MENA Q3 2023 Manager Letter

MENA equity markets posted negative returns in the quarter (-1.3%) as indicated by the S&P Pan Arab Composite Index. However, they still managed to materially outperform emerging markets, which declined by -3.7% (as measured by the MSCI Emerging Markets Index). There was a high degree of performance dispersion in the quarter, with the Dubai Financial Market General Index up 11.2% and the Tadawul All Share (Saudi) Index down 3.5%. Year-to-date, the performance spread between the best-performing market (Dubai) and the worst-performing one (Kuwait) is a remarkable ~32%. This performance divergence theme is also evident within individual markets. Saudi mid caps, for example, outperformed the broader country index by a staggering ~16%, as seen in the difference between the MSCI Saudi Arabia Midcap and the MSCI Saudi Arabia Index.

This degree of performance dispersion in the region is unusual during periods of high oil price, which have typically raised all boats, so to speak. We attribute this phenomenon to several key factors that we believe will continue to influence return dispersion:

• Banks are no longer the only conduit between fiscal surpluses and the non-oil economy. Governments are now channelling more surpluses to sovereign wealth funds and directly funding their own economic programs. This is reducing the deposit opportunity set that was historically available for the banks. This is especially apparent in Saudi, where liquidity conditions are tight, evidenced by a headline loan-to-deposit ratio (LDR) of 96%. Conversely, UAE banks are enjoying an abundance of liquidity, with a headline LDR of 75%. This marked difference in balance sheets reduces the correlation in earnings between the two countries (given banks are the largest sector in both) and is partly responsible for the ~13% performance spread between Saudi and UAE banks on a year-to-date basis in favour of the latter as evidenced by the S&P country bank indices.
• Economic policies among Gulf countries are diverging more than ever. Kuwait’s political deadlock continues to be a drag on government spending and economic growth, a stark contrast to the Saudi pro-growth agenda that is being galvanised by a single vision and strong political will. The UAE is further solidifying its regional competitive advantage through ongoing economic liberalisation (more recently creating a federal authority to regulate the gaming industry), while Qatar appears to be experiencing stunted growth and a hangover from infrastructure investments made to prepare the country for the World Cup. These economic policy outcomes have obvious ramifications for sector-specific corporate earnings growth. At oil prices of $80 and above, earnings growth has a more pronounced impact on equity returns than sovereign fiscal health, in our opinion.
• The structure of equity markets is changing, with liberalisation and issuance activity attracting a new investor base, mainly institutional, to the region. Consider Saudi: the number of listed issuers increased from 188 in 2017 to 228 in 2023, and its weight in the MSCI Emerging Markets Index climbed from 0% to just over 4%. The deeper opportunity set and increased foreign ownership has reduced the contribution of highly correlated sectors like banks and materials in the Index (from 56% in 2021 to 43% today according to Morgan Stanley; note: this has certainly been aided by performance), which has contributed to reducing regional intra-correlations.

Lower market intra-correlations, higher return dispersion, and a deeper and less cyclical opportunity set is a powerful combination that will make stock picking in the region even more interesting, and possibly more rewarding.

Having witnessed the evolution of MENA markets over a long period (since 2005), we are in a unique position to understand the impact of the developments the region is undergoing on equity returns. Our historical understanding complements an adaptive and disciplined investment process rooted in a clear philosophy and focused solely on fulfilling our return promise to investors.

Vergent Asset Management LLP