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Tracing The Money Trail

Tracing The Money Trail

As private investors from the GCC divest large portions of their wealth offshore, Aarti Nagraj investigates where the money is headed.

The GCC is home to up to 1.1 million wealthy households, with total investable assets of $1 trillion to $1.2 trillion, according to Booz and Co’s GCC Private Banking Report in 2011.

The consulting firm also estimates that between 50 to 60 per cent of the GCC’s investable assets reside offshore – one of the highest percentages in the world.

Geopolitical risks in the larger MENA region, access to better investment opportunities, interest in professional services abroad, and the desire to preserve privacy, are the combined factors that lead GCC investors to diversify their wealth, says the report.

“Local markets, although developing quickly, are still relatively immature; they have fewer products and services than offshore markets and a less established regulatory environment,” said Booz and Co.

“Investors from the region like to diversify because they learnt [after the financial crisis in 2008] that it was not good to invest everything in one country,” says Christophe Lalandre, executive vice president at Swiss private bank Lombard Odier.

According to Tamer Rashad, head of Middle East, Merrill Lynch Wealth Management, there is now less investment in real estate after the crisis. “It represents about 18 per cent now, but pre-crisis it was much higher than that,” he says, quoting the Merrill Lynch Capgemini World Wealth Report 2011 (WWR). And since most of that real estate allocation was invested locally, this wealth has now been diverted to more diversified investments outside the region.”

The top rung of the wealthy investors – the ultra net worth individuals (UHNWI) and the high net worth individuals (HNWI) began the process of diversification decades ago, explains Philippe Boutron, regional chief investment officer at Societe Generale Private Banking Middle East. “We think that overall finance plays a very important role in the investment strategy. So one would have to consider his needs for his family and invest in a portfolio that would be diversified,” he says.

While diversification is key, the one thing that all private bankers agree upon is that there is no ideal portfolio. Every portfolio is tailor-made according to the client’s needs and requirements.

“If you said to me I want to put a million dollars into a portfolio and I don’t want to touch that money for 50 years, I would say put everything into the cheapest equity market you can find,” says Paul Marson, chief investment officer at Lombard Odier. “But if you say I have one week, and I need it all back, then owning something as volatile as equity is not the best thing,” he says. “There is no one-size fits all strategy.”

That said, amid a backdrop of wildly fluctuating world markets and a potential recession in Europe, Gulf Business explores existing investor portfolios and asks wealth managers which asset classes should preferably be in a portfolio, and which ones don’t make the cut.

WHAT WORKS, AND WHAT DOESN’T

FIXED INCOME

Fixed income is the current favourite among most investors as they attempt to strike a balance between security and performance, says the Booz and Co report. And most wealth managers agree.

Societe Generale says that corporate bonds are currently the preferred asset class among regional investors. The Swiss bank recommends that a majority of that fixed income investment – 50 per cent – should be made in the US market.

“For diversification purposes, we think it makes sense to be exposed to Europe because you can pick up some particular bonds that are attractive with no refinancing risks,” says Ollivier Courcier, the bank’s global head of fixed income.

So he suggests 25 per cent in Europe, and the other 25 per cent in emerging markets.

Fixed income has gained more importance post the financial crisis, agrees Merrill Lynch’s Rashad, and according to WWR, currently represents around 32 per cent of a standard portfolio. “Within fixed income, the bias is on investment grade credit, particularly the US, persists,” he says.

JP Morgan is also particularly overweight on extended credit, especially in the US. “Within credits we prefer upper tier in a high yield spectrum,” says Jim Freeth, managing director and head of JP Morgan’s Private Banking team in the Gulf. The firm suggests a 30 per cent fixed income allocation in a portfolio.

“We also look at slightly more innovative ideas like private credit,” he says. Since several banks have pulled back from lending, there are companies that need financing from alternative sources. So there is an opportunity for those with cash to invest and effectively finance those companies, he says. Small and medium size companies look especially interesting, Freeth adds.

Most experts concur that they are currently underweight on sovereign bonds. “Sovereign bonds are potentially quite dangerous right now. The interest rates are very low, and risk is quite asymmetric,” explains Freeth.

Lombard Odier’s Marson, however, suggests that a degree of government bonds within a diversified portfolio acts as a balance.

EQUITIES

The most volatile among all asset classes, equities must be selected carefully to get the rightreturns, say wealth managers.

In 2011, the S&P 500 Index remained flat and Europe’s markets predictably didn’t have a great year: Britain’s FTSE 100 lost 5.6 per cent, Germany’s DAX fell 15 per cent and France’s CAC 40 dropped
by 17 per cent.

