PAGE 26 TAREK SAKKA INSTITUTIONALIZING THE INVESTOR. The Author. Tarek Sakka

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1 PAGE 26 TAREK SAKKA The Author Tarek Sakka is founder and CEO of Ajeej Capital, a leading independent alternative investment management company focused on the Middle East and North African (MENA) markets.

2 TAREK SAKKA PAGE 27 Institutionalizing the Investor Why has MENA lagged behind the rest of the emerging markets since the financial crisis of 2008? In the two years since the crisis, MENA markets returned an average of approximately 20 percent compared to BRICs which rebounded well over 100 percent from 1 January 2009 to 31 December It seems to be a pervasive question that many investors have been asking. Whilst there is no clear right or wrong answer, I think it is prudent to try to address this question from the perspective of investor composition. Retail Early last decade retail investors for many of the GCC (Gulf Cooperation Council) markets were the engines driving the growth. In fact, from 2002 to 2006, it was this dynamic that enabled the markets to trade at a premium to EMs. This obviously was fuelled by strong macroeconomic drivers, limited investment vehicles, strong purchasing power further enhanced by bank leverage, and, lastly, by the trickle down mechanism of last resort. The first crash came in the fourth quarter of 2005 and the first quarter of The endemic asset bubble, which had been stretched beyond imagination, fell apart burning retail investors en masse. On the other hand, foreigners in the market during this period were largely irrelevant, and the balance of 2006 through to the third quarter of 2007 was a restructuring period for them. Subsequently, their share of the trading wallet after this period picked up both in relative and nominal terms as we entered into the final quarter of The rally began and the entrant foreigner on many asset classes began to directly drive up the GCC markets, excluding Saudi Arabia, of course. For many markets retail finally had a leading indicator. Then came the crash of 2008, a time when we thought we should have been better insulated. This was followed by expectations of intervention from both a market perspective and macro perspective that were never met. Unfortunately, governments were silent during the critical periods, hence exacerbating a situation that ultimately produced a double whammy for the retail investor. The start of 2009 was visibly tepid, especially with the fundamentally negative global outlook. The negativity among retail was such that as global forecasts improved, acting to catapult emerging markets price actions, most sectors in MENA underperformed. Further erosion of

3 PAGE 28 TAREK SAKKA retail confidence based on the two years prior was purely focused on domestic manifestations of the global crisis. Moreover, elevated provisioning and large corporate bankruptcies did not help create any sustainable demand to drive the markets up. Frustratingly, retail seemed to be listening only to the negative news, whether it was regional or global. However, during the first quarter of 2010, as worries over Dubai s sovereign debt issues subsided, coupled with sustained oil prices in the 80s, sentiment seemed to pick up allowing the MENA markets, once again driven by retail investors, to play catch-up to their EM counterparts. However, the tide quickly ebbed as concerns over the stability of the Eurozone ran rampant in the minds of retail investors in May 2010, and it took the rest of the year for sentiment to restabilize and general fears to subside. As the oil price approached 100 dollars a barrel towards the end of 2010 for the second time in history, all investors, retail included, began viewing 2011 as the year when things would finally change for the MENA region. Suffice to say, change they did. I do not think anyone was quite prepared for the emergence of the Arab Spring, and, as a result, the markets once again were slammed with high volatilities, deep draw downs, and unquantifiable uncertainties; retail investors could not seem to catch a break. There was a silver lining, however. After mid- March it became clear that there was a distinct bifurcation in the political pictures in the MENA region. Ironically, it was the younger, oil-rich kingdoms and emirates that were able to weather the storm of Arab discontent despite the fact that they were on the receiving end of the harshest criticisms from the West for years vis-à-vis popular discontent and lack of democratic process. All the while, older, more established, and, perhaps, in international eyes, more democratic regimes in the region faltered, and in some cases collapsed. The purpose of this article is to address how different catalysts, along with the resultant investor compositions and their relevant psyches, have affected the MENA markets over the past few years and where things are heading.

