Investment Advisor: Emirates NBD DAsset Management Ltd.

(October 2012)

How has the Fund performed recently compared to its peers and are there any particular stocks or areas where the Fund is performing well?

Since becoming the Fund’s adviser in the summer, we have rebalanced the portfolio towards the countries and stocks we believe offer the most value. This has seen a large shift to Saudi Arabia, the UAE and Qatar.


You have recently taken over the Fund investment advisory role. What is your current strategy?

The prevailing strategy is to focus on companies with strong franchises, cash generating businesses and where the business is less reliant on the global economy for earnings growth. Local economic activity is strong, supported by local government infrastructure and intra-region trade. For example, we like Saudi banks which are benefiting from the recent introduction of a mortgage law in conjunction with the government’s emphasis of building more than 500,000 homes over the next several years.


While oil and gas play a massive part in the economies and wealth of the region, the Fund has very minimal investments in the energy and materials sectors. Why is this and do you intend to stick with this strategy in the immediate future?

Direct exposure to oil and gas companies is difficult as they are mostly government owned. The trickle down of oil wealth into the economy comes from government investment programmes and circulation of money through the economy. According to projections by the US Energy Information Administration (EIA) from May 2012, OPEC members are forecast to earn USD1.15 trillion in net oil export revenues in 2012 and USD1.11 trillion during 2013. The non-oil sector accounted for about 45% of the region’s GDP in 2011, showing the region is more than just petro-dollars. While the Fund has no direct exposure to oil producers, it does invest in related industries such as petrochemicals.


The Fund has a very large portion of its portfolio in the region’s financial sector. Is this simply because it offers the best investment prospects in the region or is there any other reason behind such a large overall allocation in one sector?

Banking is one of our favoured sectors this year, particularly in Saudi Arabia. It is one of the largest sectors, at around 40% of the S&P Pan Arabia Index. Saudi bank shares have underperformed the local market, the Tadawul, for over two years due to lacklustre profit growth. We feel 2012 is an inflection point. We anticipate robust loans growth – 2011 loans growth was 11% aided by increased expenditure by the government post-Arab Spring. We expect this to continue over the next 12-24 months. In 2009-10, non-performing loans (NPLs) and provisions rose. This peaked in 2010 and now NPLs are declining and coverage has risen to over 130% currently. Saudi banks now trade on average at FY12 PER of about 10x (low end of historical range) with earnings growth of 15% - 20%.


Many investors remain cautious on Egypt despite a degree of political stability recently returning to the country. Do you think that cautious attitude will change at any time in the near future and do you envisage future investments for the Fund in Egypt?

Our weighting to Egypt has been neutral over the last few months, in stocks that demonstrate robust cash flow. We think what’s happening in Egypt is encouraging, with political stability returning and an effort to increase capital and FDI (foreign direct investment) flows back to Egypt. We are becoming more positive on domestic Egyptian stocks.


To what extent has the unrest which accompanied the Arab Spring affected the investor perception of the region as a whole, especially views of markets which did not suffer instability e.g. Kuwait and Saudi Arabia?

We believe the Arab Spring was linked to rising living costs and low wealth, which North African countries particularly suffered from in late 2010/early 2011. The oil-exporting countries [in the region] have been able to support investors through subsidies and wide wealth dispersal. Job creation in these countries has also been a central focus.


Markets in the region are generally classed as “frontier” markets. Does this mean investors face the same kind of risks there as they do in other “frontier” markets such as, for example, Pakistan, Vietnam or Kazakhstan?

Despite having the “Frontier” markets classification, we do see good corporate governance practices in a number of companies in the region. Market regulation is on the whole improving as well, with respective capital markets authorities taking an increasing role in their governance. Liquidity in markets such as Saudi Arabia is also quite good, averaging about USD2 billion a day for the year.


Financial authorities in some MENA countries have pledged to work towards greater investment from foreign investors, including opening up stock exchanges to foreigners. Is this likely to happen any time soon and what will such changes mean in terms of investment opportunities?

Most Gulf region markets have been working hard towards attracting foreign investors, with, for example, Saudi Arabia working on finally opening up its market to foreigners. The Gulf region accounts for about 2% of global economic activity and market capitalization, but foreign investors remain scarce. What does not help is that at present, none of these markets are included in the MSCI Emerging Markets Index. An upgrade to Emerging Market status has been on the cards for months for Qatar and the UAE. This would boost local liquidity due to the number of funds that invest passively, tracking the MSCI Emerging Markets Index. This upgrade has yet to materialize as both countries still have a number of issues to resolve. The recent re-addition of Saudi stocks into the MSCI domestic indices is a positive step towards wider integration into the broader MSCI indices and global index network. Upgrades of these countries to Emerging Market status will help to put the region on the radar screen of Emerging Market managers, and therefore should provide some positive momentum to the markets.


Are there any other reforms or law changes outside capital markets planned in the region which will create more opportunities for investment?

Rapid expansion of economies and local investment is a big wealth creator. Gulf Co-operation Council (GCC) investments in energy and infrastructure sectors will exceed USD1.1 trillion over the course of the next 10 years. As the government sector accounts for 35% of the market, there is a quick and high investment multiplier effect from this spend. One example of investment spending and demand is the Abu Dhabi government’s approval to build its tenth Independent Water & Power Project which would boost capacity by almost 10%. Water and power demand are forecast to rise by nearly 14% a year in the period 2011‐15. In Saudi Arabia, the government intends to build over 500,000 homes over the next few years to support its young population, with a recent mortgage law helping to stimulate the sector.


Governments in the region have re-invested a lot of the wealth generated through hydrocarbon revenues into developing other areas of their economies. At what point do you think these economies will be strong enough to not rely on petrochemical revenues to support them?

Many of the economies in the Gulf have taken significant steps to diversify their economies - Dubai now has the fourth busiest airport and ninth busiest port in the world. Tourism is also growing to pre-financial crisis levels too. However, the economic base from oil revenue is significant and it could take many years, possibly decades, and huge investment spending to reduce its dependence on oil revenue.


What do you see as the prospects for the region’s economies and markets in the next six months?

The recent announcement by the European Central Bank on bond purchasing coupled with the US Federal Reserve’s decision to implement QE3 is likely to remain positive for globally sensitive stocks. Hence, we would expect oil prices to remain well supported. This would be beneficial for both MENA stocks and more specifically petrochemical stocks. In addition, given that interest rates are likely to remain low for a protracted period of time, we expect high dividend yielding stocks to do well. In MENA markets, it is not uncommon to find companies that pay dividend yields in line with, or above bond yields, with the additional prospect of capital gains. Despite these benefits, MENA stock valuations are not demanding. We expect these benefits to be positive drivers for MENA stocks over the next six months.


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