you can find this article here
Kuwait AUM to GDP ratio ‘highest’
Kuwait Financial Centre S.A.K “Markaz” recently released a report on the GCC Asset Management industry. The report takes an in-depth look at the asset management industry across the GCC in terms of Assets under management (AUM), number and types of Funds managed, Top Managers across the various markets, Fund Costs, Benchmarks and Performance ranking and a number of other parameters.
Industry Overview
The GCC Asset Management Industry, with roughly 100 asset management companies, manages approximately USD 29bn in assets in about 325 funds as of 31st March 2011. Geographically, Saudi Arabia country funds account for 62% of the total, followed by Kuwait country funds with 19% share. In terms of products, Money Market funds lead the pack with a 50% share, closely followed by Equities at 47% while the remainder is in Fixed Income and other funds. Of the total, Islamic funds manage USD 17.6bn in assets implying a share of 61%. In terms of number of funds, GCC / MENA mandated funds top the table with 131 funds, followed by Saudi Arabia country funds with 109 funds and Kuwait country funds with 51 funds. Contrary to pattern seen in assets under management, there are more Conventional funds (176 funds) than Islamic funds (149 funds).
Kuwait, with USD 5.4bn of assets, had the highest AUM to GDP ratio of 4.1%, closely followed by Saudi Arabia with AUM to GDP ratio of 4%. The ratio for all other countries was less than 0.5% implying lack of institutional presence in the investment segment.
Benchmarks
Most GCC country funds adopt local stock market indices as their benchmark. Among global index providers, MSCI and S&P are the most active in the region. Majority of Shariah complaint funds use S&P indices as benchmarks since MSCI discontinued Saudi securities from its indices.
In Kuwait, 7 out of the 20 conventional equity funds use KSE Weighted Index as their benchmark. 4 funds use KIC index (Kuwait Investment Company). Most GCC / MENA equity funds use S&P GCC Index and S&P Pan-Arab Shariah Index as benchmarks for conventional and Islamic funds, respectively.
Domicile
The ranking of GCC countries in terms of number of funds domiciled, indicate that country of domicile relates to the size of each country’s asset management industry with only a few exceptions. There were 140 funds domiciled in Saudi Arabia managing USD 19.3bn in assets, followed by Kuwait with 58 funds managing USD 5.7bn. Bahrain, true to its reputation as a financial hub, has 39 funds with USD 1.1bn in assets. Most of the funds domiciled in Bahrain are mandated to invest in GCC/MENA region.
Given that local investors make up the bulk of participants in GCC/MENA funds, local markets tend to suffice as domiciles for these funds, with Saudi Arabia, Kuwait and Bahrain being the most popular choices and accounting for 73% of the total.
Specialized Funds
Despite the fact that the majority of funds across the region are of the “plain vanilla” equity variety, there are new and innovative types of funds which are being introduced to deal with the unique dynamics and opportunities presented by the GCC/MENA markets. In our database, such funds are grouped under “Specialized” funds and they account for approximately 3.5% of total assets under management.
These Specialized Funds have ranged from standard sector-specific funds focused on such important sectors like Telecom, Banking & Financials and Real Estate, to more specific funds such as those dedicated to IPO’s, infrastructure, and capital protection etc. Markaz Forsa fund (based on call options) is also a good example. Some funds use advanced quantitative tools to manage risks.
Managed Assets
The Central Bank of Kuwait on a monthly basis publishes a detailed break up of the assets of the investment companies, which includes – Portfolio investments (Managed Accounts), equity, debt and investment fund units held by local investment companies, custody accounts, foreign funds and commitments and guarantees. This is by far the most transparent break-up of assets of the asset management industry available in the GCC region. This provides us with a preliminary break-up between managed accounts and mutual funds for Kuwait.
As of May 2011, the size of Kuwait fund management industry size as disclosed by CBK is at USD 6.6bn and the assets managed under portfolio’s is at USD 54bn – a factor of 8x. Similarly for Saudi Arabia, CMA provides the total assets in mutual funds, which amounts to USD 23.6bn. However, SAMA does not provide statistics for assets managed under managed accounts. This leads us to take an intelligent guess on the proportion of managed accounts to investment funds for the rest of the region.
We believe that Kuwait is an extreme outlier mainly due to the presence of higher number of investment companies as compared to the rest of the region. Therefore, we believe that, Saudi Arabia and UAE will have a lesser proportion of managed accounts than Kuwait, but higher than smaller markets such as Qatar, Oman and Bahrain.
AUM to GDP ratio was 2.7% if only mutual fund assets are considered. If Managed Accounts are also added, the AUM to GDP ratio increases to 15.3% - an increase of nearly 6 times. After accounting for assets under managed accounts, Kuwait had the highest AUM to GDP ratio of 46%, followed by Saudi Arabia with 22%.
