Seeking 'Alpha' in Mena stock markets

The current economic and financial story of the Middle East is attracting attention globally as investors seek refuge from turbulent international markets. Investors aspire to understand the dynamics of the region and explore undervalued investment opportunities that generate consistent excess returns - or Alpha.

The Middle East is no longer a story just about oil. The region is entering a new era, buoyed by strong and sustainable diversification of real GDP. This growth is driven by: increased government spending across various sectors; substantial private sector investments and projects boosting the contribution of the banking sector's project finance divisions; improvements in the regulatory and corporate governance landscape; and the general increase in regional wealth encouraging consumer spending and borrowing. These factors have a positive knock-on effect on other sectors and to the North African and Levant regions, natural beneficiaries of that spillover.

The region's apparent ability to weather the current global economic storms further boosts its appeal. The banking sector has emerged from the US subprime crisis with insignificant reported writedowns and Mena markets performed reasonably well as corporates continue to show strong profitability. This immunity from the credit crisis is a result of the region's unique internal drivers. A surplus in petrodollars coupled by governments' responsible approaches to spending and investing that windfall is translating into sustained, long-term economic growth and diversification.

In addition, up to $200 billion of foreign investments from managers tracking the MSCI Emerging Markets index may be attracted to the region if the UAE, Qatar and Kuwait are reclassified from frontier to emerging market status by MSCI.

Question of sustainability

Inflation, a macroeconomic concern worldwide, is not adversely affecting the regional companies that have strong fundamentals. Interest rates, pegged to the dollar, are low, helping to underwrite the growth outlook. Importantly, construction companies that have locked in raw material costs at 2006-07 prices have projects that remain attractive investments, as do others where the increased costs are passed on to the purchaser.

Currently, policymakers limit inflationary pressures through government imposed subsidies and freezes on price increases across various sectors. Fiscal policy is being looked at as a further macro policy tool with the UAE, for example, announcing the possible introduction of a Value Added Tax (VAT) in 2010.

What is an imperative issue to the sustainability of the economy is the improvement in regional education to support the local workforce's advancement into highly skilled jobs.

Diversification of the economies and markets herald a more sustainable business model with less dependence on oil and its price volatility. Strengthened by a young and growing population, Mena's contribution to world GDP is predicted to increase from 2.6 per cent in 2003 to 4.1 per cent in 2009. As the Mena markets mature, we can expect an improvement in corporate governance and company disclosure, as company's shift their focus to the creation of public shareholder value.

Attractive absolute and relative valuation multiples; strong profitability and expected future growth; experienced management teams and returns that have a low or negative correlation with traditional market returns in the US and Europe imply an ideal portfolio optimisation decision.

ING Investment Management believes that global investors remain considerably unexposed to the robustness of this region. We're meeting demand by manufacturing high-performing local strategies (across various asset classes) that we can export through our extensive global network, with our experienced investment team in Dubai.

The writer is chief investment officer, ING Investment Management Middle East.