The slump in oil prices over the past few years has hit producers hard in as the impact of shale oil has squeezed margins.
In the Middle East & North Africa (MENA), home to a number of the largest producers, government budgets have come under pressure and investors have become increasingly concerned about the impact on growth in the region.
Performance of Brent crude over 3yrs
Source: FE Analytics
Yet, ignoring the area could mean some investors miss out on the growth opportunities on offer and a region that is likely to become increasingly important for emerging market benchmarks.
Fadi Al Said, manager of the offshore, five crown-rated Lazard MENA fund, says the fall in oil prices has forced some rethinking in the region, with subsidies scrapped and spending plans scaled back.
But the fall in oil prices have not affected markets as investors might have expected.
The manager says oil & gas assets are owned by the state in much of the region, limiting the impact of the fall on markets.
Al Said says the removal of subsidies and adjusted budgets had impacted “some corporates that had exposure to these forms of spending” and the stock markets in some cases.
“Restructuring efforts by governments will hopefully lead to a stronger MENA economy,” he said.
However, the ‘Arab Spring’ of 2011, which saw demonstrations and uprisings in several MENA countries has had a greater impact on the region in recent years.
Governments reacted to calls for more democratic structures and concerns over youth unemployment by initiating schemes at delivering growth in the economy.
Initiatives such as Saudi Vision 2030 – Saudi Arabia’s plan to lower the economy’s dependence on oil – and the United Arab Emirates (UAE) Vision 2021, have included economic planning on a grand scale.
An important part of economic planning has been measures to increase private sector participation in the economy.
With a larger public sector, it has been hoped that private companies can help drive growth and reduce the headcount on government books.
Al Said says some of the developments proposed by governments have provided a healthy environment for private sector companies to take a greater role.
He said: “They won’t be able to improve without facing challenges. If you have some pain, that is a normal process of evolving.”
Looking outside of the Gulf economies, Al Said notes that North African countries have also had to take difficult decisions.
He says Egypt, one of the region’s largest economies recently took the hard decision to devalue its currency. While the devaluation hit the country’s savers, it had a very positive impact for the economy, according to Al Said.
Other developments are likely to change the way that investors view the region. The UAE and Qatar were added to the MSCI Emerging Markets benchmark index in 2014 and could soon be joined by another country from the region.
Saudi Arabia with its vast oil wealth is the region’s largest economy and has been taking steps to open-up the domestic market to international investors.
Recent measures allowing foreign investors to take greater ownership of Saudi companies have allowed the country to be considered for inclusion in the MSCI benchmark index.
The addition of the market would be transformative for the region’s representation in the index and in emerging market passive funds.
Coupled with the anticipated IPO of state-owned Aramco – the world’s most highly-valued company estimated to be worth $2trn – Saudi representation in emerging market investor portfolios will increase, says Al Said.
Additionally, with a potentially greater focus on the region, managers will have to increase their research capabilities, he said.
Based in Dubai, Al Said says the firm finds opportunities through a bottom-up stock picking process that avoids taking a stance on sectors or countries in the region.
“We see value companies sometimes even in the most expensive markets, it’s about having resources on the ground to look for them,” he said. “The companies we invest in offer great value for investors.”
Over the past year Al Said’s fund has returned 41.8 per cent compared with the average offshore MENA-focused fund.
Performance of fund vs sector over 1yr
Source: FE Analytics
The manager said: “Generally speaking some companies are challenged due to the fact that they are not in a favourable position but that means better companies might benefit.”
Some businesses might have come under stress because they have relied heavily on government contracts, says Al Said where it is hard to see a value proposition. “Companies that rely on individual resources are in a much more competitive position,” he said.