Manage the risks sensibly and the region can offer investors growth opportunities that are significantly higher than elsewhere in the world.
Mena at the frontier but its prospects are bright
A look at the Middle East and North Africa (Mena) region through the frontier markets lens reveals a tale of opportunity unbound.
This has been a lost decade for most developed stock markets. But for much of the developing world, it has been a period of soaring markets and unparalleled prosperity.
To believers, those gains highlight profound shifts in the global economy. Investors worldwide, in search of higher yields and more importantly growth, have been in constant pursuit of the next emerging hot spot.
While early investors in emerging markets have realised significant gains, the natural slowdown of the Bric countries has opened the door for faster-growing, lesser-known economies to rise through the ranks.
An increasing number of investors have started to take interest in frontier markets as sources of new and diversified areas of growth.
The term "frontier markets" is commonly used to describe a subset of emerging markets that are in the early stages of capital market development.
Frontier countries have dynamic, fast-growing economies, young populations, growing consumption patterns and large infrastructure needs.
The Mena region accounts for more than 60 per cent of the MSCI Frontier Markets Index and as such represents by far the largest component. With an overall GDP of more than US$1.8 trillion (Dh6.61tn), which is forecast to grow to more than $2.4tn by 2017, and with a population of 170 million, the region represents a sizeable economic bloc that compares favourably with the larger Bric countries.
The Mena region offers exposure to economies with organically high growth rates that are supported by a combination of low debt and ample reserves.
Moreover, pro-growth fiscal measures and accelerating bank lending have created some highly compelling investment opportunities for investors.
Current valuations are also attractive, from both a relative and historical perspective, and are complemented with a degree of downside protection.
As a region, the dividend yield on offer is among the highest globally. Finally, there are a number of transformative catalysts on the horizon, such as the potential liberalisation of the Saudi Arabian equity market to foreign direct equity investment.
So why has the region's performance been lagging its emerging market peers? For one, regional markets had been pressured following a series of unsettling events starting with the financial crisis in 2008 and culminating with the Arab Spring early last year.
Fortunately, markets have returned to normality and their performance this year has been positive, with the S&P Pan Arab Composite Index returning growth of 4.3 per cent asof the end of September. Markets such as Egypt, Dubai and Saudi Arabia have been leading the way, gaining 58 per cent, 18 per cent and 7 per cent respectively.
Another factor affecting the region's performance is the lack of a dedicated investor base, which has allowed for added volatility as market liquidity continues to be driven by retail investors. Fortunately, the frontiers market story is gaining traction.
This new development has opened the region to a small but growing dedicated investor pool.
Furthermore, the eventual transition of some of the Mena countries such as Qatar, the UAE and potentially Saudi Arabia from frontiers market status to emerging market status should increase the dedicated investor base from about $15 billion to $450bn.
Given the substantially weakened global growth environment, non-cyclical domestic growth companies are favoured over cyclical, export-driven investments.
Firstly, we favour consumer and retail plays wherein supportive demographics and improving spending trends underlie an exciting demand story.
Within the retail sector we prefer products that have a degree of price inelasticity and can maintain margins in a potentially inflationary environment.
We are also keen on accessing companies that are directly or indirectly exposed to governments' infrastructure spending. Specifically, we target contractors and materials suppliers to these projects.
Finally, we are invested in banks that operate within a supportive macroeconomic backdrop. We are encouraged by accelerated lending in countries such as Saudi Arabia, Qatar and Oman, a trend that is likely to be supported by high capitalisation, enhanced liquidity and reduced provisioning expenses.
In terms of risk, there are undoubtedly political and market risks involved in investing in the region.
However, investors should put these risks into perspective as they are prevalent, now more than ever, in most global equity markets.
The key to managing risks in any market is to carry out thorough due diligence and to maintain a well-diversified portfolio.
The Mena region is an attractive investment destination with high growth potential supported by continued government spending, relatively low debt levels and higher than expected oil revenues bolstering already large government reserves.
The region continues to offer strong GDP growth prospects that are significantly higher than elsewhere in the world.
Finally, we continue to be encouraged by the region's integration with global capital markets which, in our view, will allow access to new pools of capital, needed for the further development of the economy.
Salah Shamma and Bassel Khatoun are based in Dubai as portfolio managers and co-heads of equity asset management at Franklin Templeton Investments