Investors are falling into a liquidity trap in the GCC:
I am increasingly hearing of people investing into positions in the markets because they think that the price of a share is cheap due to a decline in the price. The price is not cheap, it is low for a reason.
Worse, when these investors enter the market and buy the shares they think they have made a great decision when they see prices immediately rise. But prices in such situations usually rise because the shares are illiquid and the buying just pushes up the price artificially.
To understand this we first have to define liquidity, which in this case is how quickly one can buy or sell shares without affecting the price. This alone is not specific enough, because there is a difference between selling one share and selling a million shares. This brings us to the concept of average daily trading value (ADTV), or the total value of the shares of a particular stock traded every day averaged over some period. If we look at the trading size as a percentage of value traded we can get a better picture if trading a certain size in a single day is liquid or not.
So, for example, if the trading size is 1 per cent of ADTV then it is usually safe to assume that it is liquid. However, if the trading size is, for example, 20 per cent of ADTV, then doing it all in one day without affecting price is difficult. Looking at the Dubai Financial Market (DFM), as an example, in the second quarter the value traded for Emaar Properties was Dh3,227,999,534 which gives, using an estimate of 64 trading days, an approximate ADTV of Dh50,437,493. This would indicate that buying Dh1 million shares of Emaar Ptoperties, representing about 2 per cent of ADTV, in the open market on a single day should not impact the price. On the other hand, the same calculation of Shuaa Capital gives an approximate ADTV of Dh2,452,726 indicating that an equivalent size trade to Emaar of Dh1m Shuaa shares in a single day would constitute about 40 per cent of ADTV and would likely affect the market price.
This means that for the investor who buys a relatively illiquid stock and sees a price rise, it is most probably a phantom profit as once the investor tries to sell the price appreciation will reverse or worse.
This is completely unfair if this is being done by an asset manager who is charging a fixed fee on assets under management (AUM). Let's say the manager buys Dh100m of an illiquid Dh0.50 share in a block-trade from a distressed seller. This won't move the market. But if the manager then buys Dh1m of the shares in the open market then he can easily move the price to Dh1 per share, increasing the position to Dh151m with a profit of at least Dh50m on paper.
If the manager is charging a 1 per cent management fee, then doing so on the inflated valuation of Dh151m is equivalent to charging 1.5 per cent on the actual value of Dh100m. Of course these outsize returns can be made bigger by pushing the price further.
Worst of all, when the manager tries to exit, if he can't find another investor to sell to in a block-trade, then unloading all those shares will obliterate the stock price. The asset manager would make outsize fees on inflated valuations and then walk away free.
Some will argue that the performance fees that asset managers usually charge would help to align their interests with their investors. But remember, performance fees are contingent and charged to profit whereas management fees are guaranteed and charged to the assets.
The idea of announced values being much higher than actual values is not new.
For this reason it is imperative that investors demand from their asset managers certain liquidity guidelines, or at the least apply management fees retroactively after exit. The risk is ending up with a highly illiquid portfolio that looks good on paper but you only find out the truth when you try and sell into the market.
Foreign investment in local equity markets higher:
My foray into DFM's historical data unearthed some interesting nuggets, both of which I consider positive. For the first half of this year, Arab investors, including from the GCC, withdrew a total of Dh1.6 billion from the market whilst UAE citizens invested a total of Dh421m. Here is the first interesting bit, the total investments by non-Arab investors was Dh1.2bn. That is remarkable and exactly the kind of statistic we want to see, a more balanced and broader foreign investment profile.
In essence what the above indicates is that the UAE has managed to increase foreign non-Arab investment at a time when oil prices have dropped from historical levels. This is not only a vote of confidence, it is a positive trend.
The second statistic is type of investor, with individuals selling Dh628m to institutions. This, too, is positive as increased institutional investing is key to developing a market, not least because they have a higher tendency to impose corporate governance.
Unexpected executive departures:
Last week saw the unexplained resignation of two senior executives, the chief executive of Jumeirah Group and the chief investment officer of Emirates NBD.
There are several pertinent facets to these announcements. First, both seemed to be abrupt as there was no permanent successor named in the reports. Second, both left after a relatively short tenure, with both executives having had taken on their roles in January 2016.
In the case of Jumeirah there are a number of relevant organisational changes: the chairman joined from the parent, Dubai Holding, in March and who in turn appointed Dubai Holding’s chief executive to “run the [Jumeirah Group] business together” with an interim chief executive from within the group. When a chief executive leaves three months after a new chairman is appointed to the parent, there may or may not be an issue. When the chief executive of a parent is sent in to co-run a subsidiary business the implications are not usually positive.
The matter with EmiratesNBD's chief investment officer has less going on around it but the short tenure with no prior succession planning does not augur well.
Here is my fear: are the decision-makers in these cases clear on whether the issue is with the executive or if it is simply an unavoidable consequence of our challenging economic times? If it is the latter then boards and CEOs could create unnecessary employee turnover and lose the very people who have information to help the company.
It is difficult to ascertain if this is going on as there is not enough information. This lack of transparency is unfortunate in the case of EmiratesNBD, a publicly listed company that is the second largest bank in the country and regulated by both the UAE Central Bank and the Dubai Financial Market. As Jumeirah is private there is a lower bar in terms of transparency, but if Dubai’s sovereign wealth fund the Investment Corporation of Dubai (ICD) can adopt global best practice for corporate governance and publish audited financials then I don’t see why other private entities could not adopt the same philosophy. As an aside, ICD is also the majority owner of Emirates NBD, the bank could learn from its largest investor.
The Abu Dhabi Investment Authority’s (Adia) performance:
Last year I did a bit of complex analysis, mostly trying to estimate returns, to understand Adia’s 7.5 per cent 30-year internal rate of return (IRR) ending in 2015. This year I will make it easier. Adia’s 2016 30-year IRR was reported as 6.9 per cent. Did ADIA perform poorly in 2016?
It is difficult to tell as there are two bits of information that we need. First, recall that investment performance is usually against benchmarks. We do not know what Adia’s is, but I have used the MSCI World Index. It isn’t necessarily appropriate but given Adia’s size, which means it is a major global investor, it can be insightful. The other thing we need to remember is that the 30-years ending in 2016 starts in 1986 whilst for 2015 it started in 1985. Therefore the only difference between the two are the years 2016 and 1985.
So we can look at the difference in 2016 return relative to the 1985, i.e. if Adia had a return of +20 per cent in 2016 but +30 per cent in 1985 then the 30-year IRR drops even though Adia did well in 2016. This is because the IRR gains the +20 per cent of 2016 but loses the historical +30 per cent of 1985. In this case Adia would be penalised on their good 2016 return because they had made a much better one in 1985.
From a mathematical point of view we can't get the actual difference between Adia’s 2016 and 1985 returns, but we can get the ratio. For Adia its 2016 return is 15 per cent lower than its 2015 return. The MSCI WI as per MSCI’s website is 5.32 per cent for 2016 and 36.62 per cent for 1986 which is a decline of 23 per cent. Adia clearly outperformed the MSCI WI in 2016 relative to 1985 by a large margin. Since we don’t have actual numbers we can’t tell if Adia underperformed the MSCI in 1986, outperformed it in 2016 or a combination of both.
What we can say is that Adia has, directionally, improved dramatically in its ability to manage its investments. A sign of the growth of our country not only in terms of population, real estate and economy but also in terms of effectiveness and efficiency.
Sabah al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com