- The Middle East is too big a part of the emerging market bond investment universe to disregard
- Positive reform momentum and intentions create interesting investment opportunities
- We will continue to be selective in what opportunities we pursue, but the Gulf remains a ‘classic’ EM opportunity
2023 promises to be another busy year for emerging market (EM) debt investors, but it won’t just be the geopolitics keeping us on our toes – rather the change in investable universe. 2022 saw a swathe of high-quality Russian debt exiting indices, which is fast being replaced by a deluge of predominantly investment grade-rated Middle Eastern issuance. This changes the flavour of investing in EM, leaving investors with no choice but to seriously consider investing in the Gulf region.
Cognisant of this shift we decided it was time to visit the Gulf region to meet with the governments and companies behind the issuance. There are without doubt some areas that must be quickly addressed in order to be credible in the global market in the longer term, but we also identified some real areas of opportunity.
Why the increase in issuance now?
The region benefitted from strong energy prices last year, strengthening government balance sheets and building economic resilience. The region as a whole is cash rich, and companies have very low leverage and decent liquidity buffers, so why issue at all? The reason is simple: oil and gas, which is the foundation of this financial stability, has a shelf life and the region needs to diversify. This will require access to the international capital markets. It makes sense to issue from a position of strength and proactively address the role the region intends to play in the push towards a greener tomorrow.
Since the phased inclusion of five of the six Gulf Corporation Council (GCC) countries (excluding Oman) into the JP Morgan EMBI global Diversified Index (EMBIG) from January 2019, they have rapidly grown to become a key component of the index – 24% as of March 20231.
With a slew of new issuance to come, we estimate the region could make up almost a third of the benchmark in the medium term – an opportunity set we don’t want to miss out on.
Where are the opportunities and hidden gems?
What is apparent is that as the economic landscape evolves and transformation efforts take shape in the region, investment opportunities are starting to emerge.
Firstly, quasi sovereigns now have the remit to take an active role in driving change and are issuing debt to fund ongoing giga projects2. If names like Saudi Arabia’s Public Investment Fund (PIF) are able to properly frame their environmental, social and governance (ESG) credentials and build a decent track record they could increase their appeal to more investors. Secondly, to be a major global supplier of clean energy, companies like Masdar Clean Energy (UAE) and ACWA Power (Saudi Arabia) are key. We expect energy transition names like these to issue soon, providing a more palatable investment option with tangible green ESG focus for more sceptical investors. Thirdly, we expect to see issuance from a more diverse range of sectors like industrials, non-hydrocarbon mining and retail. Many non-oil and gas companies are set to benefit from government diversification plans and there may be opportunities that offer exposure to a rapidly growing region. These companies, which will vary in size, can piggy-back off the momentum of the larger company issuances.
Challenges facing the region
The main challenge facing the Middle East is the weak social and governance track records. Progress in areas including legal, judiciary, labour and social aspects – while still at early stage – has been encouraging but uneven. One notable observation is the rapid rise in female participation in the workforce, which is also evident in the upper echelon management teams in the private sector, as well as ministerial roles in governments. We expect this positive reform momentum to continue, hopefully at greater pace and depth.
Regional financing options, which have been more limited in the past, are set to expand as development of credible sustainability/green financing frameworks gets underway. The recent successful access to green financing by a quasi-sovereign in the region has helped to set the benchmark and should open up a pathway to typically neglected smaller companies in the region. However, we remain highly selective when it comes to these investments as credibility is still lagging versus some of the green aspirations of these entities. The rhetoric we heard had a lot of ”greenwishing” – the hope to be green – but there was still a way to go. We must hope companies don’t get caught up in those aspirations too soon and can avoid a green financing crash diet and ultimately accusations of ”greenwashing”.
Conclusion
Whether you believe the transition story in the Gulf region or not, new issuances are set to come –and fast. Given the growing importance of the Middle East, not only in EMs but on the broader global stage, we see this as the right time to get involved by investing in those hidden gems where real change is starting to emerge. After all, isn’t that what EM investment is all about?
