FDI to bring diversity to region’s economies, but investment managers need to play long game

While conditions in the short to medium term may cause foreign investors to shift capital to other regions, the long-term trend is intact, writes Mohammed Salih Al Hashemi of Invest AD.

The diversification of GCC economies in the medium and long terms, in light of the prolonged low oil price, is expected to increase foreign investment into GCC markets.

While such structural macroeconomic changes open up investment op­por­­tunities, there are addi­tional factors that foreign investors consider before allocating money to regional markets.

Capital in GCC markets pre­dominantly comes from wealthy regional retail investors who base their decisions on prevailing market sentiment. It is very rare for individual foreign investors to directly seek access themselves, as they typically choose to do so through professionally managed and well-regulated investment funds.

Foreign participation in GCC markets is also driven by insti­tutional foreign investors, such as pension funds and investment arms of insurance com­panies, which directly allo­cate to GCC markets through managed portfolios.

Periods of significant market rises or declines are often partly or wholly blamed on somewhat erratic increasing inflows or outflows of capital from this investor base. The reality is that the majority of institutional foreign investors follow a very systematic approach.

We have found that there are four consistent factors that have an overriding influence on the timing and magnitude of foreign investor allocations: fundamentals, liquid­ity, index inclusion and access.

Fundamentals are important because foreign investors’ decisions to invest in GCC markets are usually made by investment managers. This means that a high level of emphasis is placed on detailed qualitative and quantitative analysis and valuation of the economies and markets, including corporate governance.

Liquidity levels are equally important. Foreign investors want to have the opportunity to shift their allocations from one region to another and will look to invest their capital into markets that do not have high barriers to exit.

The inclusion of a market in a recognised index or benchmark affects active and index-tracking foreign investment managers. The performance of the port­folios and funds they manage is normally judged against equity index benchmarks, which tends to define their investable universe.

The weight of a market in an index determines the extent to which they may allocate to these markets. The UAE makes up 0.92 per cent of the widely followed MSCI Emerging Markets Index, while Qatar makes up 0.97 per cent. This may seem like a small percentage, but the inclusion of these two markets ensures that they will at least be researched by investors who track or allocate capital in reference to this index.

A final important consideration is ease of access to the markets, including ownership restrictions. GCC markets have made steady progress in this area, including the opening up of the Saudi equity market last year to foreign investors who meet certain criteria and the gradual increase in foreign ownership limits across many UAE com­panies over the past few years, with Eti­salat a prime example.

Research has shown that capital originating from the United States and the United Kingdom accounts for more than 80 per cent of all international investment into the GCC. This is not surprising, given that the two markets have well-­developed and large asset management and pensions industries, with asset allocation mandates that include emerging and frontier markets.

The remaining 20 per cent is mostly accounted for by capital from Europe.

Interest in the region among international investors has been steadily increasing over the past few years. While conditions in the short to medium term may cause foreign investors to shift capital to other regions, the long-term trend is likely to stay intact.

The writer is the executive dir­ector of asset management at Invest AD, an Abu Dhabi asset management company