LONDON, 23 February 2004 — Two bright and enthusiastic young students from Gulf countries studying at British universities came to me recently for some advice and research materials pertaining to equities. They had chosen to do their dissertations on almost the same subject, even though they were at different universities in different cities, and one was at least a year ahead of the other.

They were interested in researching the performance of global equity funds, Islamic equity funds to be precise, against their conventional counterparts; and to ascertain whether such equity investment contributed to the economic development of the countries of the investors — predominantly from Saudi Arabia, Kuwait, the UAE, and Qatar.

This concern is hardly new, but to be fair to the two students, none of the Gulf banks nor the equity fund sponsors have conducted cost-benefit research to this effect. In fact, some banks such as Kuwait Finance House, have as a matter of policy refrained from investing in equities over the last two decades, although the bank’s Shariah board also frowned upon equity investments as an asset class from a Shariah compliance point of view. Kuwait Finance House, a few weeks ago, however, established its first private equity fund together with Global Investment House.

Most of Gulf equity investment is in global equities, which are heavily weighted in favor of US stocks (in most instances in excess of 70 percent); followed by European and Japanese stocks. Some analysts argue that it is legitimate to ask why Gulf investors invest in such funds and what benefits their countries get from this investment, other than the return and yields directly paid to the investors. After all in the Gulf states for their citizens, there is no income tax, capital gains tax, inheritance tax.

In Asia, the financial crisis in 1998, saw billions of dollars wiped off stock values in a matter of days, with fair-weather Western fund managers abandoning the ship cutting their losses and seeking hot money elsewhere. The emergence of “bizdemocracy” — just look at the cosy relationship the Bush administration in the US and the Blair government in the UK have with business. In Italy, Silvio Berlusconi is not only the prime minister, but also one of the richest businessmen and the most powerful media owner in the country.

Rightly or wrongly, the private-public financing initiative is a key manifestation of “bizdemocracy” in which the terms of contract are perceived to favor the private contractors at the expense of the taxpayers. The social costs of equity investments too can be devastating especially for the small “unsophisticated” investor, who can often lose a life times savings. This can be done through the use of unscrupulous brokers, pension providers, and financial services companies through misselling; through skewed promotional literature which fails to adequately highlight the risks and rewards associated with equity investment; and through the high hidden costs including the fee and commission structures whcih the unsuspecting investors are usually not aware of.

But why then the predominance of global equity funds as compared with country and region-specific sector funds? Both fund managers; Gulf investors; and index providers will point out that local funds in the emerging countries are very difficult to establish because of the serious lack of blue chip stocks to invest in. Apart from the lack of such stocks, there is also an under-developed culture of corporate reporting; poor transparency and disclosure. The lack of capital markets laws and developed stock markets have further served to exacerbate this situation. Even in the Islamic sector, according to one index provider, it is difficult to have a GCC stock index because many of the companies are highly geared in terms of debt and interest income, and would thus not qualify to be included in the Shariah-compliant stock universe because they would not meet the requirements or restrictions of the financial ratio screens.

Above all, analysts point to the poor culture of research and development in Middle East banking, especially in equity research and analysis. It seems that investors and the general public need to be educated much more about where the true power lies in the financial services racket.