1Q11 Performance
Almost all GCC stock market indices were down in the first quarter of 2011. GCC Equity funds also mirrored the performance with majority of funds giving negative returns in 1Q11. On an Asset Weighted basis, Fixed Income & Money Market funds gave better returns than equity funds in 1Q11. Islamic fixed income funds were top performers in GCC (+1.4%) and Saudi Arabia (+0.2%). Islamic money market funds topped in Kuwait (-0.3%) while Conventional money market funds topped in UAE (+0.8%).
Contrary to returns, equity funds were the top Alpha (excess return over benchmark) generators. Conventional equity funds produced highest alpha in Saudi, while Islamic equity funds gave highest alpha in GCC, Kuwait, UAE and Qatar. In terms of Cost, as in any other markets, Fixed Income and Money Market funds are cheaper in GCC region as well. Equity Funds in the GCC region, on average, charge 1.48% as fund management fee. GCC / MENA mandated funds charge the highest management fee of 1.06% in Fixed Income category. Saudi Arabian Money Market funds charge the highest management fee of 1.61%, which is due to high cost associated with some Trade Finance funds. GCC / MENA funds are the cheapest (0.50%).
Given that it is a nascent industry, the GCC asset management sector faces a number of challenges going forward including, but not limited to; High Volatility, Lack of market depth, Low Liquidity, Regulatory and Legal issues, Narrow Product Range, etc.
August 25, 2011
August 23, 2011
Relying on credit rating agencies
you can find this Article here
CRAs evaluate security’s risk of default
Credit rating agencies (CRAs) have recently come under intense scrutiny. After watching many highly-rated commercial debt securities become worthless several years ago, markets are now questioning the quality of CRA decisions to either downgrade or affirm the ratings of sovereign debt. In the GCC region, ratings agencies currently have a limited role since GCC governments are not aggressive fund raisers in international markets. However, given their importance in pricing and
other functions, as well as measuring market confidence, the credibility of rating agencies is important for the development of GCC bond markets which have been clocking steady growth in recent years. The total value of bond issues raised increased from $20 billion in 2003 to $81billion in 2009 before tapering off to $63 billion in 2010. However, much of the local bond issues (both sukuks and conventional) largely go unrated. There have also been instances where corporate rating has come under severe criticism by the “rated” for poor and misplaced judgment, especially when there is a down grade. In this article, Stephen M. Horan, CFA, CIPM, Head, University Relations and Private Wealth at CFA Institute, and Raghu Mandagolathur, President of CFA Kuwait, discuss the role of CRA’s in the development of regional bond markets. — Editor
By Stephen M. Horan and Raghu Mandagolathur
Question: What is the scope of responsibilities of credit rating agencies?
Answer: A primary function of CRAs is to evaluate a security’s risk of default and the relative magnitude of loss should default occur, rather than its liquidity risk, price volatility or fundamental value. CRAs do not set out to predict future valuation changes from fluctuations in interest rates. CRAs also encapsulate whether a bond issue’s rating is likely to be upgraded or downgraded in the future in a “ratings outlook” - this is the plus or minus that is attached to the rating score.
Q: What is unique about rating sovereign debt?
A: In rating sovereign debt, CRAs look at both economic and political risks. Economic risks include, amongst other things, the existing debt burden, growth prospects and fiscal flexibility whilst political risks include, amongst other things, leadership stability, consensus on economic policy objectives and barriers to global trade. Ratings depend on whether sovereign debt is denominated in local currency or foreign currency. This is because governments can often generate enough local currency to nominally meet local currency obligations using open market operations (or quantitative easing). Printing currency in this way has obvious inflationary implications and one agency, Standard & Poor’s, does consider the risk of implied default through a devaluation of the currency.
Q: What are the implications for Middle East versus Eurozone credit risk?
A: GCC countries, although pegged to the dollar, have independent currencies and a measure of monetary discretion. Eurozone countries issue debt in a common currency over which they have little to no monetary control. As a result, their ability to implicitly default through a devaluation of the currency is limited. Any default would have to be comparatively explicit. Nominal default rates on debt denominated in foreign currencies are historically higher than those on debt denominated in local currencies. But for these sovereigns the built-in inflationary guardrails of a foreign currency debt can ameliorate one source of credit risk leading to a higher rating and lower cost of debt.
Q: Do CRAs predict defaults well?
A: Studies show that poorly rated debt defaults more frequently than highly rated debt. Unfortunately, rating changes tend to lag valuation changes. A more forward-looking estimate of the probability of default is the spread implied by collateralized default swaps which investors purchase to protect from the probability of default. By this measure, the relative probability of default by the United States is relatively low and stable with an annual probability of only about 1.3 percent, even after its recent downgrade. In contrast the risk of default by France is more than twice as high at over 4 percent, despite its triple-A rating being recently affirmed. By comparison, the risk of default for Egypt and Italian debt is about 71/2 percent.
