DUBAI, 3 June 2007 — Lack of innovation, clear regulations and badly managed funds are still holding back the regional mutual funds industry, which is widely estimated to be $55 billion, despite resurgent equity markets.
Mutual funds, which emerged in the region as strong market stabilizers, were battered just as badly during the 2006 equity market crash as retail investors, raising doubts of their efficiency.
“Asset managers have a lot to answer for,” says a disgruntled investor who placed his money in a mutual fund from a UAE bank, hoping to get a diversified and balanced exposure to equities. “During the market crash though, the fund was just as exposed as the retail investors who went in directly. On top of that, I had to cough up management fee as well.”
Many analysts observe that asset managers did get greedy during the boom period of 2004-2005.
“There were some disciplined managers, but there were many of the smaller funds that got carried away. They rose with the ocean level and fell with it,” says a Saudi mutual fund manager.
Not surprisingly, it appears that despite burning their fingers during the crash last year, retail investors are entering the market directly again. And asset managers will have to work hard to regain their trust.
“Although investors are a lot more cautious now, I don’t think that will necessarily mean that the average retail investor will invest in a mutual fund, rather than directly into the market,” says Mark Friedenthal, head of Funds & Quants, at EIS Asset Management.
Despite its shortcomings, the mutual funds industry continues to blossom, not just in equity-focused, but diverse, fixed income and other forms of mutual funds. However, given the region’s allure of the stock markets, equity-based funds will continue to dominate the industry.
According to the Zawya Mutual Funds Monitor research, the GCC mutual fund industry is estimated to grow to $160 billion by 2010, with the UAE fund industry alone reaching a size of $50 billion. Saudi Arabia, which currently has more than 200 operating mutual funds, will continue to have the biggest concentration of funds.
“In Saudi Arabia, they are beginning to license non-banking financial institutions and financial institutions and advisory management which would raise the profile of mutual funds,” says Dr Khan Zahid, chief economist at Riyad Bank. “In general, the regulatory system is in good shape in Saudi Arabia, but more needs to be done — one of the main issues is to encourage mutual funds in IPOs.”
Recently, the country’s Capital Market Authority allowed mutual funds to buy shares of Saudi Vitrified Clay Pipe Co (SVCP) during the IPO period, a first in the Kingdom. Unleashing pent-up demand, 11 Saudi mutual funds reportedly subscribed to 3.15 million shares of SVCP.
Dr Zahid, though, still believes that the industry is hamstrung with lack of free-floating shares and market depth impacting the industry.
Which is why, innovation will be the catalyst driving the market.
“I see mutual funds having more innovation and sopshisticated financial products this year,” says Sulaiman T. Al-Abduljader, vice president, corporate finance & investment services group of Coast Investment and Development Company, which manages the Coast Investment Fund focused on Kuwaiti equities.
“I believe the industry will take off in the region if it looks at these innovative products. At the moment there are too many similar products around and there is little choice for investors.”
Innovation in Shariah-compliant funds will also be a great catalyst for the industry. “The growth in Islamic mutual funds will continue. The demand for Islamic products — not just mutual funds —is very strong, with substantial demand for investments such as Islamic structured products,” says Friedenthal, which who has Islamic funds in its bouquet of mutual funds. “Looking around the market I see the development of a range of new structures and exciting funds which will be rolled out of the next 12 to 18 months.”
Rising equity markets are also expected to boost the industry. “Some mutual funds had severe losses during the market crash, but relative to the market they were much less, although some mutual funds did lose 35 to 40 percent,” says Mustafa Sinno, vice-president of Evolvence Capital, GCC, which launched Evolvence Capital Semi-Exotic Equity Derivatives (ECSEED) Fund, a $150 million, open-ended fund investing in equity derivatives in the GCC markets.
Sinno believes that attractive valuations are evoking an interest in foreign fund managers and institutions into the region.
“More institutions in the region will be launching their funds as market valuations are very attractive. The sharp corrections in the GCC did not strongly impact the economies, and we expect that the average projected revenues for listed companies this year to be around 20 percent,” says Sinno.
However, legislation continues to hound the industry, especially in the UAE. A senior banker noted that the UAE Central Bank held a workshop in Abu Dhabi last year with an international panel of speakers on regulation, with strong suggestions that the Emirates Securities and Commodities Authority (ESCA) was actively working on introducing a Collective Investment Scheme law.
“Months on, we have not seen anything, perhaps due to initiatives of the Dubai Financial Services Authority,” says the banker. “ESCA has not been proactive in putting the legislation together. For now, the UAE, outside of the DIFC, remains unregulated from a mutual fund point of view.”
The arrival of the Dubai Financial Services Authority (DFSA) with its Collective Investment Scheme could well prove to be a fillip for the market.
“The increasing prominence of the DFSA should be positive for the local mutual funds industry,” says EIS’ Friedenthal, which is registered by the free zone authority. “I also believe some of the international fund houses will choose to domicile funds within the jurisdiction of the DFSA over the next few years.”
In time there will be a proliferation of international institutional fund managers looking to structure mutual funds holding regional equities, although issues of legal ownership of equities will continue to be a problem, as foreigners are prohibited from holding certain assets in many countries.
Bahrain, which has also launched new rules for collective investment schemes, also aims to capture a number of regional mutual funds as well.
But like other sectors of the financial services industry, the industry is beset with problems of finding and retaining talent.
“A lack of financial engineers is impacting growth,” says Al-Abduljader. “But I believe it is part of the evolution. Packages are getting competitive and we see a trend towards training and education and importing the know-how into the region.”
The writer is managing editor, Zawya.com