JEDDAH, 23 February 2004 — Mutual funds are indirect investments into the financial markets, with subscribers pooling their savings together, while fund managers take care of the asset allocations into different short-term (money market, other funds), medium-term (bond funds) and long-term (equity funds). Also, fund managers aim to diversify these investment funds across different sectors, thus seeking to maximize returns on investment and at the same time try to spread or reduce its associated risk. On the other hand, the traditional option would be to directly invest in the financial markets, as in money markets, capital markets and derivative instruments. However, the direct method of investment, in say Dell stock would require monitoring the price of Dell stock and prices of its competitors. In addition, tracking the price to earnings (P/E) ratio of Dell, this indicates whether it’s over/under valued. Moreover, investing in individual US stocks, one ought to be updated with the latest US economic indicators that can have an impact on the US equity markets. Given a bullish market, a single US stock will show higher volatility as opposed to returns on a US equity fund. Conversely, with a bearish market, losses of individual stocks will exceed those of a mutual fund. Therefore, mutual funds are more attractive to the average investor, due to the fund’s natural diversification of risk, and the professional management by fund managers who aim to maximize returns on the funds. However, investors in the Saudi mutual funds market, generally tend to have a relatively short-term horizon, particularly small-size investors. In comparison, American and European investors would be in mutual funds market for the long-term, seeking to finance their sons and daughters’ college tuitions and retirement plans.

Asset Funds by Type

The Saudi Arabian Monetary Agency (SAMA) divides assets of mutual funds into four broad categories; others funds (including non-interest, trade finance), money market funds, share funds, and bond funds, with each category investing in local and international markets. Total assets of the Saudi mutual funds market surged by 6.8 percent to SR53.4 billion by September 2003 over a year ago, with around 80 percent invested in other funds and money markets funds. Assets growth in mutual funds was largely due to a 51 percent increase in local stock funds and 42 percent rise in international stocks, whereas international assets in money market funds and others funds (including non-interest) fell by 2 percent and 16 percent, respectively, over the 12-month period ended September 2003. This substitution out of low risk other funds and money market funds into local and international share funds was due to the magnificent performance of the Saudi index (TASI), which shot up by 76 percent and the recovery in the international equity markets, particularly the US NASDAQ Composite index that jumped by 50 percent in 2003. However, the bulk of investors in the Saudi funds market remain risk averse, preferring to invest in low-risk and low-return funds. Moreover, local banks total demand deposits (non-interest bearing accounts or NIBs) reached SR162 billion during the first nine months of 2003 and constituted 60 percent share of the total customer deposits (NIBs and time & savings deposits). This, however, demonstrates how much Saudi investors are still risk averse.

Meanwhile, those investors’ preferring higher returns could enter the equity funds, which typically carry middle to high risk. Bond funds make up only 0.3 percent (SR155 million) of the Saudi funds’ market compared to its highs of SR3 billion in 1998, largely attributed to SAMA’s re-classification of government bonds that are currently part of the balanced funds, which are composed of bonds and equity under “other category.” Meantime, equity mutual funds accounted for 20.6 percent of the total market, with assets in Saudi share funds reaching SR4.0 billion, while international share funds amounted to SR6.9 billion by the end of September 2003. Noteworthy, assets in local funds surpassed assets of international funds since 2001, reflecting the increased ability of the Saudi economy to absorb local investments. By September 2003, funds in local assets reached SR36.7 billion and accounted for 69 percent of total assets, while funds of international assets amounted to SR16.7 billion or 31 percent share of the total. Furthermore, investors in Saudi funds are of high net-worth, given that average investment per subscriber rose by 7.2 percent to SR316,707 compared to SR295,510 over the year ending in September 2003. At the same time, total number of participants investing in funds edged lower by 0.3 percent to 168,484 subscribers by the end of September 2003.

