6.36 AM Friday, 29 March 2024
  • City Fajr Shuruq Duhr Asr Magrib Isha
  • Dubai 04:56 06:10 12:26 15:53 18:37 19:52
29 March 2024

Institutional investors to spur markets: report

Firms' rebound to be U shaped. (EB FILE)

Published
By Staff Writer

Institutional investors in the GCC, both foreign and homegrown, look poised to play an increasingly greater role in the region's stock markets, according to a new report, which says this is expected to bring down the prevailing high volatility in the regional bourses.

Prepared by NCB Capital, the report said the participation of institutional investors, especially non-bank ones, would steer the region's markets away from being the retail investor-driven ones that they are at present. And the demise of western markets as high- value churners, coupled with the stability of the GCC economy, the continued presence of high net-worth individuals (HNWI) here and big ticket infrastructural projects, are all expected to provide the needed impetus for foreign institutional investors to focus on the GCC's money markets.

Dr Jarmo T Kotilaine, Chief Economist at NCB Capital, said: "The impact of foreign investors, mainly institutional ones, on the GCC's capital markets has been fairly marginal. However, evidence from other countries fairly consistently indicates that, over time, foreign institutions can play an important role in accelerating the move towards less retail investor-driven markets."

Non-bank institutional investors can significantly help reduce the volatility of capital flows, the report said. Their presence tends to have positive effects, such as increased research and the tendency of many retail investors to mimic their behaviour, it added.

Despite a dent in the recent investment flows into the GCC region, the prevailing uncertainty in the global economy, large long-term infrastructure projects and major diversification plans in the Gulf region have the potential to attract institutional investors towards GCC bourses. "Foreign investor interest in the GCC region is likely to grow in view of the regional economies' solid track records of macroeconomic stability and technocratic policy-making," the report said.

The process will be further helped by the gradual emergence of new types of funds that foreign investors can freely tap, it added.

"An enduring peculiarity of the GCC capital markets has been the relatively marginal presence of domestic non-bank financial institutions in spite of the existence of large pools of capital in the region, as regulatory changes in the recent years have successfully fostered the growth of regional capital markets and the role of institutions in terms of their size, numbers and market participation," the report said.

It highlighted the fact that proposals to consolidate the UAE's exchanges will create another large and attractive market for investors interested in the region. The GCC is increasingly viewed as an important underexploited opportunity in the global context.

"For instance, the Saudi Arabian stock exchange is the 25th largest exchange in the world, comparable in size to markets such as Malaysia, Mexico and Turkey, which constitute established and recognised parts of the investor universe," the report added.

It said low institutional participation in GCC equity markets was largely due to the uneven development of parts of the financial sector, as well the relatively young age of the regional stock exchanges. Key segments of the financial sector – in terms of market participants, platforms, and products – are still modest in size, although growing rapidly in some cases. Important structural investment opportunities, such as the massive infrastructure projects and private equity, can still be difficult for investors to tap.

In spite of rapid growth in investable surpluses, recurrent market volatility highlights the need for professional asset management, the report said. Retail investors, especially, tend to favour individual equities with a relatively short-term horizon while relying on cash as their default risk-management vehicle. Also, real estate investments have been hit by volatility. This highlights the opportunity for investor advice and education but also product innovation, which recent regulatory steps have greatly encouraged, it added.

Collective investment schemes, along with a portfolio investment culture, remain underdeveloped in the region. Nonetheless, especially the introduction of new Shariah-compliant products has increased the appeal of regional mutual funds. While government pension funds have boosted their presence in regional markets, occupational and voluntary schemes offer potential additional opportunities to foster a long-term investment horizon among retail investors.

"The accumulation of regional expertise, coupled with a conducive regulatory environment, bodes well for the maturing of the GCC capital markets. Moreover, the GCC has been progressively attracting greater foreign institutional participation as previously restrictive foreign investment laws have been relaxed. Further progress in this regard is likely and the increased presence of regional bourses in key benchmark indices will further accelerate the process," said the NCB Capital report.

"The Gulf region is one of the world's leading repositories of capital, not least because of the large capital windfalls generated during periods of high oil prices. In 2008, the regional economies earned a daily average of $2 billion (Dh7.34bn) from their oil exports, which took the cumulative current account surplus in 2003-2008 to some $1 trillion.

"Although the regional governments used a portion of this figure to retire sovereign debt and boost economic diversification, much of the money was invested through various funds. Also the private sector has large concentrations of capital, not least due to the presence of important family offices, some of them of very long standing," the report said.

HNWIs stay afloat

The International Monetary Fund (IMF) in 2008 put the collective private wealth in the GCC at $1.5trn, but some other estimates are far higher, one of them (by Oliver Wyman) pegging the wealth of the region's HNWIs alone at $2.1trn in 2007. Moreover, this money seems to have fared better during the global crisis than was the case in many other parts of the world. While the number of HNWIs globally declined by 14.9 per cent in 2009, along with a 19.5 per cent drop in their wealth, the corresponding figures for the Middle East were "only" 5.9 per cent and 16.2 per cent, the report pointed out

Despite the GCC's growing wealth, its capital markets differ from those of the advanced economies due to the hitherto relatively marginal role of institutional investors – large government, pension, insurance and mutual funds. However, recent indicators suggest that the situation is beginning to change. While institutions accounted for 4.98 per cent of the value traded on the Saudi Stock Exchange in 2009, their share rose to 8.67 per cent during the first four months of 2010.

