From the April 2011 issue of Investment Advisor • Subscribe!

April 1, 2011

Dollars and Dissent: What Regime Changes in MENA Countries Mean for Investors

Regime changes in the Middle East and North Africa have implications for investors beyond those countries’ borders

Few would disagree that the uprisings that ousted the leaders of Tunisia and Egypt, and the effect they have had in spurring dissent in the rest of the Middle East/North Africa (MENA) region, have underscored the pressing desire of the people there for democracy, transparency and the right to a more equitable life. But everything that has transpired, and more importantly, the speed at which it has transpired, has also shown that the road to democracy is rough, rocky and unpredictable, and as these countries chart their course to get there, the global economy and the financial markets will be fraught with uncertainty.

As this issue of Investment Advisor goes to press, the Egyptian stock market—the oldest, largest and most diversified in the Middle East/North Africa (MENA) region—remains shut and some fear the country may even be disbarred from the MSCI Emerging Markets Index. While Egypt’s prime minister-designate has named a caretaker cabinet to guide the country in its path toward free elections, violence in Libya is escalating to the point of civil war; oil market uncertainties continue to dominate the headlines; and the recent protests in the Persian Gulf state of Bahrain include a sectarian aspect that threatens to involve other countries in the region, not least Saudi Arabia, where there is a cyber-movement toward inciting protests on March 11.

The ongoing geopolitical problems have repercussions both in the short term and in the long term. Oil, of course, is central to the story, particularly with Libya in chaos and Saudi Arabia on the brink. A disruption in oil production from Libya alone would not be detrimental, says Joseph Tanious, a market strategist for JP Morgan Asset Management, since the country is only ranked 18th in a list of world oil producers, but if the troubles were to spread to Saudi Arabia, the situation could take a turn for the worse.

MENA produces 35% of the world’s oil and Saudi Arabia is the region’s biggest oil producer,” Tanious says. “Even as each MENA country is unique and complex, they have a lot of similarities, like high inflation and high unemployment among a young population, so the risk of contagion is strong.”

That risk and the way in which it plays itself out is coming to bear on the region’s political stability and fiscal flexibility.

“What’s important now is seeing how MENA sovereigns cope with changes once they have been set, and whether new governments have the wherewithal to carry on with reforms,” says Mike Noone, associate director covering the MENA region at Standard and Poor’s in London. “There is going to be pressure from the public on the governments because expectations are high and public demands for improvements in the standard of living, as well as increased demand for food subsidies will place fiscal pressure on these governments. There is going to be a new administration in Egypt later this year, so we’ll have to see how they deal with all this. Even though there may be experienced people from before, coping with all the changes will be a big challenge.”

How governments respond to the demands of protesters is also extremely important, Noone says. While the countries of the Gulf Cooperation Council (GCC) have low debt burdens and oil revenues, and can deliver on subsidies and social spending, things are not so clear-cut for oil importers, he says. Egypt, for instance, has a fiscal deficit officially forecast at between 8.2% of GDP and 8.4% of GDP for this fiscal year ending June 30, “so it could be very difficult for them to find the cash to meet demands unless they cut capital spending,” he says.

At a turbulent time, foreign investors are looking to the governments of the MENA countries to take the right course of action. Undoubtedly, the instability in the region has impacted foreign investment in the short term, but the need for fundamental changes that lead to greater stability in the long term is what the investors interviewed for this article are more focused on and are hopeful for.

The speed at which the MENA “revolution” has gained momentum was unprecedented and completely unexpected. But the paradigm shift it could result in would be invaluable for foreign investment going forward, and those governments that are able to effect those changes are the ones that will inspire investor confidence in the future.

Monem Salam, director and vice president of Islamic Investing and manager of the Amana Funds, Saturna Capital

There is an old Middle Eastern adage, says Monem Salam, director and vice president of Islamic Investing and manager of the Amana Funds for Bellingham, Wash.-based Saturna Capital, which states that every new leader ends up being worse than the first one. It has been proven right at different points in history in different parts of the world, but Salam is hopeful that this time, the countries of the MENA region will prove it wrong.

Monem Salam, director and vice president of Islamic Investing and manager of the Amana Funds, Saturna Capital“In Ireland, there was a ballot, in Egypt, they took to the streets, but this is all about the feelings that have come to the fore in the aftermath of the 2008 financial crisis,” Salam, (left), says. “What’s important is that the average age of the person who protested in Egypt and across the rest of the region is the same as the generation of baby boomers was in America when they were out on the streets. Their protests led to great things for America, and in the same way, we think that this can happen for the MENA region, too. We are very optimistic that the younger generation can lead the way to a much-needed change.”

Change, Salam says, is inevitable, even in the GCC countries. Those governments may have money to spend, but appeasing their populations through food subsidies and other measures is only a quick fix to a longer-term problem that has to be resolved, he says.

Salam would expect to see a lot of volatility in the short term, but he hopes that macro level changes in the MENA region, when they happen, will give him a greater opportunity to invest in it. The Amana funds have only invested peripherally in MENA (“We preferred to buy companies in Turkey that have distribution in MENA, for instance, because Turkey is more liquid and less volatile,” he says.) and its emerging markets exposure is currently in Southeast Asia and Latin America. But looking ahead, “I do think there will be value [in MENA] and opportunities in the long term, once calmer heads prevail,” Salam says.

Larry Seruma, chief investment officer and managing principal, Nile Capital Management

Through the Nile Pan Africa Fund, Larry Seruma, chief investment officer and managing principal, Nile Capital Management, invests in all African stock markets from Cairo to Capetown, looking for growth businesses that are trading at value prices.