Q: What improvements could be made to the CRA process?
A: Since the financial crisis of 2008, CFA Institute is striving for greater accountability and more effective oversight of CRAs and greater due diligence of the underlying loans they are rating. These efforts include addressing conflicts of interest and lack of competition in the credit rating industry that allowed issuers and CRAs to collaborate on ratings for mortgage-backed securities.
Q: What should fund managers take away from this?
A: Monetary, fiscal, political, and currency considerations make rating sovereign debt more complex and nuanced that corporate debt. Fund managers can better interpret sovereign credit ratings by understanding the nuances and limitations of the CRA process.
CRAs evaluate security’s risk of default
Credit rating agencies (CRAs) have recently come under intense scrutiny. After watching many highly-rated commercial debt securities become worthless several years ago, markets are now questioning the quality of CRA decisions to either downgrade or affirm the ratings of sovereign debt. In the GCC region, ratings agencies currently have a limited role since GCC governments are not aggressive fund raisers in international markets. However, given their importance in pricing and
other functions, as well as measuring market confidence, the credibility of rating agencies is important for the development of GCC bond markets which have been clocking steady growth in recent years. The total value of bond issues raised increased from $20 billion in 2003 to $81billion in 2009 before tapering off to $63 billion in 2010. However, much of the local bond issues (both sukuks and conventional) largely go unrated. There have also been instances where corporate rating has come under severe criticism by the “rated” for poor and misplaced judgment, especially when there is a down grade. In this article, Stephen M. Horan, CFA, CIPM, Head, University Relations and Private Wealth at CFA Institute, and Raghu Mandagolathur, President of CFA Kuwait, discuss the role of CRA’s in the development of regional bond markets. — Editor
By Stephen M. Horan and Raghu Mandagolathur
Question: What is the scope of responsibilities of credit rating agencies?
Answer: A primary function of CRAs is to evaluate a security’s risk of default and the relative magnitude of loss should default occur, rather than its liquidity risk, price volatility or fundamental value. CRAs do not set out to predict future valuation changes from fluctuations in interest rates. CRAs also encapsulate whether a bond issue’s rating is likely to be upgraded or downgraded in the future in a “ratings outlook” - this is the plus or minus that is attached to the rating score.
Q: What is unique about rating sovereign debt?
A: In rating sovereign debt, CRAs look at both economic and political risks. Economic risks include, amongst other things, the existing debt burden, growth prospects and fiscal flexibility whilst political risks include, amongst other things, leadership stability, consensus on economic policy objectives and barriers to global trade. Ratings depend on whether sovereign debt is denominated in local currency or foreign currency. This is because governments can often generate enough local currency to nominally meet local currency obligations using open market operations (or quantitative easing). Printing currency in this way has obvious inflationary implications and one agency, Standard & Poor’s, does consider the risk of implied default through a devaluation of the currency.
Q: What are the implications for Middle East versus Eurozone credit risk?
A: GCC countries, although pegged to the dollar, have independent currencies and a measure of monetary discretion. Eurozone countries issue debt in a common currency over which they have little to no monetary control. As a result, their ability to implicitly default through a devaluation of the currency is limited. Any default would have to be comparatively explicit. Nominal default rates on debt denominated in foreign currencies are historically higher than those on debt denominated in local currencies. But for these sovereigns the built-in inflationary guardrails of a foreign currency debt can ameliorate one source of credit risk leading to a higher rating and lower cost of debt.
Q: Do CRAs predict defaults well?
A: Studies show that poorly rated debt defaults more frequently than highly rated debt. Unfortunately, rating changes tend to lag valuation changes. A more forward-looking estimate of the probability of default is the spread implied by collateralized default swaps which investors purchase to protect from the probability of default. By this measure, the relative probability of default by the United States is relatively low and stable with an annual probability of only about 1.3 percent, even after its recent downgrade. In contrast the risk of default by France is more than twice as high at over 4 percent, despite its triple-A rating being recently affirmed. By comparison, the risk of default for Egypt and Italian debt is about 71/2 percent.
Q: What improvements could be made to the CRA process?
A: Since the financial crisis of 2008, CFA Institute is striving for greater accountability and more effective oversight of CRAs and greater due diligence of the underlying loans they are rating. These efforts include addressing conflicts of interest and lack of competition in the credit rating industry that allowed issuers and CRAs to collaborate on ratings for mortgage-backed securities.
Q: What should fund managers take away from this?
