The relative youth of the asset management industry in the Middle East is illustrated perfectly by the fact that Dubai-based Mashreq Capital, with its mix of equity and fixed income funds with five-year track records, is the longest-standing business to have such a range.
Abdul Kadir Hussain is chief executive of the DIFC-licensed subsidiary, and since April 2006 when he joined the business, he has helped migrate all the asset management operations over from the parent Mashreq, the largest privately owned bank in the UAE.
The bank has just under AED90bn ($24.5bn) in assets, which it has built up from inception in the ’60s, while Mashreq Capital has around $900m, split between fixed income ($600m) and equities ($300m).
There is an interesting jurisdiction split between where the funds are registered, namely the DIFC, Bahrain and Ireland, where Mashreq has a Ucits-compliant fund. Hussain is the manager for the Makaseb Income Fund, domiciled in Bahrain and the Mashreq Al Islami Income Fund, domiciled in the DIFC.
Size is everything
“I don’t think there is any fixed income fund that has a longer track record than us. There are a couple of equity funds that have similar length track records. Asset management in the region is a very young business by UK standards – even our oldest competitors started in 2004.”
Hussain adds that while in the past most of the competitors in this field have used the funds as “calling cards”, that has changed in the past 18 months with increasing inflows as they get on to platforms and people start to see a number of funds with assets of $50m or more.
“Before 2012, getting a fund over $20m in size was unheard of in this region, so we’ve definitely progressed.”
Hussain’s background is an international one, having grown up in Pakistan, and then moving to university and an early career in the US. He subsequently joined Credit Suisse in Singapore, later becoming a managing director running some proprietary money for the company in emerging market bonds.
“The entire time I’ve been associated with bond markets and it has helped a lot in navigating some relatively tricky waters,” he says.
At Mashreq, Hussain sits as a fund manager on the fixed income team, which includes three analysts. On the equity side there is another portfolio manager plus three analysts who report to him in his capacity as chief investment officer.
Macro man
The investment approach is to take a macro view of the world first, then to focus on the Middle East region, then to take a strategic view of where such indicators as interest rates and oil prices are heading.
Specific asset allocation decisions come next and after that the selection of securities on a bottom-up fundamental basis.
“Even though some of our funds are benchmarked we like to be benchmark agnostic investors. We take an independent view of what we like. It’s more about fundamental value.
“In terms of the equity markets we’ve had a pretty decent catch-up period over the past 12 to 18 months. These markets were significantly undervalued and significantly underperformed global emerging/frontier markets until the middle of last year. Since then the markets in the regions have been on a pretty strong upward trend. A lot of it has been catch up.”
Market shifts
Hussain says valuations of markets in the Middle East do not provide the same kind of discounts as they did 18 months ago, though prices “are not expensive by any means”.
“Now we are looking at what is going to re-rate these markets. The MSCI upgrade of the UAE and Qatar is one of the factors but there are other driving forces.”
A positive trend in both these markets is the potential of continuing domestic sector spending, while the hosting of the world cup by Qatar and the World Expo 2020 in Dubai can only benefit the property and banking sectors.
Hussain argues the underlying fundamentals over the next 24 months look quite strong, with global growth giving continued support to oil prices.
“If the global economy grows at a decent pace – and you are getting a good volume of international trade and tourism – both of those are key drivers for Dubai.”
Dubai sits in an interesting part of the world, as the pan-Asian African trade route – something which a lot
of companies in Dubai are now focusing on – continues to grow, he points out.
The other big equity market, the biggest in the region, is Saudi Arabia, which Hussain characterises as a relatively undervalued, pretty closed market, which is difficult for investors outside of the GCC to access.
However, through Mashreq’s Bahrain-domiciled income fund he can have unfettered access into the Saudi market, and through the Ireland-registered fund, the Mashreq Arab Tigers Fund, parts of this market can be reached.
“We have generally been quite bullish on Saudi banks, and there the theme post the Arab Spring continues to be very strong domestic spending to make sure the local population is well taken care of.”
He says some of these retail companies are up 100% to 150% over the past year and a half and they have benefited Mashreq’s fund significantly.
“We don’t expect that kind of performance going forward but given relatively decent valuations for the big banks and given the continued infrastructure spending, the fact that oil prices will probably continue to stay at above break-even levels we think the market is well positioned. Those three markets provide a pretty strong case for the region and we’ve been up over 25% this year.”
Shariah-compliant
On the fixed income side, contrasting the performance of his income fund with the Shariah-complaint one Hussain also runs, he says the latter is slightly underperforming relatively because of the cost of interest rate hedging.
This is a much more tricky thing to do in an Islamic fund, as he explains: “We can do it but it’s a little bit more expensive to do. They have ‘profit rate’ swaps which are Shariar-compliant versions of interest rate swaps so it has exactly the same mechanism by taking fixed interest rate payments and swapping them with a counterparty.
“You pay that counterparty a fixed interest rate and they pay you a floating rate in return, so that way you hedge out or eliminate interest rate risk. But as the benchmark rate goes up you continue to pay the fixed rate but they are giving you a higher and higher return back because they are paying you a spread over a benchmark rate.”
By contrast, in the conventional income fund the hedging can be achieved through futures or shorting treasury stocks.
Another difference is the concentration of the Shariah-compliant portfolio in the UAE, which is not surprising given that almost 70% of the issuance that is considered compliant by Mashreq’s Shariah board is from there.
Mashreq also has a supervisory board of three Shariah scholars, which decides which sukuk transactions that have a fatwa certificate are suitable for the Shariah-compliant fund.
The way the income fund works is it can only invest 20% outside the region hence MENA is always between 65% to 80%.
“It gives us a little bit more flexibility. For example, in 2009 and 2010 when the Dubai crisis was at its peak we were able to move the maximum 20% outside Dubai and try to cushion the volatility a little bit.”
One of the top holdings in both funds is Emaar, which Hussain has liked for the past 15 to 20 months.
“From a credit perspective it is a company with strong recurring capital flows now, it’s no longer a pure property developer. It has the hotels business and the huge Dubai mall with its very strong foot traffic and very high rents.
“The issue about Islamic finance is that you can pretty much take any business, cut off a piece of it and ring fence it from the rest of the business and say this piece is purely Islamic or Shariah compliant. That’s the piece that is going to raise the money and the financing to do it.”
In Emaar’s case they have done two separate sukuk transactions. Essentially they have taken a bunch of assets and structured them in a sales lease back structure which makes it Shariah compliant.
Interest rate headwind
Mashreq has faced the same mountains to climb as other fixed interest investors, given an “undoubtedly rising US interest rate cycle to deal with”, Hussain says.
Most of the issuance that comes out of the region is in US dollars, and even if it is not, most of these currencies are pegged.
“The ability to generate returns going forward is going to depend quite a bit on the ability to successfully manage interest rate risk. I compare it to cycling uphill or downhill or with the wind or against the wind.
“Over the past five years or so most bond managers have been cycling downhill with the wind on their backs and it’s been quite easy to go quite fast.
“Now we are starting to cycle uphill and we’ve got a bit of wind in front of us and it separates the guys who have had the experience and have been through rate cycles in the past versus some who may not have.”
His expectation is that if interest rate risk is successfully managed over the next 12 to 24 months then the funds should be able to generate between 4% to 6% returns on annualised basis.
“That’s significantly lower than what they have done over the past two years. So it’s going to be a little bit more of a challenge.”