He believes he’ll be able to find what he wants in Egypt, a market that he is committed to as a long-term investor and one in which he thinks individual companies offer potential against a broader, more positive macro backdrop.

Larry Seruma, chief investment officer and managing principal, Nile Capital Management“When the Egyptian market opens, we expect to see selling pressure that will create more value opportunities for long-term investors,” Seruma, (left), says. “Before the crisis, Egypt’s market traded in line with other emerging markets, which are now trading at 11 times P/E. When Egypt’s market opens, it may trade between 7 times P/E.”

Seruma gives the example of Commercial International Bank (CIB), a stock that traded at 2.85 P/B before the uprising began in Egypt. Investors may have an opportunity to buy it at 1.5 times P/B or below when the market opens, he says. He also likes Orascom Construction, which gets half of its revenues from construction and the other half from fertilizers, an industry that is now experiencing high prices, a dynamic that is benefiting Orascom. “Over the last two years, Orascom has traded at an average multiple of 15 times P/E, but it may trade much lower when the market opens,” Seruma says.

While he has no choice but to wait for the Egyptian stock market to open, Seruma, like any other investor, is waiting for the dust of the uprisings to settle, and to get a clear picture of what the new government will look like. But he is confident that things are going to turn out well in Egypt.

“The revolution in Egypt happened at a time when the economy was strong and Egypt has retained the quality and the strength of both people who could be potential leaders in the transition period and institutions that had been built up,” Seruma says. “I do think that what has happened in Egypt will prove itself to be beneficial going forward and we will see stronger and stronger institutions there that are good for the long-term investor who can set valuations in that context.”

Sven Richter, managing director and head of frontier markets, Renaissance Asset Managers

The problems in the MENA region have naturally led to a knee-jerk withdrawal of investment funds from those countries and from emerging and frontier markets in general, but Sven Richter, managing director and head of frontier markets for London-based investment management firm Renaissance Asset Managers, believes that those investors who are able to take a step back and distinguish between different markets can, at times like these, actually find great investment opportunities at good prices.

Sven Richter, managing director and head of frontier markets, Renaissance Asset ManagersRichter, (left), is particularly bullish about Africa. Countries like Nigeria and Ghana—both oil producers—stand to gain from the higher oil and gas prices, for instance. And a predominantly agricultural country like Kenya will, in the longer term, benefit from the higher food prices that are also a consequence of the MENA problems, Richter says. In fact, the African continent represents more than half of the world’s unused farm land, and there has already been a great amount of investment into this by countries like China and South Korea. Africa also has great infrastructure needs and investments into this sector will create more growth opportunities going forward.

“There is a tremendous opportunity in Africa and it is important for investors to distinguish between different markets and be aware of the relative risks and rewards in each one,” he says.

While African countries as a whole will suffer from short-term market sell-offs, the long-term potential these markets offer will become apparent in due course, Richter says. Even in Egypt, there could be opportunities to be had once the stock market opens up again. Egypt was underweight in Renaissance’s $5.7 million Pan-African Fund, he says, because the firm felt Egyptian stocks in the period prior to the troubles were too expensive.

“We still have those assets but we were lucky to be underweight,” he says. “The decision on what we do with them will depend on where things trade when the market opens up, and if things are very cheap, we could even add to our exposure.”

But for Richter, every investment in Egypt—and in the MENA region in general—will depend on what happens at the macro level and how individual governments cope with issues that are evidently not going to go away. Governments have a real chance to address genuine concerns from populations that want better opportunities and a greater chance to be a part of their nations’ growths, he says, and there is no other option for them but to find ways to answer those demands. These needs have been clearly expressed in Tunisia, Egypt and now in the Middle Eastern countries, but they will also start to sound in the countries of sub-Saharan Africa.

“We will have to monitor every country carefully and see how each government is handling things, but it’s clear that people everywhere are asking to participate more in their country’s growth,” he says. “We will see greater democracy, even in places like Saudi Arabia and Kuwait, and a move to bring about a deeper, more fundamental change that will ultimately only help to make these countries stronger and more attractive as investment destinations.”

Kevin Daly, portfolio manager, Aberdeen Asset Management

The MENA region is a relatively small component of the emerging market fixed income universe, but investors like Kevin Daly, a portfolio manager who helps oversee about $6 billion in emerging market bonds at Aberdeen Asset Management in London, were still quick to exit their holdings in assets like Egyptian T-bills when troubles began in the country.

Kevin Daly, portfolio manager, Aberdeen Asset Management“We were getting attractive yields of around 10% and the currency was relatively stable, but when the problems started, yields on those instruments increased, the currency weakened and it is potentially susceptible to further weakness so we pretty much closed out all our exposure in early February when things were heating up,” Daly, (left), says.

Most of the MENA markets don’t offer the kind of investment opportunities that Aberdeen is looking for, Daly says (the firm’s Africa exposure is concentrated in South Africa and it has some holdings in Sub-Saharan Africa, as well), but it is invested in the external debt of Jordan and Bahrain.

“For now, it does not look as though those governments will topple, but of course there is still some risk of a regime change,” Daly says.

In the near term, then, Daly is staying away from MENA and whether Aberdeen chooses to invest there in the future will depend on the kinds of opportunities available but also, with respect to Egypt in particular, what successive governments will look like.

The MENA crisis has in general been negative for the debt of most frontier markets, which are either in the region or will likely suffer from the spillover effect of higher oil prices, says Daly.

“Having said that, we are unlikely to see further downside pressure on frontier market credits unless the situation spills into Saudi Arabia, which we see as a very low probability,” he says.    

Savita Iyer-Ahrestani is a freelance writer and regular contributor to Investment Advisor and AdvisorOne.com based in New Jersey.

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