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The profitability of asset managers in most Gulf countries will face moderate to high pressure in the next 12-18 months, according to a report by Moody's. It also noted that factors such as the COVID-19 crisis and the drop in oil prices have weighed on assets under management (AUM).
“The sector's relatively low geographic and product diversification and regional geopolitical tensions will add further pressure,” said Vanessa Robert, VP-Senior Credit Officer at Moody's. “Still, an improving regulatory environment and growing interest from foreign investors will provide some counterbalancing uplift.”
Current weak oil prices will hold back economic growth and public spending across the region, with negative consequences for asset managers. Oil is also a key source of revenue for the sector's investor base, which consists largely of local high-net worth individuals, family offices, and government-related institutions, including sovereign wealth funds (SWFs).
According to Moody's GCC governments' plans to reduce their economic dependence on hydrocarbon extraction and privatise certain state-owned assets should contribute to medium to long term growth, and encourage the development of capital markets.
"We expect the modernization of GCC economies and their diversification away from oil to take time. However, the process will over time stimulate private investment across the region, attracting more international investors, and ultimately supporting the growth of the asset management industry," Robert said.
Geopolitical risks
Geopolitical tension is a risk. A recent increase in tension between the US and Iran may harm investor confidence, delaying large scale infrastructure projects, and weakening regional growth. This will weigh in turn on the asset management industry.
“Although we assume that the US and Iran will avoid an outright military conflict, an outright conflict would trigger economic and financial shocks that would significantly worsen operating and financing conditions, with negative consequences for GCC sovereigns,” Robert said.
Regulatory standards
Financial regulations are at different stages of development in each GCC country, but are gradually raising transparency standards, supporting the development of capital and asset management markets, Moody’s noted.
"Recent regulatory changes have improved market efficiency, liquidity, and investor security, and will likely help attract foreign investment, despite the region's comparatively high geopolitical event risk and still limited transparency," Robert said.
"Saudi Arabia, UAE and Bahrain have been at the forefront of recent regulatory improvements. We expect Qatar, Kuwait and Oman to catch up over time," she added.
According to Moody's, the sector would benefit from a standardised set of rules across the region, as well as market consolidation.
GCC asset managers are under pressure to align their corporate governance policies with international standards following the failure of Dubai-based private equity firm Abraaj Group in June 2018, Moody's said in the report.
Abraaj Group went into administration after allegations that it had mismanaged clients' money led prompted legal action from investors, triggering high redemption volumes.
Opening to foreign capital
GCC markets are opening to foreign capital. Most GCC countries have made regulatory changes to attract foreign investors since 2014, when falling oil prices made economic diversification more urgent.
The inclusion of Saudi stocks in the MSCI emerging stock market index in May 2019 has encouraged foreign investment. It also encouraged BlackRock (Aa3 stable) and HSBC Global Asset Management to launch ETFs focused on the MSCI Saudi Arabia 20/35 Capped Index, which concentrates on mid and large-cap companies.
"As GCC markets open, local asset managers will likely capitalise on their expertise in the region to attract foreign clients," Robert said.
Kuwait is on course to be upgraded from an MSCI frontier market to an emerging market in November 2020, "We estimate the change could attract inflows of $2 billion. The planned upgrade follows Kuwait's successful implementation of market segmentation, settlement times, and an increase in the range of products traded on the exchange," she added.
Growth opportunities
The growing demand globally for Shariah-compliant investments has served asset managers in the GCC well. Islamic AUM stood at $84 billion in H1 2019. "We expect global compound annual growth in Islamic AUM to slow to around 2 percent to 4 percent during 2020-2021 from around 10 percent between 2016-2018 as a result of economic and market upheavals related to coronavirus pandemic," Robert said.
The changing economic and regulatory reforms are attracting more local and international investors who want to invest in a more diverse pool of products and asset classes.
Local asset managers are increasingly complementing their traditional product offerings with passive strategies (index funds and exchange traded funds) as well as alternative classes such as multi-assets, real estate and private equity, Moody's noted.
Investor expectations regarding transparency, oversight and corporate governance are rising.
GCC asset managers' ability to attract foreign investment, or to develop partnerships with international peers, will therefore depend on whether they can meet international standards.
“We believe asset managers, in combination with governments, will also drive better corporate governance in the companies they invest in. In Saudi Arabia, for example, the creation of the Parallel Market3 will likely raise standards of transparency and corporate governance for small and medium-sized enterprises (SMEs),” she added.
(Writing by Seban Scaria; editing by Daniel Luiz)
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