Don't forget about bonds

When I moved to this region in 2006 I was surprised at the lack of diversification in the investment portfolios of most of the clients I met.

Aside from a few institutions, most focused purely on bank deposits, private equity or the regional equity markets. This situation was even more apparent in the private investor market with many people's wealth concentrated in a couple of asset classes such as real estate, equities and again, bank deposits.

Little has changed in the last two years, but given the turmoil in international credit markets and some of the rich valuations in the regional real estate markets, it is now time for Middle East investors to broaden their investment opportunity set.

Regional capital markets now offer more opportunities to diversify than they did only a few years ago. Not only are regional equity markets easier to access, real estate regulation is helping foreign ownership and most importantly the regional bond market is mushrooming. The types of issuers in this market are also increasing.

A couple of years ago the regional bond market was dominated by financial institutions, now we see issuances from non-financials like TAQA, DP World, Nakheel, and SABIC. This means investors have plenty of choice when looking at bond options.

Yet most institutional and individual investors hardly participate in this market despite the attractive valuations on offer. First, investors in this region are more risk-loving by nature. Second, people do not have a firm understanding of how bond markets work.

There is no primary "exchange" for bonds which are traded mainly in the over-the-counter market. Hence investors who are not active traders in bonds are hesitant and for good reason.

Third, it is often not possible to buy bonds in small denominations and bonds can be cumbersome from an administrative point of view.

So how does one overcome these arguments? Firstly, let's take a live example, say you have 500,000 dirhams that you do not ‘need' for the next two years. Current rates for one-year dirham deposits in the UAE are around 2%.

If you extend that for two years the rate jumps to about 2.25%. Conversely you could invest in a two-year bond at about 4.25%. If you invested the 500,000 dirhams for two years you would earn almost 17,000 dirhams more with this bond.

While this may not sound like much, you have to ask yourself how much more risk have you taken to invest in that bond. The risk that you have taken is that the bond issuer will not be able to repay that bond in two years, which I would argue is a very low risk, - for which you have been paid an extra 17,000 dirhams.

For a very short investment horizon, a bank deposit is often the best solution, but for anything longer a combination of stocks, bonds and deposits will almost always yield the best risk adjusted returns.

So how do you buy bonds, especially in smaller quantities and how do you administer them? In most developed markets, investors gain exposure to the bond market through mutual funds.

This solves the problem of price discovery and of administration of the bond. The bond fund business is growing in this part of the world and I expect it to grow more as these markets develop.

There is an increased sophistication of the financial products on offer which means regional investors must also increase the level of sophistication of their investing.

One basic area that investors have generally neglected is the bond market. The local bond market is growing rapidly, it is attractively priced and access via mutual funds is readily available. The only thing that seems to be missing is the investor.

Abdul Kadir Hussain is CEO of Mashreq Capital.

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