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Historical Significance of Capital Appreciation vs. Traditional Saving

Date : 29/09/2019
Author:  Abdulmohsen Al-Mudhaf


Data source: MorningStar, Jan 2008 to Jan 2018. Past performance is no guarantee of future results. 
*Please note slight overlap of Savings and Inflation lines.

Growing up, most individuals are conditioned to think under a certain umbrella of operations and actions. One that is fairly universal and familiar to us is the idea of saving which, as we will examine later on, carries with it a wide range of definitions. Conventional thinking adopts a low-risk, ‘sensible’ method of saving in its usage of commercial banking savings accounts. While this may be a fairly easy option for most, historical evidence may advocate for other means of appreciating collected savings and could point to a vast difference in both. The objective of this piece is to highlight both ideologies and, hopefully, set the scene for an argument that has existed since the dawn of the modern-day financial era. Moreover, when we examine the aforementioned methodologies for what they are and understand exactly how they satisfy certain related subgroups of the general population, we are able to then visualize the spectrum of risk appetites and see just how intricate that spectrum can get.

When we generally think about our ‘savings’, more often than not we are thinking about the money collected through time in our respective bank accounts (i.e. Checking and/or Savings account). The availability and increasing accessibility of commercial banking nowadays provides us with the opportunity to easily save our hard earned cash with no additional worry of lacking the financial knowledge needed to do so. Adding to that, should the individual choose to place his or her money into a savings account that accrues interest (i.e. fixed or compounding) over time, they are also getting the additional benefit of interest payments over time; or so they believe. Unfortunately, the economic climate pertaining to our financial world isn’t as black and white as we would like it to be. There are many crucial variables that must be accounted for when thinking about the long term effect of our savings. One of the more relevant variables to our equation is inflation and how it, unfortunately, has the potential to offset the interest payments collected over time through traditional savings accounts. For example, assume an individual in the US saves $10,000 at a fixed 2% compounded every year for 10 years. Assume also, that the average annual inflation rate is 2.1% (rounded average CPI from 2000-2018). The principal amount ($10,000) plus interest (2%) leaves that individual with $12,189.94 at the end of those 10 years. However, assuming a 2.1% inflation rate, the principal amount ($10,000) is now worth $12,309.98, so, in actuality, the individual has actually lost $120.04. This is a very basic example that skips over some of the more technical aspects of the concept, but the general message remains the same: inflation has the potential to offset interest gains from conventional saving.

The opposing side of this argument comes by way of capital appreciation in the financial markets. The process here is geared more towards investing (either self-invested or through an investment advisor) in financial securities and reaping the benefits through appreciation of the funds invested. One obvious downside to investing, however, is the susceptibility of exposure to all types of risks (i.e. market risk, liquidity risk, margin risk etc.). This is the main driver for the hesitancy that individuals exhibit when exploring such an option. Common practice and historical evidence have shown us otherwise, however, in that the use of sound investment practice has the capability of generating returns that far exceed those of the conventional saving model. Let’s revise our earlier example, but instead of investing the principal with a constant 2% annual rate, let’s assume the same individual instead invests the amount into an S&P500 ETF ($SPY) allowing for a broad US equity exposure. Let’s also assume that same individual invests at a peak right before the recession in 2008. This situation is contrary to what sound investment practices advise individuals to do. However, with that being said, the return on a less than ideal investment scenario, as our example illustrates, would still yield better results than our conventional savings example (within the same 10 year span). The amount an investor receives on a $10,000 investment placed on January 31st 2008 into an S&P500 ETF alone is $20,521.22  (including principal) on January 31st 2018.


Tags:  appreciation, Capital, savings

 Current rating: 0 (3 ratings)

