Richard Lee and Marwan Haddad, senior portfolio managers at UAE-based Emirates NBD Asset Management, discuss the developments shaping the local market and provide their outlook for financial markets across the Middle East.
What have been the key geopolitical, economic, and regulatory factors influencing the UAE market over 2018-2019?
In fact, all these factors have continued to influence the market outlook for not just the UAE but the entire region, which is adapting to lower oil prices. Among these, the most difficult one to predict is geopolitics as past playbooks do not work and you can’t model or position for it. In relation to regulatory factors, the government has certainly taken a number of steps to fine tune the economy by reducing fees and increasing incentives for businesses to attract more private sector investments. In terms of economic factors, both domestic and external drivers have underpinned the macro backdrop for UAE real estate and property sectors.
On the positive side, higher US interest rates boosted margins and thus profits for banks, offsetting the uninspiring loan growth due to a soft macro-economic environment. However, weak real estate market fundamentals negatively impacted asset prices of property developers. While we are aware of ongoing developments in the region, our preference is on building client portfolios by taking a mix of a bottom-up and top-down approach, focusing extensively on company fundamentals.
That being said, in Abu Dhabi, the bank consolidation theme gained momentum with the three-way merger of ADCB, UNB and Al Hilal after the successful merger between NBAD/FGB. Furthermore, First Abu Dhabi Bank set the precedent by increasing their foreign ownership limit from 25% to 40%, which led investors to speculate similar moves in other UAE-based names.
Looking ahead to the next 12 months, where do the main risks and opportunities lie?
We highlight a global growth slowdown as a key imported risk as the economic environment in Europe remains weak alongside the ongoing trade war between the US and China, impacting Asian growth. In this backdrop, the downside risk to oil prices from their current level is significant particularly when higher US shale oil production is factored in.
In the local market, the imbalance between demand and supply of real estate continues which could put further pressure on real estate asset prices and rents. The weaker economic environment with a downward trajectory in US rates can negatively impact banks’ margins. Current valuations seem to indicate that some of these concerns are overdone and we expect a rebound in sentiment and economic activity as Expo 2020 draws near.
In the coming 12 months, investors have to be careful with stock picks/themes as there is likely to be significant divergence between winners and losers. We see specific opportunities in bank consolidation and in high quality companies within healthcare, logistics and real estate sectors that are likely to gain market share from smaller and weaker competitors, enabling them to increase cash flows and dividends.
Furthermore, we see opportunities in fundamentally sound companies at reasonable valuation who could also benefit from an increase in foreign ownership limits (FOL). The UAE market trades at a significant discount to its peers; couple that with the potential FOL increase and country rotation from Saudi – the UAE market could see strong performance in 2020.
What is your outlook for financial markets in the MENA region over the longer term?
We do not think geopolitical issues and oil price volatility can ever be profitably predicted well ahead of time over the long term. Hence, investors will have to adjust the equity risk premiums accordingly. That being said, while these risks remain, on a fundamental basis, we are constructive on MENA markets for the long term. Sovereign balance sheets are strong, currencies are pegged (for the most part) and government/regulators across the region have been very proactive in addressing key issues such as structural reforms, market transparency, liquidity, and foreign ownership levels. We do foresee these developments having a meaningful impact on the economies/markets and consequently, the MENA region shall play a more prominent role for investors in the broader emerging market basket. Having said that, reform programs are likely to lead to structural shifts creating winners and losers within different industries. Our top-down and bottom-up approach of identifying how individual sectors and companies are positioned shall enable us to capitalize on sector or stock-specific stories that are likely to generate returns in the 12-18 month horizon.
As more countries in the Middle East look to facilitate securities lending and borrowing activities, what impact could this have on regional markets and asset managers’ engagement with securities finance?
The Saudi market had seen more securities lending and borrowing activities after the first tranche of the Saudi MSCI inclusion in May and that number is expected to accelerate by the end of August, when the second tranche takes place. Given a small free float, a somewhat limited foreign ownership, against a backdrop of large government ownerships and participation in MENA markets, however, we do not expect to see a lot of inventory available for lending. The passive investors, most probably, will be the main providers. Given these factors and along with an increased volatility in emerging market inflows, shorting will be even more risky. An example in the region – Qatar – we have seen many investors trying to short the Qatari market in 2018, which did not end very well for many of them. Nevertheless, it is expected that securities lending and borrowing shall improve market liquidity and price discovery in the MENA markets.
What does 2020 have in store for Emirates NBD Asset Management?
At Emirates NBD Asset Management, we follow a disciplined investment approach focusing on value and alpha creation. Built on the success of our MENA equity franchise, we are excited to add new geographies to our investment universe. The focus will always be on emerging/frontier countries where market inefficiencies are high. Given the heavy concentration of oil exporters within the MENA region, we will start with large diversified economies who are mostly oil importers, hence, offering a wider product range to our clients. Markets such as Turkey, South Africa and Russia rank highly on our value screeners, today.
This Q&A features in the Middle East and North Africa Securities Finance Guide 2019. Download the full guide here.