Slow On The Uptake

   In a region that stretches from Morocco to Kuwait and covers terrain from mountains to desert, the range of economic activity in the Middle East and North Africa (MENA) is as varied as the geography. "In terms of sectors, each country has its own sweet spot”. Investors are now scrutinizing each sector in the wake of the global economic downturn that swept through the region in 2009, and the Arab political unrest that erupted in 2011. Funds are focused on markets where economic growth is driven by solid fundamentals and sectors that are resistant to the fluctuations in the global economic cycle.

    In 2011’s first quarter, global investment markets were shaken by a range of extraordinary events – from social and political unrest throughout the Middle East and Northern Africa, to unresolved nuclear event in Japan following a catastrophic earthquake and tsunami. Over the course of the first quarter, investors were able to easily adjust their allocations to various markets and asset classes by rotating into and out of various exposures, reacting to the events in the Middle East and North Africa.

    Looking at the chronology of the global fund industry, and if you assume it started at the same time as stock exchanges were formed, then the European fund management industry has the longest history (around 400 years ago), followed by the US (started around the end of the 18th century) with Asia being the most recent entrant into the business. What is clear from these statistics is that influence is shifting from Europe and the US to other parts of the world, namely Asia, Latin America and the Middle East. This has been underway for some time and is not a surprise to anyone. The question is how this affects the emergence of future fund management businesses, particularly in the MENA.

    The Middle East may be riddled with political unrest and near constant warfare, but on the business end, its stock markets could not be performing better. Improving global economic and political conditions have created a conduit for the Middle East to grow into the second richest emerging market in the world.

    The Middle East isn’t just a bubble. Since 2000, the Middle East has grown at a rate greater than 5% per year, without any large draw downs in growth. When most people think of the Middle Eastern region, they automatically think only of oil. There is a lot of money to be spent and a lot of diversified industries and companies in Middle Eastern countries. MENA is often associated with fast growth, dynamic markets and innovation. And in the Exchange-traded funds (ETFs) space, MENA certainly merits these labels.

    Is this the time for Middle East investment? It wasn’t long ago that investing in the Middle East was off-limits to small investors. Several newly-created exchange-traded funds (ETFs) offer access to stock markets in the United Arab Emirates, Qatar, Kuwait, Saudi Arabia and several other countries. The Middle East seems to be unfazed by the global economic crisis and investors are putting more money into the region.

    ETFs have become increasingly popular in many markets around the world as a convenient way to track index performance. MENA, with UAE and Saudi Arabia in particular, are no exceptions; the development of ETF market in this region has been phenomenal.


    Before the financial world fell apart, everyone wanted a piece of the Middle East. Western investors either wanted exposure to its markets or to its investors, or both. Now the picture is vastly different. The drop in the oil price in the last part of 2008 made Middle Eastern exchanges less attractive as shares followed oil downwards. As they are essentially index-related products, this relatively inhospitable environment could hamper the possibility of ETF development on Middle Eastern markets.

    Frontier markets are an investment sector that is just gaining traction with investors. ETFs tracking these markets have given individual and institutional investors alike exposure to exotic markets with growth potential.


    According to Tadawul, “ETFs are investment funds divided into equal units traded on the exchange during trading time, similar to stocks. ETFs enjoy advantages of both mutual funds and stocks. Like other investment funds ETFs are composed of a basket of assets (listed companies shares), however unlike mutual funds ETFs are traded on the exchange. What differentiates ETFs from Mutual Funds and why do we use ETFs, you can clearly find it here:

·         Transparency: Investors can generally see the ETF composition at any given time.

·         Liquidity: ETFs offer two sources of liquidity. The first is Traditional Liquidity measured by secondary market trading volume. The second is the liquidity of the underlying assets via the creation and redemption process.

·         Diversification: ETFs offer immediate exposure to a basket or group of securities for instant diversification; as well as a broad range of asset classes including equities, bonds, commodities, investment themes, to name a few.

·         Flexibility: ETFs are listed on exchanges and can be traded at any time the market is open. Pricing is continuous throughout the day.

·         Cost Effectiveness: ETFs offer a cost effective route to diversified market exposure

·         Securities Lending: ETF units and underlying assets can be lent out to potentially offset holding costs.

    For investors who use ETFs correctly, there’s no question: ETFs aren’t just equivalent to mutual funds, they’re qualitatively better.

    Usually, when people make this argument, they focus on the fact that ETFs are, by and large, cheaper than mutual funds. While true in general, it’s almost irrelevant. Some institutional mutual funds have lower expense ratios than any ETF. Also, ETF investors bear additional costs in terms of commissions and bid/ask spreads, which mutual fund investors don’t pay.

On costs alone, it’s a tossup.

Where ETFs truly excel—where they are definitively superior to mutual funds—is on fairness.