Asian markets were also disappointing: the Nikkei tumbled 17 per cent, the Shanghai Composite and Hang Seng sank more than 20 per cent and India’s Sensex fell substantially by 24.6 per cent.

Equities and stocks currently represent 28 per cent of a portfolio, says Merrill Lynch’s WWR. “Equity outperformance relative to higher risk corporate debt will be modest this year,” forecasts his firm. They are more bullish on US and UK equities than Japan and Europe. In terms of sectors the company is overweight on tech, consumer staples and discretionary because they “focus on yield, quality and growth,” says Rashad.

JP Morgan suggests a 40 per cent portfolio allocation to equities on a strategic basis although the firm is currently underweight on the segment. The firm is underweight on Europe and likes equities in US, Asia and Japan.

The most crucial element with equities is market timing, explains Paolo Moscovici, managing director and head of JP Morgan Private Bank Middle East and Emerging Markets. “If during a crisis you panic and go from 40 per cent equity to zero, and then the market picks up again, you would have got killed on the way in and you would have lost on your way out,” he says.

“It’s very difficult to get it right all the time, so you have to stay the course,” he advises.

There is less focus on equities because the sector has suffered from extreme market fluctuations in the recent months, says Societe Generale’s Boutron.

“The equities that we are looking at now have characteristics that are a little bit similar to corporate bonds. We are looking at companies that have a good visibility on their earnings, and a more than that good visibility on their dividends,” he says.

Lombard Odier’s Lalandre says that regional investors lean towards German and French equities, and are inclined towards the IT and luxury goods sector because they like and understand those sectors well.

In terms of country equity allocation, the Swiss bank favours Germany, Italy, Mexico, Russia and Japan, and is more cautious about the US, China and Indonesia. In terms of sectors Lombard Odier backs healthcare, IT and financial options, but is less keen on utilities, consumer staples and materials.

CURRENCIES

According to Societe Generale’s Boutron, the second biggest asset investment class is currencies (dollar, pound, Euro, and emerging).

“This is done through investment solutions that, such as structured products, allow the client to benefit from short and midterm trends in those markets with a level of protection,” he says.

Merrill Lynch predicts a good first six months for the dollar in 2012, while Lombard Odier is overweight on the dollar, Swiss Franc and underweight on the euro.

JP Morgan’s Freeth says that the firm doesn’t find the dollar or the euro interesting on a long-term basis.

Currencies are more opportunistic and probably one of the hardest asset classes to get right, says JP Morgan’s Moscovici.

“FX is tricky because you have to think about the reference currency of the client. In the Middle East most of our clients are dollar referenced. So whenever we make any kind of investment that’s outside of the US dollar, we think about what effect that might have on the return of the portfolio driven by the currency,” he explains.

COMMODITIES

Gold demand reached 14 year-highs in 2011, mainly driven by record investment and central bank purchases.

The precious metal performs very well in a portfolio, forms a hedge against credit crises, and offers the safest and best return, says Lombard’s Marson.

Boutron shares a similar view. “A moderate part of the client’s portfolio is invested in gold-related instruments that provide a partial hedge against systemic risk and extreme events,” he explains.

Gold is never going to be a huge allocation in our portfolio, but it is part of our philosophy of risk management and diversification, says Moscovici.

Merrill Lynch’s 2012 Year Ahead Report recommends copper, as its prices currently look “unusually cheap.”

GEOGRAPHICALLY SPEAKING

Anecdotal evidence suggests that Switzerland is still the most popular destination for Middle Eastern assets, especially for Saudi investors, says Booz and Co. “Other favoured offshore destinations include London, the Channel Islands (Jersey, Guernsey), Isle of Man, and, to a lesser extent, Singapore,” it says.

“The status of emerging markets as key drivers of growth and the role they play in global recovery is undisputed, and, therefore, continue to be the most popular asset class among investors,” says Niall Husbands, regional head of Wealth Management, MENA at HSBC.

Rashad agrees that most of the investment is heading towards emerging markets, particularly the BRICS – Brazil, Russia, India, China and South Africa.

“More investors from this region specifically have a bigger appetite for Asia within that. Obviously China and India are number one followed by other markets including Singapore, Hong Kong and Korea,” he states.

However, Lombard Odier’s Marson is more pessimistic about the region, opining that the BRICS story is “done”.

Freeth from JP Morgan states that the way you play BRICS is crucial. “For example, we would prefer to play China and Brazil through private capital,” he says.

THE WAY AHEAD

The main question top of investors’ minds during the financial crisis was ‘is my money safe,’ says Freeth. And they are still asking the same question.

“So discipline around risk management, particularly in volatile times is crucial,” he advises.

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