Home bias among GCC Funds - Preference for Domestic Stocks in Regional Funds

Date : 19/07/2017
Author:  Marmore MENA Intelligence

Home is where the heart is….
Strong bias in favour of domestic market stocks/securities among international equity funds in developed markets is well documented through various academic studies. For instance, U.S investors in international markets allocate nearly 70% per cent of their fund to domestic securities despite the fact that U.S equity market comprises only 60% per cent in the benchmark index (MSCI World). Though such behaviour is inefficient from a diversification standpoint; the phenomenon, dubbed as “home bias” is widely witnessed globally.
Institutional constraints such as barriers to invest across boundaries, limitations on repatriation of investment income, varying corporate governance standards, higher transaction costs and currency risk have been put forth as possible reasons. Interestingly, closer to home regional mutual funds in GCC markets suffer from home bias as well, despite the region being largely homogenous and frictional costs to invest across the region are largely non-existent.
The primary goal of a fund manager is to maximize returns while minimizing risk. However, the presence of varying country-level exposures among fund portfolios in achieving a common goal – to outperform the benchmark index (S&P GCC Composite Index for conventional equity funds and S&P GCC Composite Sharia Index for Islamic equity funds) – is puzzling, as this bias is a result of conscious and intentional move made by the fund manager. Indeed by overweighting domestic exposure the fund managers are adding on to the risk that they could have diversified away.
Possible explanation for such behaviour could be attributed to the perceived informational advantage of fund managers over their country stocks. Fund managers are more familiar with domestic stocks and thus have a higher degree of confidence in their ability to generate outperformance through active management. For instance, local fund managers could talk with employees, managers, and suppliers of the firm, they could obtain key information from local media, social events, and the close personal ties with senior management, all of which could provide them with better information than their regional peers and provide a distinct advantage. In part, home bias could also be an extension of “confirmation bias” as fund managers may simply feel more comfortable about their domestic investments when they keep hearing about them in local media. Country specific systemic risk factors such as political risk or poor corporate governance practices could also influence the fund manager allocations resulting in home bias.
An analysis of the GCC funds
In our analysis we observe that the level of home bias among GCC mutual funds (equity) is heterogeneous in nature. Funds in markets such as Saudi Arabia and Kuwait exhibit significant home bias (greater than 10% overweight to home market) while United Arab Emirates (UAE) funds have been observed to exhibit moderate home bias (greater than 5% but less than 10% overweight of home market). Funds based out of Qatar and Oman exhibit relatively minimal home bias. Based on our observation, Bahrain funds did not exhibit any home bias. In fact, GCC funds domiciled in Bahrain had underweighted their domestic country.


Liquidity, Trade Costs & Home bias
In general, home bias, especially by Saudi Arabia and UAE fund managers could be justified due to their larger size and presence of multiple sectors. Greater size and diversified nature of their markets enable them to be relatively liquid in comparison with other markets in the region. Higher liquidity would also reduce direct transaction costs and market impact costs. On the other hand, fund managers based in Kuwait and Oman with home bias should reassess their portfolio allocation due to illiquid nature of their markets on account of relatively smaller market size and concentrated sector exposures.
Impact on Performance
All the funds considered in our study that exhibit home bias has underperformed their respective benchmark in the past 1year. Though GCC markets are largely inefficient and have greater scope for alpha generation through active management, the results suggest that excessive home bias could take a toll on the fund performance. Interestingly, the Qatar-based fund with least home bias had also underperformed the benchmark.

As per our analysis, funds exhibiting home bias have underperformed the benchmark index. In light of this finding, fund managers of GCC funds should avoid the temptation of overweighting their country of domicile as they run the risk of being over-run by foreign funds that need not have home bias. Additionally, fund investors especially the institutional investors could have home bias as an additional parameter of analysis while selecting regional fund managers.

 This article is published in "Marmore Blog" 

Tags:  Capital, Funds, GCC, Market, Stock

 Current rating: 5 (3 ratings)

Bankers can finally look forward to merger activity

Date : 08/08/2016
Author:  Marmore MENA


The article originally appeared in The National | Business
The GCC’s investment bankers must be a stressed lot – too much work and such little reward.

The fee-based investment banking business has four key components – syndicated loans, equity capital markets, debt capital markets and mergers and acquisitions (M&A). While in other markets we can witness activity across these four components, in the GCC investment banking advisers depend on syndicated loans for their survival – 50 per cent of total investment banking fees on average.

Equities is dull thanks to poor performing capital markets and the related dull initial public offering environment.

The debt capital market looks promising given the slew of activity expected from sovereigns and corporates.

However, the sticky point seems to be M&A, which can be erratic and suffers from some idiosyncrasies.

The fallout of the global financial crisis and the recent oil price crash have dented the stamina of corporates, leading to weaker balance sheets for many companies. The operating environment has become difficult because of stagnant earnings and increased cost of capital. After hitting a peak of US$70 billion in 2014, our research expects that corporate earnings will touch $62bn this year. This should be a dream environment for M&A advisers, as difficult environments force corporates to restructure, improve efficiency and productivity, hive off non-core assets and concentrate on strategic business. In other words, corporates need the help of M&A advisers to do all this.

However, the value of announced M&A transactions reached $18.7bn during the first half of this year, a decline of 29 per cent compared with a year earlier, and the slowest first six months for deal-making in the region since 2014, according to Reuters.