A: Monetary, fiscal, political, and currency considerations make rating sovereign debt more complex and nuanced that corporate debt. Fund managers can better interpret sovereign credit ratings by understanding the nuances and limitations of the CRA process.
August 21, 2011
" Mutual funds have limited presence in Gulf"--Interview with MR
Article By Gaurav Ghose in Gulf News. you can find here
By comparison with other regions, mutual funds have only a limited presence in the Gulf, owing to a host of factors such as market liquidity and regulation. Clearly, institutional development is needed if this traditional way of diversifying exposure is to make much headway.
With Saudi Arabia, the Gulf's largest economy, and its stock market forming roughly 50 per cent of the combined market capitalisation of the GCC region, it is no surprise that the country leads in locally-domiciled mutual funds with 224 at the end of June, according to Lipper, a Thomson Reuters company. It is followed by 72 in Kuwait and 45 in Bahrain. The UAE lags behind with 17 locally-incorporated funds. Oman and Qatar have eight and five funds respectively. The assets under management (AUM) in locally-domiciled funds for Saudi Arabia-based firms stand at about $21.2 billion (Dh77.8 billion), comprising 76.6 per cent for the region's total AUM, as against $4.6 billion for Kuwait and $1 billion for Bahrain.
However, in a report on mutual funds issued by National Bank of Abu Dhabi last November, in terms of AUM, money market funds have nonetheless become a force to reckon with, thanks to the impact of the large funds based in Saudi Arabia.
The average size of a GCC equity fund was about $50 million, while the average size of a money market fund was more than $250 million. These funds primarily depend on institutions (pension funds, banks and insurance companies) rather than the general public for their capital. That may say something about attachment to cash and currencies rather than stocks.
The mutual funds industry has been growing rapidly in the last decade, only to slow down in more recent years because of the local stock market meltdown, followed by the global financial crisis.
But the trend is still positive, according to fund managers and researchers. For instance, in Saudi Arabia, between 2006 and 2010 AUM grew by about 12 per cent in aggregate to reach around $25 billion at the end of last year. This has come despite the stock market having declined by around 16 per cent during the same period, highlighting the net flows that the industry has been able to garner during this time.
But as Osama Shaker, Managing Director and head of financial markets, HSBC Saudi Arabia, points out, the money invested through mutual funds is approximately only 8 per cent of the level of banking sector deposits in Saudi Arabia. In developed markets, this ratio can even reach as high as 100 per cent. Clearly, the secular growth story of the fund industry in principle has some way to run yet.
According to a recent Boston Consulting Group global study, three of the six densest millionaire populations (proportion of millionaire households by market) are in Kuwait, Qatar and the UAE. So the market itself has a high-net-worth bias. It's normal that most funds products are designed to cater to that segment, says M.R. Raghu, Senior Vice-President — Research, Kuwait Financial Centre (Markaz).
There are a number of challenges that need to be addressed before the industry matures further. Among the issues cited include the problem surrounding low liquidity, the fragmented nature of the industry and low fees, poor distribution channels, unsatisfactory corporate governance, lack of market breath and depth, and foreign ownership restrictions.
Liquidity is a prime concern when managing risk, says Shakeel Sarwar, head of asset management at Securities and Investment Company (SICO) Bahrain.
Funds generally have minimum liquidity criteria when investing in a stock, so the market impact is minimal when entering or exiting that stock. When a fund is growing, this liquidity threshold goes up. "However, over the past two years, the liquidity of GCC stocks has been on the decline. [That] poses a significant barrier to regional mutual industry growth," he says.
Raghu agrees. "Lack of liquidity and shallow markets hinder the fund manager's choice of investments." There's an important addendum. "Stock market regulation in GCC is still evolving," he notes, "with investors often being cynical about their effectiveness and independence."
Yet the biggest challenge, according to Shaker of HSBC, is distribution, and attracting assets during these turbulent times. The underdeveloped nature of distribution channels acts as a barrier for the regional funds to reach a wider capital resource base.
As to the regulatory environment, Shaker asserts in fact that "the CMA [Capital Markets Authority, the market regulator] has been supportive, and local regulations and oversight should be a source of comfort to investors". "The CMA has been gradually encouraging new types of funds," Shaker notes, and, apart from traditional equity funds, "we have seen real estate funds, ETFs, and recently received approval for a commodity fund that we expect to launch after the Eid".
But corporate governance and legal issues remain a sore point. Additional improvement in this area, particularly in company disclosures, would cause more global investors to look at investing in this area, says David Varghese, Fund Manager, Emirates NBD Asset Management.
For example, institutional investors and individuals alike are sometimes at the mercy of a major shareholder when they make key strategic decisions, with regards to its operations or capital structure, says Sarwar of SICO in Bahrain. "Capital market regulations in the GCC have to improve a lot more to protect the rights of minority shareholders. In addition, the legal framework applicable to financial markets have significant room for development."