The main four areas in the Saudi mutual funds market are the following: Others funds, which includes non-interest funds and balanced funds (41.8 percent or SR22.1 billion), money market funds (37.4 percent or SR19.8 billion), shares funds (20.6 percent or 10.9 billion) and bonds funds at a mere 0.3 percent (SR146 million) by end of September 2003. The other funds (including non-interest) are low risk and modest return; include “Murabaha” type commodity trading transactions, which are Shariah compliant. Investing in short-term money market instruments includes bank deposits, and Certificates of Deposits. Moreover, the Saudi funds’ investing in the local economy versus the international markets were as follow: Shares funds (7.5 percent local versus 13.1 percent international) and bonds funds (0.02 percent local versus 0.28 international). Also, assets of the other funds (29.8 percent local versus 12.0 percent international), while money market funds were mostly in the local markets (31.2 percent local and 6.2 percent international). With equity funds share amounting only to 20.6 percent, this clearly indicates that the majority of subscribers into the Saudi mutual funds remain risk averse.

NBC’s Islamic Funds

The National Commercial Bank (NCB) is the pioneer in the Saudi mutual funds market with its first open-ended Al-Ahli Short Term Dollar Fund dates back to 1979. Other local banks followed suit but NCB has managed to maintain a significant 45 percent share of the funds market as assets invested in Al-Ahli funds reached SR22.4 billion by September 2003, while the other nine Saudi banks account for the remaining SR27.5 billion (55 percent share). Also, NCB’s subscribers reached 49,165 representing a 30 percent share of total subscribers in the Saudi funds market. Moreover, by mid-1999, NCB began to convert most of its conventional funds into Islamic or Shariah compliant funds as the share of Al-Ahli’s Islamic funds surged to 70 percent, of the bank’s total assets in funds from 56 percent in the four-year period ended September 2003. Accordingly, assets in Islamic funds reached SR15.7 billion, while conventional funds amounted to SR6.7 billion by the end of September 2003. Likewise, NCB’s subscribers in Islamic funds accounted for 79 percent of NCB’s total subscribers by September 2003. This reflects NCB’s customers’ preference of Sharia Compliant mutual funds over the conventional funds.

NCB’s top Islamic funds is Al-Ahli SR Trade Fund (SRTF) with assets over SR10 billion or about half of NCB’s total assets in mutual funds. In the second place comes Al-Ahli International Trade Fund (ITF) with assets of SR2.4 billion, and the third was Al-Ahli Global Trading Equity Fund (GTEF) with assets around SR1.4 billion.

Performance of Saudi Funds

Risk versus reward analysis is vital to any investor, with typically short-term funds (non-interest and money market) carrying the least risk and lowest returns, while on the other side of the spectrum, long-term funds (equity) have the greatest volatility and therefore have the highest returns in the long-run. Riyad bank’s American Fund, was the only international shares fund to outperform the Dow Jones Industrial Average index in 2003. Meanwhile, the technology led NASDAQ Composite index rose significantly by 50 percent last year, suggesting that it may be useful to set up funds based on major US indexes. On the other hand, the Tadawul All Share Index (TASI) registered an excellent performance in 2003, reflecting high corporate earnings by Saudi companies. This was witnessed in the Saudi equity funds, including the Saudi Equity Trading Fund by the British Bank, which out performed the Saudi index (up 82 percent). Other high performers were Rajhi Local Shares fund (up 72 percent); Riyad Equity Fund 2 (69 percent), Samba’s Al Musahem fund (68 percent), and Al-Ahli Saudi Trading Equity fund (63 percent).

Bond funds are normally associated with the medium term (1-3 years), and their returns would come somewhere in the middle of the spectrum. In addition, bond funds are debt instruments that generate income in line with the level of interest rates, while preserving the capital value of the bond fund. However, it should be noted that the ‘timing’ of entering the bond and equity funds market is critical, as these types of funds have a positive correlation to capital markets. Therefore, subscribers should aim to enter the equity mutual funds when the equity markets are at a low and exit when markets near their peak, thus maximizing gains. Meanwhile, following the interest rate cycle is vital for investing in bond funds, as these debt instruments generate income in line with the rate of interest. Elsewhere, other funds (that include non-interest) had a wider performance range from 0.8 percent to 28.2 percent during the whole of 2003. However, other funds are not time-bounding and most of them are Shariah compliant. Meantime, the money market funds registered relatively lower returns, given the low interest rates in 2003, with Riyad bank’s Al Hadi portfolio in pole position among the money market funds gaining 3.7 percent for the year.

(Dr. Said Al-Shaikh is chief economist at the Jeddah-based National Commercial Bank.)