What can explain this conundrum?
The GCC market is dominated more by private companies than public companies. Scouting opportunities in the private market are onerously difficult because of lack of transparency and family control. This prevents deal flow even though there may be genuine need for M&A. Even when assuming healthy deal flows (cases where companies express interest to hive off non-strategic units), the actual completion of transactions can be low (poor deal closures), as poor information can prevent meaningful negotiations and conclusion of transactions.

The M&A environment in the GCC is also characterised by dominance of "mega" deals. Take the recent example of Emaar Properties chairman Mohamed Alabbar leading a group that bought a $2.36bn stake in Americana along with a group of investors; or the merger of National Bank of Abu Dhabi and FGB, which is expected to create a mega-bank with total assets of about $171bn; or the celebrated Emirates Bank and National Bank of Dubai merger to form Emirates NBD in 2007.

Such mega-deals can crowd out other transactions and can also create league tables – rankings of investment bankers – that can look very different and distorted from one period to another, thus making it difficult to compare.

How will things be going forward?
Given the low oil price environment, corporate stress levels are bound to increase. The need to restructure, enhance productivity and efficiency and hive off unnecessary non-strategic assets will be pursued vigorously by private and public players.

This should certainly be good news for investment bankers. Also, it is unusual that companies are sitting on very high levels of cash as measured by data available for publicly listed companies. At the end of last year, total cash levels reached about $250bn, with financials (read banking) accounting for $155bn. Hence, banking-related M&A transactions will continue to see action, followed by energy and telecoms. Mega- deals may continue to dominate the scene, but given the oil price effect across the board, representation from mid-level segments and SMEs can also increase.

This will help to improve the ratio of pipeline to closure, which should be good news for investment bankers.

Tags:  Capital, Economy, GCC

 Current rating: 3 (3 ratings)

Reasons for poor Analyst Coverage in Kuwait

Date : 13/12/2015
Author:  Marmore MENA


The present scenario

Compared to all other stock exchanges in the GCC the number of large- and mid- cap stocks, as per the above definition, is much lower in Kuwait, than in peer countries, whereas the number of small-cap stocks is over 91% of the market. Qatar has the most even cap divide, while Kuwait sits at the other end of the spectrum. In terms of analyst coverage (as a percentage of all stocks in the exchange), Kuwait is the lowest at 8.1%, while Saudi is the highest at close to 49.7%. For Qatar and the UAE analyst coverage ranges stands at 42% and 30%, respectively. Looking at the cap-wise analyst coverage, other than Qatar (64%), all other GCC nations have over 90% analyst coverage for large-cap stocks, due to the popularity of these stocks among the investors and the relatively higher amount of research and information available in the public domain. This coverage value decreases for mid-cap companies, with a high of 91% seen for Saudi Arabia, and a low of 57% for UAE. It falls further for small-cap companies, with a high coverage of 28% seen for Saudi Arabian small-caps and a low of 3% for Kuwaiti small-caps.

In terms of cap-wise coverage as a percentage of total analyst coverage, Kuwait has a higher coverage among mid-cap companies, followed by small-cap. But the very low total coverage indicates that these numbers are much lower compared to other GCC nations. With the exception of Qatar, Kuwait has the lowest coverage in the small-cap segment among the four GCC nations.

Under GCC stocks that are followed by 5 or more analysts, Kuwait has the lowest coverage at 33.3% (only 5 companies) of stocks with analyst coverage, while the rest of the countries under consideration have more than 40% of stocks with analyst coverage that are covered by 5 or more analysts. Again, since the markets in the region are top heavy, most of the stocks with 5 or more analysts fall under the large cap, with lesser such coverage for the mid-cap and close to nil coverage for the small-cap stocks.

BUY and HOLD recommendations dominate the GCC markets, with close to or over 90% recommendations for Kuwait, Saudi and the UAE, while for Qatar it is 76%. SELL recommendations are the least popular in the region, with Qatar faring marginally better compared to its peers.


The reasons
Markets driven by retail investors
Over 45% of the value traded in Kuwait, across the years, is attributed to retail investors. Companies and funds, which are the major consumers of research, together accounted for around 30%, on average, since 2009.

This figure is over 85% for Saudi Arabia, 73% for Dubai and 47% for Qatar. Primary reason why analyst coverage is low in the region is the relative lower consumption of research in the region

Most research material widely available in English and not Arabic
The presence of larger expat population compared to local population in the region and investments from companies and foreign institutions have pushed demand for research in English, while research in Arabic still lags behind. The demand for research in Arabic is less, which has led to lesser consumption of research among local investors, which has in turn led analysts to shift their focus to research primarily in English.