With regard to Kuwait, their CMA is in the process of drafting new laws. New regulations like a cap on fund management fees, sales commission, etc. will change the way industry works. The asset management industry should be prepared for changes that the CMA might enforce, says Raghu.
That the regional markets lack breadth in terms of asset classes is a familiar refrain. The fixed-income market has still a long way to go, both in terms of market size and liquidity, says Sarwar. Trading in derivatives is non-existent. If present, these instruments would have complemented conventional equities and debt markets, he adds.
In all, the GCC fund management industry is small compared to that of developed markets, besides being fragmented so that no single fund has AUM of more than $1 billion.
Despite that, regional fund managers are being pressured to lower their fees in line with the mutual funds in developed markets. Doing so might push the monetary value of fees to unsustainable levels, says Sarwar. "Their problems have been compounded by the fact that regional equity market returns have been very low compared to the rest of the world, and there have been no performance fees earned."
And there's more — not least among concerns are a lack of professionally qualified human resources, as well as low institutional participation and information asymmetry.
It seems it may be some time before mutual funds, serving the cause of diversified stock market investment, and the industry's practitioners themselves, make serious headway in this region.
Mixed performance
There was a feeling of relief at the end of the first half of the year when it comes to the performance of the GCC domestic mutual fund industry. The hope was that the second half would be better, with the political situation stabilising — though recent turbulence has perhaps dampened expectations.
The funds originating and domiciled in the region and managed by domestic fund managers lost a mere 0.67 per cent, according to data provided by Lipper Reuters — see charts on the opposite page.
This was despite all GCC regional markets closing negatively at the end of June amid unprecedented political unrest in Mena, doubts about global recovery, inflationary pressures from emerging countries and nervousness associated with sovereign debt in Europe and the United States — which was in fact about to impact imminently.
The relatively small decline was mainly due to strong performance outside the GCC frontier, and mainly in Europe, where investors took advantage of the appreciation of the euro against the dollar, said Paris-based Dunny Moonesawmy, head of Fund Research, Western Europe, Middle East and Africa, Thomson Reuters.
"It is clear that even faced with a deep crisis in the Eurozone, the euro showed strong resistance. GCC investors gained from the 7 per cent decline of the US dollar against the euro over the first half, reflected mainly in bond funds as the European equity markets were mainly in negative territory," he noted.
"When currency appreciation is disregarded, stock investments have been in the red in most regions and sectors."
When it comes to equity funds, Lipper data show that the Equity GCC category resisted better than the Mena category, the former decreasing 2.65 per cent against the latter's decline of 3.52 per cent.
"The consequence of political unrest on economic activity is important, but at the same time GCC countries are fundamentally strong with either good revenue streams, such as Saudi Arabia and Qatar, or a diversified economy, as is the case with Bahrain," said Moonesawmy.
Similar performance reviews over three and five years show that investors took advantage of their emerging markets investments over the long run. The Equity Asia Pacific ex-Japan category posted 16.4 per cent performance over three years. Conversely, the Equity GCC category lost 37.3 per cent.
Considering all equity funds registered for sale in the GCC, both domestic and foreign funds, they were almost flat during first half of 2011, gaining 0.3 per cent.
Bonds funds managed by local fund managers performed well during the first half in most bond categories.
By comparison with other regions, mutual funds have only a limited presence in the Gulf, owing to a host of factors such as market liquidity and regulation. Clearly, institutional development is needed if this traditional way of diversifying exposure is to make much headway.
With Saudi Arabia, the Gulf's largest economy, and its stock market forming roughly 50 per cent of the combined market capitalisation of the GCC region, it is no surprise that the country leads in locally-domiciled mutual funds with 224 at the end of June, according to Lipper, a Thomson Reuters company. It is followed by 72 in Kuwait and 45 in Bahrain. The UAE lags behind with 17 locally-incorporated funds. Oman and Qatar have eight and five funds respectively. The assets under management (AUM) in locally-domiciled funds for Saudi Arabia-based firms stand at about $21.2 billion (Dh77.8 billion), comprising 76.6 per cent for the region's total AUM, as against $4.6 billion for Kuwait and $1 billion for Bahrain.
However, in a report on mutual funds issued by National Bank of Abu Dhabi last November, in terms of AUM, money market funds have nonetheless become a force to reckon with, thanks to the impact of the large funds based in Saudi Arabia.
The average size of a GCC equity fund was about $50 million, while the average size of a money market fund was more than $250 million. These funds primarily depend on institutions (pension funds, banks and insurance companies) rather than the general public for their capital. That may say something about attachment to cash and currencies rather than stocks.
