There are market-beating returns to be found in GCC mutual funds, but investors need to pay attention to performance and fees
Mutual funds are actively managed investment funds that invest mainly in equities or fixed income products, or a mixture of the two. With an investment strategy guided by a skilled asset manager, mutual funds aim to provide market-beating returns.
However, with nearly 400 GCC-domiciled mutual funds on offer, plus many more offshore funds, picking the right ones, and having good diversification in a portfolio, is essential.
Fees are unavoidable when an investment is under active management, but some funds charge higher fees than others, so investors need to make sure they closely read the terms and conditions in the prospectus.
Why mutual funds?
With many GCC-domiciled mutual funds investing in local equities, bonds or sukuk, and exclusively long the market, they typically need some degree of economic upswing and positive growth in stock markets or fixed income if investments are to grow.
“First of all, investors [in local funds] need to believe in the regional growth story, or believe that there’s opportunity here,” says Ali Al-Salim, co-founder at Arkan Partners, an alternative investment advisory firm.
Investors should also consider the downsides. Markets here are mainly classified as emerging, meaning greater risk, while the economies of the GCC are still heavily reliant on the price of oil, Hamzah Shalchi, the Middle East regional director at Guardian Wealth Management, says.
“I would not be advising people to be putting a huge majority of their portfolio [into GCC funds] unless they’re willing to ride the storm. There’s great opportunity for growth but the region is very volatile, [investors should be] looking at investing 10-15 per cent of their portfolio here,” he said.
Indeed, GCC investors are becoming more and more eager to gain exposure to non-GCC markets, Giorgio Medda, the head of MENA and Turkey (MENAT) region for Azimut Group, an Italian-headquartered asset management company, says. He adds that some locally-domiciled funds can provide this.
For instance, Azimut Group offers a global sukuk fund, with $200 million of assets under management – of which 40 percent is invested outside of the Middle East, including Asia and Europe.
“That gives investors exposure to the regional macro trends – most importantly, the oil price – and the possibility of being invested in a product where there are exposures that are driven in inverse correlation to oil prices, such as investments in Turkey or Indonesia where a falling oil price is a key positive for these economies to perform better,” said Medda.
By shifting the ratio between equities and fixed income, managers can also look for growth in equities when stock markets are performing well, while fixed income products can provide stability when indices are generally performing poorly.
Masraf Al Rayan’s Al Rayan GCC Fund was launched in May 2010 and for the first five years of the fund’s life the ratio was around 85-90 percent in favour of equities to take advantage of the bull run in the markets – that ratio has now shifted to around 50 percent equities, 45 percent sukuk, according to the senior director of asset management at Al Rayan Investment, Akber Khan.
It is the largest shariah-compliant GCC fund in the region, with around $68 million of assets under management, says Khan.
Which are the good ones?
While picking any investment path requires research and due diligence on the behalf of the investor, when it comes to mutual funds, analysing past performance of a fund can give clues about where to look for good returns in the future.
“There are at least a dozen active fund managers in the region, with long, consistent, well-signposted track records,” Khan says.
Most funds will post their past performance relative to benchmarks such as a local equity index, and investors can look at the website of a fund manager to see their track record and compare it with other players in the market. An absence of information on their website “will be a worrying sign”, says Khan.
“If they try to make it difficult for you to find their track record, don’t pursue it too much because they’re probably hiding something,” he adds. The size of the fund is also important – if it’s too small, it may not survive, says Khan.
To select funds, using an investment advisor can be a smart choice, believes Medda. Investors should not “self-select” investment areas since they often make a choice based on information such as a news story they’ve heard, highlighting a growth area. This approach means “they will be joining the party late,” he says.
“Investors should always end up in the capable hands of an advisor who is able [to carry out] asset allocation, and find the right fund managers for an investor’s strategy,” said Medda.
Checking whether the funds have the right governance framework in place is also essential, believes Al-Salim.
“In light of the Abraaj situation, this topic should be front and centre on all investors’ minds,” says Al-Salim.
“One fund can do better than other funds in any given year, but ultimately if ethics, governance and best practices are not instilled in those asset managers, over time you, as an investor, are exposing yourself to a risk where there is no upside – there is risk that you lose money, but there is no sort of premium associated with investing in a manager that doesn’t have the right infrastructure and internal controls in place.”
Finally, when placing their capital, investors should also look to “average in” their investment, rather than putting it in all in at one time. “It’s important to learn to average in and also average out,” says Khan.
Is passive a better option?
With global, low-fee passive index trackers having performed strongly in recent years, internationally there have been outflows from managed funds, such as mutual and hedge-funds, into exchange-traded funds (ETFs). Though there are relatively few ETFs available that track GCC markets, these are becoming more widely available and their greater use will provide more competition for active managers, said Al-Salim.
In the GCC, the relative lack of depth of capital markets means that investors should look at passive fund options, says Al-Salim. Many mutual funds are investing in the same large-cap companies as other funds – stocks where “all the information is already priced in”, making it hard for one asset manager to have an advantage over others, he believes.
At the same time, there’s not enough market depth for thematic funds, he says.
“It’s not like you’re going to find a fund manager in the region who is a retail specialist – we just don’t have enough retail stocks. You’re not going to get that specialisation,” Al-Salim adds.
Nevertheless, Khan believes that while passive funds have proven their mettle in developed markets, in emerging markets the advantage shifts to active funds. Whereas in developed markets probably around 85-90 percent of funds underperform the benchmark after fees, in emerging markets probably 85 percent outperform the benchmark after fees, he says.
“There are more opportunities to create alpha and generate excess returns in frontier and emerging markets where information is less readily available, and the average investor is more short-term, so a medium-to-long term investor can actually take advantage of short-term volatility to outperform the market,” Khan argues.
Fees, fees, fees
Mutual funds have a variety of fees. The most common is the annual management fee, which may be in the range of 1-2 percent for an actively managed fund. Equity funds typically have higher fees than fixed income, because in theory the returns are higher. Other significant fees can include a front end fee, also known as a subscription fee, which may be in the range of 0.5-2 percent, while some funds also have redemption fee.
Redemption fees may decrease the longer capital is held in a fund, sometimes to zero. Performance fees may also be added, while there may also be other charges such as custody and transaction fees as well as expenses, so it’s important to read the fine print in a fund’s terms and conditions to check for any unexpected fees. If you invest through a private bank there may also be marketing fee.
So what constitutes a good deal? Finding a management fee of 1 percent for an active fund would be a very good deal in the region, said Khan. Of course, with investors looking for net returns, simply picking funds with the lowest fees might not produce results, he notes.
“If fund A has management fees of 1 percent, and fund B has management fees of 1.1 percent, but if fund A has consistently underperformed fund B over the past 10 years you probably want to pay that extra 0.1 percent because of the far better performance if that was to continue,” Khan points out.
The rise of ETFs is also putting downwards pressure on mutual fund fees across the GCC. Steven Cronin, the founder of the website DeadSimpleSaving.Com, singled out mutual funds sold in the region that offer exposure to international equity markets as potentially offering poor value for investors, given the availability of low-cost, passively managed funds from the likes of Vanguard or Blackrock.
Fees on such funds can be as low as 0.25 percent, or even free. Going forward, the increasing availability of ETFs, and new distribution channels within the region, such as robo-advisors, will continue to put downwards pressure on fees, Cronin says.
“For GCC stocks, there is a valid niche, but it’s going to be increasingly hard to [sell mutual funds] for international stocks. Active managers are really having to fight against that tidal wave of money going into passive, and I’m not sure that tide is going to reverse any time soon.”