4 TAREK SAKKA PAGE 29 What can we expect out of retail moving forward? I am certainly not proposing that there are no more skeletons in the closet, and certainly the skeletons differ remarkably from one market to the next. Nor am I suggesting that the geopolitics of the region can ever be completely discounted. However, I believe, based on domestic issues, that the probability of a further erosion of confidence is low. Obviously, global indicators and regional politics cannot be ignored, but as credibility is restored in the corporate sector and oil prices are maintained in the 80s, let alone above 100 where they are currently, I feel that retail confidence can be revived. Foreign As for foreign investors, it has always been the structural frameworks of the different MENA capital markets that have defined their participation. Most economies in MENA are either unclassified or part of the frontier market investment pot, with Morocco and Egypt being the clear exceptions. As a direct result of the classifications of its underlying markets, the region has been a magnet to hot foreign money; a tragic dynamic at best. The momentum-betting foreigner began focusing on the GCC markets during the fourth quarter of 2007, and continued to funnel money in at an alarming rate all the way through the first half of Unfortunately, this influx of capital was not a result of sound fundamentals (which were abound at the time), but, rather, due to oil trading at historical highs, a dollar carry trade backed by rumors of a currency depeg, and, finally, rumors of the potential reclassification of the certain GCC markets to MSCI EM. Then, as the world fell apart, the mass exodus of foreign capital began; reversing in a three-month period what took three quarters to build. And as a direct result of the overexuberance of the hot foreign and supposedly institutional investor, MENA experienced its second crash in two and a half years. Since the crisis of 08, foreign investors have been absent from MENA for the most part, focusing their efforts on other EMs and, specifically, on the BRICs in the case of some, whilst others have been waiting for inevitable reclassification of the markets before considering investments in MENA once again. The emergence of the Arab MSCI CLASSIFICATION OF MENA MARKETS MOROCCO TUNISIA LEBANON ISRAEL SYRIA IRAQ ALGERIA LIBYA EGYPT SAUDI ARABIA KUWAIT BAHRAIN OATAR U.A.E. Emerging Market Long Term Money OMAN Frontier Market Hot Money YEMEN No Classification Retail Money Source: MSCI Barra

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6 TAREK SAKKA PAGE 31 Spring with regards to foreign investors has, in fact, been a double-edged sword. On one hand, significant potential allocations to the region were put on hold indefinitely during the first quarter of 2011, which has been frustrating for local regional managers catering to foreign institutions such as ourselves. However, the flipside is the squelching of hot foreign capital that was poised on the sidelines ready to pounce on the oil rally or the re-emergence of Qatar and the UAE s potential for reclassification, without paying heed or notice to any underlying fundamentals. However, thankfully the Arab Spring seems to have done little to dampen the interest of the most institutional of foreign investors who are looking to invest behind real growth opportunities in frontier and emerging markets. As it stands today, there are two markets which are being discussed most actively and they are Qatar and the UAE. Disappointingly, very little has been done in the past 3 years to address the structural issues that have held these two markets back from their otherwise deserved EM status. Neither market provides its investors with a functional DVP settlement infrastructure, whilst both markets still maintain stringent foreign ownership limits that make it very difficult for global institutional investors to take meaningful stakes in public companies. Given the announce ments heard over the past few months, most pundits are betting that Qatar may actually do enough to be given the green light for an upgrade, while the UAE with its three distinct and somewhat incoherent markets has a little more to do before joining the likes of Egypt and Morocco in the EM space. The real trigger for the region as a whole is to be on the radar screen of global investors when Saudi opens up its largest market in the region to foreign investors. Saudi is taking concrete steps in this direction and aims to be more prepared for such a possibility in the coming months. The region will then be on the global map and attract the right type of foreign investor that will help institutionalize the markets. The market with the greatest depth in MENA, Egypt, was included in the MSCI EM Index on 31 May 2001, and it is clear that the market composition has benefitted greatly over an investment cycle by greater depth in investor composition which in turn would lead to a louder call for institutionalization and establishment of a corporate governance framework both from a topdown and bottom-up perspective. For these reasons, I am excited about any potential classification upgrades for the GCC markets, and although the changes are taking longer than expected, it is good to see that, once again, talks and steps are underway after nearly a two-year hiatus. The ultimate goal The objective is to create sustainable demand drivers based on the merits of fundamentals and transparent frameworks. Yes, I know I m being an idealist and that this objective applies to all markets, but the gap analysis of the region puts MENA well behind the global peer group average in this regard, and the only way to go is up on convergence towards general standards. So whilst the movement may be revolutionary in nature, it is also evolutionary. I believe that for the time being, the onus is on the independent asset manager to push for a greater level of institutionalization by assuming a larger role in the market. This would ultimately keep many of its actors honest in what they do, and challenge the system without any clear conflicts of interest, by investing funds based on solid fundamental theses, whilst taking advantage of the inefficiencies in the market.