The mutual funds industry has been growing rapidly in the last decade, only to slow down in more recent years because of the local stock market meltdown, followed by the global financial crisis.
But the trend is still positive, according to fund managers and researchers. For instance, in Saudi Arabia, between 2006 and 2010 AUM grew by about 12 per cent in aggregate to reach around $25 billion at the end of last year. This has come despite the stock market having declined by around 16 per cent during the same period, highlighting the net flows that the industry has been able to garner during this time.
But as Osama Shaker, Managing Director and head of financial markets, HSBC Saudi Arabia, points out, the money invested through mutual funds is approximately only 8 per cent of the level of banking sector deposits in Saudi Arabia. In developed markets, this ratio can even reach as high as 100 per cent. Clearly, the secular growth story of the fund industry in principle has some way to run yet.
According to a recent Boston Consulting Group global study, three of the six densest millionaire populations (proportion of millionaire households by market) are in Kuwait, Qatar and the UAE. So the market itself has a high-net-worth bias. It's normal that most funds products are designed to cater to that segment, says M.R. Raghu, Senior Vice-President — Research, Kuwait Financial Centre (Markaz).
There are a number of challenges that need to be addressed before the industry matures further. Among the issues cited include the problem surrounding low liquidity, the fragmented nature of the industry and low fees, poor distribution channels, unsatisfactory corporate governance, lack of market breath and depth, and foreign ownership restrictions.
Liquidity is a prime concern when managing risk, says Shakeel Sarwar, head of asset management at Securities and Investment Company (SICO) Bahrain.
Funds generally have minimum liquidity criteria when investing in a stock, so the market impact is minimal when entering or exiting that stock. When a fund is growing, this liquidity threshold goes up. "However, over the past two years, the liquidity of GCC stocks has been on the decline. [That] poses a significant barrier to regional mutual industry growth," he says.
Raghu agrees. "Lack of liquidity and shallow markets hinder the fund manager's choice of investments." There's an important addendum. "Stock market regulation in GCC is still evolving," he notes, "with investors often being cynical about their effectiveness and independence."
Yet the biggest challenge, according to Shaker of HSBC, is distribution, and attracting assets during these turbulent times. The underdeveloped nature of distribution channels acts as a barrier for the regional funds to reach a wider capital resource base.
As to the regulatory environment, Shaker asserts in fact that "the CMA [Capital Markets Authority, the market regulator] has been supportive, and local regulations and oversight should be a source of comfort to investors". "The CMA has been gradually encouraging new types of funds," Shaker notes, and, apart from traditional equity funds, "we have seen real estate funds, ETFs, and recently received approval for a commodity fund that we expect to launch after the Eid".
But corporate governance and legal issues remain a sore point. Additional improvement in this area, particularly in company disclosures, would cause more global investors to look at investing in this area, says David Varghese, Fund Manager, Emirates NBD Asset Management.
For example, institutional investors and individuals alike are sometimes at the mercy of a major shareholder when they make key strategic decisions, with regards to its operations or capital structure, says Sarwar of SICO in Bahrain. "Capital market regulations in the GCC have to improve a lot more to protect the rights of minority shareholders. In addition, the legal framework applicable to financial markets have significant room for development."
With regard to Kuwait, their CMA is in the process of drafting new laws. New regulations like a cap on fund management fees, sales commission, etc. will change the way industry works. The asset management industry should be prepared for changes that the CMA might enforce, says Raghu.
That the regional markets lack breadth in terms of asset classes is a familiar refrain. The fixed-income market has still a long way to go, both in terms of market size and liquidity, says Sarwar. Trading in derivatives is non-existent. If present, these instruments would have complemented conventional equities and debt markets, he adds.
In all, the GCC fund management industry is small compared to that of developed markets, besides being fragmented so that no single fund has AUM of more than $1 billion.
Despite that, regional fund managers are being pressured to lower their fees in line with the mutual funds in developed markets. Doing so might push the monetary value of fees to unsustainable levels, says Sarwar. "Their problems have been compounded by the fact that regional equity market returns have been very low compared to the rest of the world, and there have been no performance fees earned."
And there's more — not least among concerns are a lack of professionally qualified human resources, as well as low institutional participation and information asymmetry.
It seems it may be some time before mutual funds, serving the cause of diversified stock market investment, and the industry's practitioners themselves, make serious headway in this region.
Mixed performance
There was a feeling of relief at the end of the first half of the year when it comes to the performance of the GCC domestic mutual fund industry. The hope was that the second half would be better, with the political situation stabilising — though recent turbulence has perhaps dampened expectations.
The funds originating and domiciled in the region and managed by domestic fund managers lost a mere 0.67 per cent, according to data provided by Lipper Reuters — see charts on the opposite page.
