This year was a fairly unpredictable one for the GCC. In spite of significant geopolitical events, there were clear signs that the economy was beginning to turn around. Higher oil prices brought fiscal deficits down further, and will likely enable a more expansionary fiscal policy in the year ahead. Non-oil GDP also continued to grow and corporate earnings finally saw a positive inflection – all leading to signs of more growth.
In this context, I believe GCC bonds could hold the key to unlocking significant investment opportunities in 2018. This asset class consistently offers lower volatility, higher yields and stronger risk-adjusted returns than developed market bonds. When it comes to emerging market bonds, GCC bonds often have better underlying fundamentals and higher credit ratings. We are therefore constructive on GCC fixed income as an increasingly relevant and growing asset class.
And yet GCC bonds remain an area that many global investors under-appreciate. According to our analysis, very few active bond managers appear to invest in GCC countries. For example, GCC bonds are not included in most major benchmark indexes, or have negligible representation in them. The region has only a 0.4 percent allocation in Bloomberg Barclays Global Aggregate Index, and a 1.4 percent allocation within the JP Morgan EMBI Global. Therefore, the assumption that active investment managers – even in the emerging-market space – provide significant exposure to the GCC is not a correct one.
I believe there are two main reasons for this underappreciation. The first is local knowledge and expertise. GCC bonds suffer from a lack of active managers who have ‘boots on the ground’ in the region, without which it can be a difficult market for a non-local investor base to understand. As one of the only global asset management firms based in Dubai with local asset management capabilities, this gives us a unique insight into the GCC’s fixed income markets.
Second, there is a misconception that GCC markets are volatile and may increase portfolio risk. Many investors assume the region is susceptible to headline risk and oil price volatility, despite the counterintuitive reality that GCC bonds have very low correlations to the price of oil, for example. In fact, GCC bonds fact have proven relatively stable amid geopolitical uncertainties, and dedicated, domestic demand for this asset class has remained resilient even during downside scenarios. The idea that GCC fixed income markets are heavily impacted by shifts in oil prices is largely inaccurate.
As we look towards 2018, we believe that the GCC bond market will continue to remain an attractive asset class because of three larger trends we see continuing: improving fundamentals, stable credit ratings, and healthier issuance growth.
For example, with a market size of approximately $300bn, the GCC as a market continues to benefit from sizeable pools of reserve assets, relatively low debt to GDP and a well-capitalised and committed investor base.
This is a conducive environment for the growth of GCC bonds, with Saudi Arabia and Kuwait both indicating that issuances are increasingly becoming a stable source of raising revenue. Lastly, potential downgrades are at historic highs globally. The GCC, however has just emerged from its economic and rating down turn with almost $3 trillion in foreign exchange reserves (representing approximately 200 percent of the region’s GDP) and a distinctly different stage of the credit cycle to look forward to.
For all of these reasons, it appears that the region is indeed more insulated than the rest of the global credit universe, and that there are investment opportunities in its fixed income space. Despite the ongoing geopolitical tension we may continue to face in the New Year, we think GCC bonds could be an increasingly attractive asset class for many investors.
We are excited about the year ahead and what opportunities for growth GCC fixed income may present.
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