Investments based on sentiments and speculation
GCC markets are top-heavy, and investments are restricted mostly in the large- and mid-cap space. These investments are driven primarily by sentiments and speculation. Trading volumes are driven mostly by word-of-mouth information.

Lack of Liquidity in the mid-cap and small-cap space
Lack of liquidity, especially in the mid-cap and small-cap space, and general lack of investor interest has led to lower research offerings in this segment. The draining liquidity and the top heavy nature of the Kuwait bourse has led to dwindling analyst interest in the mid-cap and small-cap segment. Lack of new listings in the domestic market and landmark events in other regional indices has also contributed to lower liquidity in Kuwaiti bourse. Stock turnover ratio has been on a declining trend and stood at 22% in Kuwait Stock Exchange as against GCC average of 76%.

Shell or Investment Companies
A lot of the companies in the Kuwait stock exchange, especially in the small-cap segment, are shell companies or investment companies that trade on many of the asset classes, such as equities and real estate. Many of these experienced severe losses in the wake of the 2008 global financial crisis, and have not recovered since. Before the crisis, credit towards purchasing of securities, to the real estate sector and investment companies amounted to almost 50% of the total credit disbursed. The fall in equity value was exacerbated by leveraged positions of the market participants and consequently, credit disbursal fell to low single digits contributing further to lower liquidity in the bourse, which led to these companies halting their trading operations.

Information disclosure and Time taken
Kuwait companies lag in timely disclosures compared to their regional peers, and the time taken for compliance is a lot more lenient. This can be seen in regular filings of financial results, where Kuwait lags behind the rest of the GCC. Delays in acquiring time-sensitive information and minimal public disclosures discourage analysts from following companies.



From the above two tables it can be seen that while the number of companies that have declared results seem much lower, in terms of market cap it is relatively higher. The reason for this is the declaration of financial results happens faster large-cap companies, as compared to mid- and small-cap companies. In the case of Kuwait, while only 16% of companies had declared Q4 results on 22 Feb 2015, this represented a market cap visibility of 54%, which implies that large-cap companies are quick to comply with exchange regulations compared to other companies. Also, compared to the GCC countries, Kuwait seems to have relatively lenient regulations as can be seen with the lowest company visibility.

Following the outbreak of financial crisis, regulators have increased required disclosures and filing requirements. But the cost of compliance, which includes auditing and disclosure costs has increased. In certain cases, the various costs associated with listing such as continued expenditures related to filing financials and ad hoc material information disclosures may no longer be a viable proposition, especially for smaller and undervalued companies.

The issuance of new regulations by the Capital Market Authority (CMA) of Kuwait in 2013 to improve investor confidence, gave the CMA greater independence to stop market irregularities, and boost transparency in bourse dealings. This gave the regulatory authority teeth to go after companies that are non-compliant with issued regulations and exchange rules, as seen with a number of companies that have been delisted recently – voluntarily or involuntarily – due to long inactivity, suspension of trading or failure to publish financial results within the stipulated time. Poor operational performances of firms resulting in losses that cumulatively exceed 75% of their capital are also delisted. But the strict enforcement of corporate governance and exchange rules still lags behind the rest of the GCC peers.

What should be done to increase analyst coverage?
Kuwait is behind the curve compared to other GCC countries in improving capital market efficiencies. Despite being the oldest stock exchange with the maximum number of listed stocks, the market lacks the required breadth and depth due to the concentration of stocks to a limited number of sectors. Increasing the depth would encourage research activities. Steps should be taken for Kuwait to represent the MSCI EM Index similar to UAE and Qatar. The first step to achieve that would be encouraging foreign investors to invest in the market. The fact that the market is dominated by retail participant’s disincentives the needs for research. Steps should be taken to encourage domestic institutional investors who have a longer term investment horizon to invest in the stock market which would also bring in the much need liquidity.

The Capital Market Authority should look at enforcing corporate governance codes to improve quality of disclosures. It should also encourage companies to engage with the analysts on a regular basis to ensure maximum information sharing. The CMA should also ensure that there is timely availability of information and data on listed companies either on through a separate website or through the existing system. Cross-listing stocks on other regional exchanges where there is more analysts coverage could aid in spurring research in Kuwait.

Published by Marmore MENA

Tags:  Cap, Capital, GCC, Market

 Current rating: 0 (3 ratings)

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