This was despite all GCC regional markets closing negatively at the end of June amid unprecedented political unrest in Mena, doubts about global recovery, inflationary pressures from emerging countries and nervousness associated with sovereign debt in Europe and the United States — which was in fact about to impact imminently.
The relatively small decline was mainly due to strong performance outside the GCC frontier, and mainly in Europe, where investors took advantage of the appreciation of the euro against the dollar, said Paris-based Dunny Moonesawmy, head of Fund Research, Western Europe, Middle East and Africa, Thomson Reuters.
"It is clear that even faced with a deep crisis in the Eurozone, the euro showed strong resistance. GCC investors gained from the 7 per cent decline of the US dollar against the euro over the first half, reflected mainly in bond funds as the European equity markets were mainly in negative territory," he noted.
"When currency appreciation is disregarded, stock investments have been in the red in most regions and sectors."
When it comes to equity funds, Lipper data show that the Equity GCC category resisted better than the Mena category, the former decreasing 2.65 per cent against the latter's decline of 3.52 per cent.
"The consequence of political unrest on economic activity is important, but at the same time GCC countries are fundamentally strong with either good revenue streams, such as Saudi Arabia and Qatar, or a diversified economy, as is the case with Bahrain," said Moonesawmy.
Similar performance reviews over three and five years show that investors took advantage of their emerging markets investments over the long run. The Equity Asia Pacific ex-Japan category posted 16.4 per cent performance over three years. Conversely, the Equity GCC category lost 37.3 per cent.
Considering all equity funds registered for sale in the GCC, both domestic and foreign funds, they were almost flat during first half of 2011, gaining 0.3 per cent.
Bonds funds managed by local fund managers performed well during the first half in most bond categories.
August 01, 2011
Fair Value Accounting and Improving the Transparency of Financial Instruments
The International Accounting Standards Board (IASB) and Financial
Accounting Standards Board (FASB) share a vision of a single set of
high-quality global accounting standards and are working on a joint project on
financial statement presentation and a movement towards fair-value accounting. Following an earlier article in the
Financial Times (FTfm supplement), Mr. Raghu Mandagolathur, president of CFA Kuwait, and Mr. Stephen M.
Horan, head of private wealth and investor education at CFA Institute, discuss
the role of fair value accounting in the current market environment.
While valuation is a global
theme, it is has secured a great deal of recent interest in the GCC region
given the stress companies in the region have faced over the last two years.
The region’s stock markets still suffer from high volatility and speculation
primarily due to stakeholder’s inability to assess the impact of changing asset
values. Fair value accounting would enable regional companies to reduce overall
borrowing cost as lenders/investors will be in a better position to assess the
risks better. However, it won’t solve
everything especially challenges related to valuing illiquid assets. GCC
companies and lenders would still have to deal with the issue of “hard to
value” assets. Central banks in the
region have been proactive in some cases in enforcing fair value requirements.
However, regulatory coordination among various GCC central banks on this
extremely important aspect will be highly welcome.
Q: What are the benefits of fair value accounting?
Fair value accounting is intended
to reflect in reported financial statements the essential economic,
market-based information related to a firm’s activities. It can provide early warnings of changes in a
firm’s financial position by continuously reflecting the changing value of its
assets and liabilities, and thereby provide a more accurate picture of firm
risk than historical cost accounting, which can obscure and defer recognition
of economic realities.
A historical cost regime can
provide managers an option to realize gains when asset values increase but to
conceal losses when asset values drop. This
flexibility can encourage managers to undertake speculative projects knowing
that historical cost puts a floor on their reported losses. Although recording impaired assets at the
lesser of their original cost or their current market value as dictated by
traditional rules mitigates this incentive, adherence to this rule depends on
management judgment.
Moreover, managers may have an
incentive to pursue excess leverage or hidden risks because historical cost
accounting artificially smoothes results.
Ironically, the incentive to take on more risk than is justified by the
economics can result in turmoil like we are currently experiencing in credit
markets.
Q: Why do stakeholders prefer one over the other?
Corporate managers tend to prefer
historical cost accounting, believing that the fundamental role of accounting
is to provide a verifiable record of historical transactions. It tends to stabilize reported earnings over
time, which may also smooth out a manager’s incentive-based compensation.
Corporate managers believe that historical cost reduces market volatility and
that fair value information is costly to obtain.
Investors, on the other hand,
tend to value accounting information that reflects underlying economic conditions. According to a recent survey of CFA Institute members, 79% of respondents believe that fair value accounting improves transparency
of financial institutions while 74%
believe that it improves market integrity.
No. Security valuation hinges on the quality of
information managers convey. Fair value information
on assets and liabilities simply provides investors a better starting point and
complements rather than replaces the external valuation process.
