 35 per cent to be placed in Israel and Turkey. In the period, shares in the closed-end fund have fallen from the issue price of $15 to between $10-11.
Promoting the open-ended Alliance Middle East Fund, targeting the same markets as Foreign & Colonial and launched at the start of January, has proved an even tougher task. By the end of the initial offering period at the end of January, the fund managers, Alliance Capital Management, had raised only $3 million, well below the target figure of $40 million. This time, it was the Mexican crisis that took its toll. But as an open- ended fund, the managers hope to raise more capital as investor confidence picks up.
Funds set up earlier in 1994 fared better. The closed-end Framlington Maghreb Fund, mainly investing in Moroccan stocks, raised $30.5 million, $20 million below the initial target figure. The Oryx Fund, the first to offer foreigners the opportunity to invest in Omani shares, is capitalised at $52 million.
Societe Marseillaise de Credit (SMC) has launched two open-ended funds specialising in Middle East equities, both of which are managed by its subsidiary GP Banque. The Maroc Privatization started investing in Moroccan equities in early 1994, and has raised capital of between FFr 35 million- 40 million ($7 million-8 million). SMC also succeeded in launching a regional fund in November 1994 that has so far invested in Morocco and Egypt, but also plans to target Jordan and Tunisia. However, the fund, called Mediterranee Marches Emergants, remains comparatively small with capital of only FFr 10 million ($2 million).
In contrast, the Fleming Arab Countries Fund, a regional fund planning to invest only in Arab stock markets, has been postponed from its planned launch in early 1995. The managers say it will still go ahead, but only after marketing conditions improve.
‘We couldn’t get people to focus on taking a decision to invest,’ says Charles Lillis, director of Fleming Investment Management. ‘We didn’t want to push people in, because then you have a seller on your hands. We want people to come in for good commercial reasons.’
Flemings are confident that funds targeting the Middle remain a commercially sound prospect. Mohamad Mourabet, Middle East investment analyst at Flemings, says the investment climate in the region is changing rapidly, and will soon draw back the investors. ‘The change in the political situation is being accompanied by changes in the economies, but the two are not linked,’ he says. ‘Even if the political process is stalled, as we have seen in the peace process, the liberalisation measures can continue.’
He says most of the Arab markets that Flemings will target with its fund, such as Jordan, Morocco and Egypt, are carrying out or have completed IMF-sponsored structural adjustment programmes. And these measures are not only transforming the economies, they are also encouraging the markets to open up to foreign investment.
But the fact that these markets have been closed to foreign capital until recently, is in itself attractive to foreign investors. ‘The word we’re trying to get out is that our fund could be used as a diversification tool within a portfolio,’ says Omar Masri, who manages the Foreign & Colonial fund. ‘There is no foreign capital to be sucked out.’
For the institutional investor, creating a balanced portfolio across regions that act on a different cycle is an essential part of risk management. None of the Middle East markets has substantial foreign capital investment, which means that they are largely unaffected by the herd instinct that can drive global capital flows. As investors retreated from many markets in Latin America and the Asia-Pacific countries in the wake of the Mexico crisis, Middle East markets remained relatively calm.
‘As with most emerging markets, we would prefer to see a domestically driven market with a good system, than a market driven by foreign capital with a bad system,’ says Peter Douglas, head of Foreign & Colonial Emerging Markets. He compares the paper market of India with the performance of Chile, one of the few Latin American markets driven by local investors. India has promoted itself well, but has struggled to cope with the foreign demand it created, he says. In contrast, Chile is fundamentally more stable and has escaped the volatility which other emerging markets have experienced in recent months, he adds.
Risk management has also been the main reason why fund managers look favourably on regional funds in the Middle East. This allows them to overweight or underweight a country as and when prospects improve or deteriorate. But as the markets develop and larger markets open up, country funds may become more attractive. ‘If we were to see – and let’s dream a little – Kuwait and Saudi Arabia open up, both these would merit their own fund,’ says Flemings’ Lillis.
It is, however, a dream that seems some way from being realised. Gulf markets have remained stubbornly closed to the outside world. Oman has allowed foreigners into the market, but has limited this to a few listed companies and the Oryx Fund. In Bahrain, only a handful of listed companies are open to foreign investors.
Saudi Arabia has been flirting with the idea of opening its share market to foreigners, possibly through local mutual funds rather than direct trading. Bankers are eager for any moves that would ease the liquidity squeeze which has caused shares to fall almost 40 per cent in the past 15 months. But the government has yet to make any clear commitment on the issue.
Like Saudi Arabia, the UAE and Qatar have no formal exchange and there is no talk of opening up yet. And in Kuwait, where there is a fully fledged stock market, foreign participation still appears a distant prospect.
‘There is still a battle to be won to encourage a number of senior figures in the region of the benefits of a stock market, and one that is well regulated,’ says Angus Blair, head of Middle East research at Baring Securities, which backed the Oryx Fund. For many of the markets in the Gulf the need to raise money through a stock market was not apparent in the past, and the issue of an exchange is only now becoming important, he says.
It has been a chequered start for Middle East funds. In North Africa and the Levant, where the fund managers are now receiving permission to invest, domestic demand is often so high that foreign investors are being pushed aside. Fund managers regularly pay premium prices to get hold of newly privatised stock, as in Morocco, or are no longer bothering to register for new issues because they will not receive an allocation, as in Egypt. In the Gulf, where foreign liquidity could help revive flagging bourses, the interest in opening up the markets is still subdued. But there are convincing arguments for buying into Middle East stocks, and fund managers are ever willing to present them.