    Exchange traded funds are transforming the investment landscape for high-net worth investors and wealth managers. While ETF adoption lags far behind that of traditional mutual funds, wealth managers are on the leading edge of a trend that’s in the middle of its second decade.


    Studies show that Dubai is still attracting maximum foreign investment and international companies see Dubai as an essential stepping stone into the MENA. The government is enacting new laws and updating regulations to increase investor confidence, since they are attracted by its economic maturity, the ability to build a strong infrastructure and the country’s business-savvy approach and innovations. Saudi Arabia is still the largest foreign direct investment location for the region, followed by the UAE.


    In the United Arab Emirates, National Bank of Abu Dhabi PJSC started the Gulf’s first ETF in March 2010, followed by Falcom Financial Services’ Islamic fund in Saudi Arabia that month. Global ETF assets surged to $1.37 trillion as of February, from $74.3 billion in 2000, according to BlackRock Inc. data.


    ETFs have taken the conventional world by storm, and are now as much a part of the investor’s compendium as the balanced fund. However, in the world of Islamic finance they are a fringe product.


    In a nutshell, Exchange Traded Funds (ETFs) provide the performance of a basket of securities and are listed and traded on a stock exchange just like other stocks. Emerging from a traditional equity index product, ETFs have broadened into fixed income, commodity, real estate and energy, reaching a total of about $1 Trillion in AUM, Globally, across 2,300 products and over 5,000 listings.

    All the criterias that ETFs hold, have broadened the investment options for investors, in an easy and transparent way.

    A study in 2010 identified 8 ETFs focusing on the GCC, five of which are listed outside the GCC, and three are listed in the GCC, being the first 3 ETFs listed in the region. One was listed at the Abu Dhabi Securities Exchange and two were listed at Tadawul in Saudi Arabia.

    The National Bank of Abu Dhabi, and after a two years of hard work with the Abu Dhabi Securities Exchange has launched the UAE’s first ETF, and first to be launched on any GCC exchange. UAE’s first ETF was launched in March 2010 and trades on the ADX(Abu Dhabi Securities Exchange)  by the name of “NBAD OneShare Dow Jones UAE 25 ETF”, with a ticker code “1UAE”, as number “1” reflects the first ETF and have exposure to UAE as a whole. 1UAE was domiciled in Ireland under the brand name “OneShare PLC”, representing the platform for future creations of ETFs in UAE.

    “NBAD OneShare Dow Jones UAE 25 ETF”, as its name suggests, tracks an index of 25 UAE shares created by Dow Jones. The index is split between shares quoted in Dubai and Abu Dhabi, covering different sectors, and is available on all stock exchanges.

    There are two ways that an ETF can be managed; either swap based or physical. In a physical ETF, the ETF manager buys the underlining shares aiming to replicate the performance of the index being tracked. However, there is a risk of tracking error for investors if the manager fails to replicate the index. With Swap-based ETF, there is no risk of tracking error. Investors are aware that the NAV of the ETF will track the performance of the index perfectly, but carrying a Total Expense Ratio that is deducted from the NAV return before distributing profits to investors.


    1UAE is being used as a Swap-based ETF with the first swap provider being the Financial Markets Division of NBAD, and acting as an Authorised Partisipant responsible for order tacking from investors through the primary market, leading to be identified as a market maker for the ETF having the role of a liquidity provider. Above all, 1UAE is a UCITS Compliant, allowing it to appeal to local and international investors through acceptable standards for collective investment schemes. Being a Swap-based, 1UAE has no restrictions on international investors, limiting their ownership, but rather provides them with full economic exposure to companies that might be hard for due diligence.


    Investors can resume a work of research analysis of 25 companies with just one ETF purchase taking full exposure to the UAE’s stock markets. 1UAE had AED15.973 million on June 6, 2011.
    On another note, on March 2010, Saudi Arabia’s Tadawul has successfully launched their first ETF “Falcom Saudi Equity ETF”, known as Falcom 30, aiming to provide investors with long-term capital appreciation and growth. The fund passively invests in the listed Saudi equities in order to achieve the results that correspond to the performance of its own index that includes 30 stocks with the following criteria:

1.        Sharia-compliant as per Falcom’s Sharia screening.

2.        For each stock to be eligible, non-trading days in the Saudi Stock Exchange (Tadawul) must not exceed 7 trading days during the past quarter.

3.        Top 30 floating market capitalization stocks. The stocks should also be member of Tadawul public indices.

    A second ETF was launched by Falcom, “Falcom Petrochemical ETF”, on the 8^th of July, 2010. The Fund invests at least 95% of its assets in equities from the petrochemical sectors that are Sharia-compliant, listed and traded  in the Petrochemical sector of Saudi Stock Exchange (“Tadawul”). The Middle East produces 11% of the world’s petrochemicals and it is expected that this ratio will rise to 16% by 2015. The Fund aims to provide investors with long-term capital appreciation and growth.