Companies, often family offices whose role is in many ways analogous to that of institutions, had shares of 3.2 per cent and 5.6 per cent respectively. The still low capital market participation of institutional investors is especially striking in view of the fact that savings in the region are highly institutionalised, with the existence of a large number of long-standing state pension and social insurance institutions, as well as sovereign wealth funds (SWFs).

By contrast, their private-sector counterparts are far less important in terms of their assets. The modest role of institutional investors in the GCC capital markets has been not entirely due to their size. Most regional institutions with large assets under management have been conservative in their investment strategies, partly as a result of regulatory and human capital constraints but just as importantly due to limitations of regional investment opportunities.

The NCB report said this has led to large-scale offshoring of fund-management and, consequently, of funds. It quoted a recent Oliver Wyman study as revealing that 45 per cent of Middle East HNWI assets were placed abroad, compared with a global average of 16 per cent. Even this looks set to change, however, with more and more GCC investors favouring local assets and a growing number of global asset managers seeking to build a presence in the region.

Asset managers keen

A 2007 McKinsey & Co survey said 22 of the top 30 global asset managers were active in the GCC. According to the NCB Capital report, a number of structural drivers are now converging with the potential to transform the role of institutions in the GCC capital markets. Among others, institutional investors are benefiting from high-profile financial centre ventures, which have also helped attract a growing number of foreign players to the region. Bahrain took an early lead in this regard in the 1970s after civil war broke out in Lebanon.

"Dubai has sought to don the mantle more recently with the creation of the Dubai International Financial Centre (DIFC), a separate jurisdiction based on English law," said the report.

Qatar, which set out on a similar path with the creation of the Qatar Financial Centre (QFC) in 2005, announced in 2007 that a single national financial authority would be established on the basis of the best-practice paradigm championed by the QFC.

Despite the recent economic instability, the financial centre projects have made considerable headway. More funds are expected to be regionally domiciled in the near future, thanks to the arrival of custodial and fund administration services to these centres. Added to the general progress in regulatory standards, the necessary infrastructure for the expansion of regional asset management services is increasingly in place.

Also, the behavior of GCC institutions is beginning to change. The region's established state pension schemes, in addition to carrying out a host of parametric and structural reforms, are seeking to boost their investment returns. Among other things, this has led to a greater emphasis on local equities and corporate debt, a trend that is likely to continue further given the abundance of long-term investment opportunities in the Gulf, the report added. Moreover, the regional insurance sector is growing rapidly, albeit from a low base.

Insurance focus

GCC insurance companies have tended to be aggressive equity investors, unlike their conservative global peers. Many of them have relied heavily on investment income rather than their core underwriting revenues, leading to some concern over their solvency in the aftermath of the 2008 correction. Partly in response, asset-specific investment restrictions were announced in Saudi Arabia and Oman.

"Even individual investors appear to be changing their behaviour in favour of collective savings with a growing number and diversity of different funds available on the market. The high volatility of equities and real estate in recent years, while contributing to increased risk aversion, has also prompted a search for alternatives as well as for informed advice. Whereas much of the decline in the regional stock trading volumes has been cyclical, it also seems to involve an element of a structural transition toward a more institutionalized market," said the report.

New opportunities

A growing number of alternative investment opportunities have also begun to take shape as equity markets have established themselves. The capitalisation of the seven GCC exchanges has been growing at an accelerating pace since 2002. This positive trend has benefited from successful privatisation initiatives, especially in sectors such as telecommunications.

The total aggregate capitalisation of the regional bourses stood at around $720bn in March 2010, some five per cent the size of the US market and a fifth of the Japanese market.

The Saudi bourse makes up half of the region's overall market capitalisation, while the Kuwaiti, Qatar and the UAE markets are roughly comparable in size, each accounting for about 15 per cent of the total.

However, one of the challenges facing institutional investors in the GCC has been the limited range of regional investment opportunities, the NCB Capital report pointed out. This is linked to the relatively young age of most regional stock markets.

The oldest organised market in the region is the Kuwait Stock Exchange, established in 1962. The Bahrain Stock Exchange only followed in 1987 and the Muscat Securities Market a year later.

Although OTC trading in Saudi shares began in 1984, the Capital Market Law – which established a proper regulatory and institutional basis for the market – was adopted only in 2003.

The Dubai and Abu Dhabi bourses began operations in 2000. During the past decade, however, the seven regional exchanges have grown rapidly and significantly widened the investable universe facing regional institutions at home.

Recent years have also seen gradual steps towards more comprehensive and better regulated debt capital markets, although these lag far behind the international norm and still continue to make it difficult for institutions to buy into some of the most attractive GCC growth themes through tradable instruments, said NCB Capital in its report.

Why institutions matter

Institutional investors play a key role in the global financial system, as stocks tracked by them tend to experience higher liquidity over time. This is in part because retail investors often follow institutions. Institutional investors play a critical role in promoting corporate governance.

By virtue of their large investable assets, voting rights and occasionally legal mandates, institutions are in a position to exercise oversight on companies. Empirical evidence points to significant gains in corporate governance as a result of their efforts.

Institutional investors have fostered professional asset management by managing savings collectively on behalf of individual and corporate investors toward specific objectives in terms of acceptable risk, return-maximization and maturity of claims. They serve as a critical source of financing through their active involvement in capital markets.