Some argue that fair value
write-downs triggered margin calls and capital requirement violations that
forced liquidations that suppressed prices further and caused further
write-downs. However, fair value
accounting probably brought the extent of write-downs from sub-prime financial
market instruments to light sooner, which may have prompted more timely
intervention from central banks and in turn prevented further deterioration of
market liquidity.
Lower-of-cost-or-market practices would have required write-downs in any
case.
Ideally, direct market quotes of
actively traded assets can be used to mark-to-market. The credit crisis highlights that market
prices of some financial instruments may not be readily observable, especially
in illiquid or unbalanced markets. For these assets, fair value might be
estimated using prices of similar securities in active markets.
Q: What problems arise if some assets and liabilities are not reported
at fair value?
A mixed attribute accounting
model, which blends fair value and historical cost treatments, can create
mismatches with unintended consequences.
For example, if a firm uses fair value accounting for a derivative
security intended to hedge the interest rate risk of a loan recorded at
historical cost, the accounting mismatch can create artificial volatility in
the reported value of the combined position.
Markets, however, have an uncanny
ability to discern economic reality when given the proper data. For example, markets place higher price
multiples on earnings it judges to be more persistent. Studies also show that market prices tend to
respond negatively to changes in accounting principles intended to artificially
inflate earnings.
Q: Can fair value accounting be improved?
Financial
statement presentation proposals under consideration by the IASB and FASB can
help isolate the impact of fair value reporting on reported financial
performance. These proposals suggest
separating gains and losses from financial instruments from operating
activities. This will improve understandability in
either full fair value or mixed attribute measurement regimes.
Most importantly, fund managers
should become familiar with using the additional information available through
fair value reporting and distinguish mixed attribute volatility from true
economic volatility. Second, those who
appreciate the added value and transparency of fair value accounting might
demand fuller disclosure, such as specifics about valuation methodology, its
inputs, and its sensitivity to those inputs.
Finally, fund managers might consider supporting the IASB and FASB
efforts to promote fair value accounting and to improve financial statement
presentation.
GCC Outlook 2H11
Semi-annual Review…click here to download the full report
Of 2010, we said that it “simply lacked any triggers”... well, in that case 2011 seems set to be nothing but triggers (mostly negative). From natural disasters to ongoing financial ones (e.g. Greece, US debt, GCC corporate and sovereign debt) in addition to political turmoil; the first half of 2011 has not lacked in terms of headlines, highs or lows.
In our previous note we upgraded our outlook to a mostly Positive view on the region. This was due to many factors including; healthy economic growth, expected recovery in key sectors like Banking and Real Estate in addition to healthy valuations. We had adopted a Neutral stance on Dubai (due to persisting debt overhang and a struggling Real Estate sector), Bahrain (due to lesser corporate recovery), and Saudi Arabia (due to muted banking performance and investor sentiment).
We were wrong on all counts. The political turmoil which swept the region at the beginning of the year brought down all markets and proved a drag on earnings. Additionally, various corporate issues (in terms of M&A, debt restructuring etc) in addition to some regulatory and market developments (Kuwait CMA, MSCI not upgrading of UAE and Qatari markets etc) has dampened investor sentiment across the board.
Previous Recommendations & Market performance
For the rest of 2011, we have adopted a rather Neutral view of the markets due mainly to muted earnings growth and lackluster market liquidity and activity. We remain Positive on Abu Dhabi and Qatar due to positive economic growth and earnings potential.
Of 2010, we said that it “simply lacked any triggers”... well, in that case 2011 seems set to be nothing but triggers (mostly negative). From natural disasters to ongoing financial ones (e.g. Greece, US debt, GCC corporate and sovereign debt) in addition to political turmoil; the first half of 2011 has not lacked in terms of headlines, highs or lows.
In our previous note we upgraded our outlook to a mostly Positive view on the region. This was due to many factors including; healthy economic growth, expected recovery in key sectors like Banking and Real Estate in addition to healthy valuations. We had adopted a Neutral stance on Dubai (due to persisting debt overhang and a struggling Real Estate sector), Bahrain (due to lesser corporate recovery), and Saudi Arabia (due to muted banking performance and investor sentiment).
We were wrong on all counts. The political turmoil which swept the region at the beginning of the year brought down all markets and proved a drag on earnings. Additionally, various corporate issues (in terms of M&A, debt restructuring etc) in addition to some regulatory and market developments (Kuwait CMA, MSCI not upgrading of UAE and Qatari markets etc) has dampened investor sentiment across the board.
Previous Recommendations & Market performance
For the rest of 2011, we have adopted a rather Neutral view of the markets due mainly to muted earnings growth and lackluster market liquidity and activity. We remain Positive on Abu Dhabi and Qatar due to positive economic growth and earnings potential.
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