    To go deeper with analysis, according to BlackRock Industry Review, Falcom Financial Services ranked 130 among ETF providers around the world in terms of assets, at the end of the first quarter of 2011, while National Bank of Abu Dhabi ranked 162. In terms of AUM, Falcom ranked 89 and NBAD ranked 111. Another study of ETF listings by exchange, showed Falcom on the 15^th Rank and NBAD 22^nd.


    Shrinking the study and narrowing it just to the Middle East and North Africa Region, Falcom Financial Services ranked 8^th and NBAD ranked 10^th by AUM among ETF providers. Further studies by BlackRock showed that “Falcom Saudi Equity ETF” was ranked 10^th by average daily US Dollar trading Volume, and 9^th by change in AUM, among the top 10 ETFs in the MENA.

    When NBAD and Falcom launched their ETFs, many investors thought that they were participating in an IPO, as opposed to investing in a passive investment product. When the investor community realized the nature of the product, optimism and liquidity swiftly drained away. It took 17 years for the conventional ETF phenomenon to morph into a $1trn industry. If 1993 was the start of the conventional ETF market, the Sharia-compliant market is by comparison in 1995. The existing funds have to prove that they can perform;investors have to be educated about the value of long-term, low-cost, liquid, passive investment, and there needs to be a significant coordinated effort to put assets into the sector before Sharia-compliant ETFs can truly become a substantial part of the global Islamic finance industry.

     With so many ETFs being invented, there are more planned. Egypt is planning to launch an ETF, “CASE 30 Index ETF”. After the success of the two ETFs in Saudi Arabia, it has been decided to launch a third one, “Saudi ETF”, while UAE is considering four new launches, “Al Mal UAE Falcon”, “Dow Jones GCC Titans 50 ETF”, “Global Fund ETF” and “HSBC Islamic ETF”.


    Above all, whenever it comes to creating a new ETF, a number of criteria must be looked at to make sure the product can be successful. For example, the index must be representative of the region. So it is needed to create a broad index that gives the investor a good exposure respective to the economies. No country shall dominate the other. In addition, the liquidity of the index constituents that are trading on a daily basis, must be looked at, along with the average turnover.



    Reputation of the management, size of the fund house itself, size of the individual funds and the risk management procedures at the firm assume a lot more significance than just performance.


    They are not a gimmick, but at the same time ETFs are not the brave new world of investing, either, as some of the wags want to believe. The Dubai problems are likely to be forgotten for a few days or weeks, as long as stocks keep moving north. Falling prices, however, will lay bare many previously forgotten financial problems and make them headline material once again.

    No doubt we live in fascinating times, both economically and politically. As always, danger always brings with it commensurate opportunity and there will be winners and losers on both sides of the trade. The situation in the Middle East is a fast moving, highly volatile and dynamic political drama, and venturing into this region isn't for the faint hearted or risk averse. However, one thing is certain and that is that the old forces of risk and reward will be at work as this fascinating drama plays out over the coming days.

    It will be important in the coming years to ensure that as new generations of ETFs come to market, investors are educated on their structures and mechanics when they deviate from the traditional definition of ETFs as exchange listed, open-ended, liquid with secondary and primary in-kind creation and with real time indicative NAV, and transparent where the underlying portfolio is disclosed on a daily basis.


    ETFs have been embraced because we are in a ‘back to basic’ environment. This new and growing awareness of ETFs is causing more people in various types of firms and regulators to look at ETFs. Many firms are hoping to find a way to make money from the growing ETF industry. These new participants and potential tax and regulatory changes are the new forces impacting the traditional ETF ecosystem in 2011.


    ETFs are the first tool you would think of for starting an investment in an area where you don’t feel 100% comfortable about the situation. If you wanted to get into the Middle East, but you’re a bit concerned, you would go for ETFs because you can exit anytime.


    I think structured products will always be there and funds will be constantly facing challenges. ETFs are affecting mutual fund sales at the moment. Their volumes are quite high even though advisers do not make much margin on them.

    The UAE and the rest of the Gulf’s recent financial experience was simply part of a learning curve for a robust frontier capital market that will bounce back in no time. Professionals of all types are being bid up, including sales and compliance people. However, this is part of a general boom in MENA, which sees the region wanting to grow its fund management companies anyway. If institutions want to expand into the Mena, they need to understand the region, commit bodies to the ground and develop products that will work in a patchwork of markets.

    In a bottom line, as products are rolled out, investors tend to benefit from increased choices and better variations of product and price competition among providers. It's important to note the differences between ETFs and mutual funds, and how those differences may impact your bottom line and investment processes. With ETFs, investors can enjoy the benefits associated with this unique and attractive investment product, without even being aware of the complicated series of events that make it work. But, of course, knowing how those events work makes you a more educated investor, which is the key to being a better investor.  

    And as every fund manager in the Middle East says: “We want to be the bridge between MENA and the rest of the world”.

 “Exchange Traded Funds are Turning Market Lemons Into Lemonade”