Middle East funds seek oasis of calm

The launch of Dubai’s Atlantis hotel last week, complete with Dame Shirley Bassey and a firework display costing £3m, drew attention from around the world. But it is likely to take more than a party, however lavish, to raise a smile from many of the region’s investors.

So far this year, the MSCI Frontier Markets Index, which takes a majority of its constituents from the Middle East, has fallen 50 per cent. The index had outperformed emerging and developed markets in previous years, but this year the MSCI Emerging Market Index has fallen significantly less far.

Nevertheless, HSBC, one of the world’s largest investors in emerging markets, says it pays to take a long-term view toward investing in these areas, rather than trying to time the market.

Investors who remain in the region also point to the fact that it is home to some of the least leveraged financial companies in the world. For example, Shuaa Capital, a Dubai-based bank, is only 1.7 times leveraged.

In fact, some fund managers talk of investment in the Middle East as the only way to avoid the excesses of the global economic crisis.

According to Bill Browder of Hermitage Capital Management, the strategy is to stay “off the financial grid”. By this, he means investing in frontier markets, young and underdeveloped economies that proffer opportunities for rapid growth.

Browder says there is historically a low level of correlation between the Middle East and other global equity markets. He reports that over 10 years, the UK has a correlation of 0.93 per with the S&P 500. By contrast, Saudi Arabia, Kuwait and the UAE all have correlations of less than 0.42 per cent.

The oil-rich states of North Africa and the Middle East, such as Qatar, UAE and Kuwait have already aroused interest this year from investors attracted by high energy prices, large infrastructure projects and high GDP growth forecasts.

A number of new frontier funds have come to market to tap into this interest, including HSBC’s New Frontiers fund and GAM’s Star Frontier Opportunities.

But while risks such as non-transparent financial regulation, political instability and lack of liquidity were known, recent developments such as falling oil prices and inflationary pressures have since led many investors to desert the region.

Even so, good bottom-up stockpicking can still unearth strong investment opportunities, argues Amr Seif, portfolio manager for the Investec Middle East and North Africa fund, which is down 23.7. per cent since its launch in April.

“It’s true that in times like these there is no way for these markets to be insular,” says Seif. “But these are wide and deep markets containing around 500 stocks to pick from.”

Not everyone agrees. Devan Kaloo, manager of Aberdeen’s Emerging Markets Fund, which is down 29.3 per cent in the year to date, says Middle Eastern economies are just as tied to global markets as everywhere else.

“Everything in these countries is backed by the government and the government is backed by oil,” says Kaloo.

Oil has fallen two thirds in price from its peak in July. However, analysts say many counties in the area can survive low oil prices without having to pull back on investment plans.

Alex Tarver, spokesperson for HSBC Global Asset Management, where the New Frontiers fund is down 46.49 per cent in US dollars since its inception in February, says that in spite of the falling oil price, infrastructure projects are still taking place because the countries balance their budgets to an oil price as low as $35 a barrel.

“It’s the tortoise and the hare,” he says. “Frontier markets like those in the Middle East are not the playgrounds for fast-moving investors. So that means they are less volatile, and they will not fall as far as other markets.”