MENA Q1 2025 Manager Letter

MENA equity markets ended the first quarter of 2025 with returns of 2.7% (for the S&P Pan Arab Index Net Total Return) broadly in line with the MSCI Emerging Markets Index which was up 2.9% in the same period.

While index-level returns were healthy in the first quarter, they were flattered by rather aggressive buying in large cap Saudi stocks (the largest member country in the index) in the four days leading up to the Eid holidays (close of March 27). In fact, 1.9% of the 2.7% gains for S&P Pan Arab Index in the quarter occurred in those four days of trading. Underlying trends in the Saudi market were far less encouraging, with 169 of 246 stocks in the Tadawul All Share Index posting a negative quarterly return amidst significant underperformance from midcap stocks (MSCI Saudi Midcap Index -4.0% in the quarter).

Uncharacteristically, it was the smaller Kuwait market that stood out in the quarter, with the MSCI Kuwait Index up 11.4%. After nearly a year’s wait, the country’s reform program is beginning to take shape, with the cabinet approving the long-awaited debt law that is counted on to unlock a significant proportion of the financing required for a much-needed infrastructure spending program. The approval of the debt law also paves the way for the new mortgage law, which is expected imminently. The mortgage law creates a new market estimated at $65 billion (source: Bloomberg) which allows banks – for the first time – to offer mortgages. Kuwaiti banks are obvious beneficiaries as they are sitting on significant excess capital which can be deployed in attractive risk-adjusted assets in corporate lending (infrastructure spending), government bonds (via the debt law) and mortgages.

Another (even smaller) market that performed positively in the quarter is Morocco. The MASI Free Float Index was up a remarkable 25.6% in the quarter, although its impact on the regional index is limited due to its small size. The market was supported by a one-off 5% tax amnesty that brought almost $10 billion worth of assets and cash (from Morocco’s large grey economy) into the banking system and the equity market. Interestingly, this also resulted in a doubling of retail investor participation from the historical average of 12-15% to over 30% year-to-date ending March. The market was further bolstered by a policy rate cut of 25 bps which catalysed further flows into equities. Moroccan institutions have limited options to deploy capital outside of their local capital markets and as a result exhibit high-interest rate sensitivity that manifests itself in visible and sometimes aggressive shifts between equities and bonds.

Looking forward, the investment outlook has been muddied by the ongoing escalation and volatility in US trade policy. While the direct impact of tariffs on the region is limited, the indirect impact is significant and captured primarily by the weak oil price. Cracks in the OPEC+ alliance are also beginning to appear, which, together with slower global trade, cast a long shadow on the oil price outlook. While there are varying degrees of sensitivity to the oil price in the region, a sustained low oil price (in the low $60s on Brent) is invariably negative. Fortunately, the region’s countercyclical buffers are plentiful and can absorb the fiscal and current account pressures of a lower-for-longer oil price environment.

The region’s geopolitical position also appears robust and highly relevant, which puts it in a good position (relative to other regions) to weather the fallout from the rising tensions in Sino-American relations. The end of the multi-year USD bull run is another factor to consider; increasing openness to foreign portfolio investors and the USD peg increased the share of the region’s ex-US capital inflows in the last decade or so. Insofar as USD bearishness is coupled with a weaker oil price (as is the case now), the region’s share of global inflows is likely to decline in % terms. This, of course, would be the opposite for the smaller oil-importing markets in MENA like Egypt and Morocco, where a weak USD and a lower oil price sets up an accommodative environment for fiscal and monetary conditions, and ultimately asset prices.

While we have a view on macroeconomics, that is certainly not our investment edge and therefore not a tool we count on for making major investment decisions. As we’ve articulated in previous letters, our edge comes from having a deep understanding of the companies we invest in. This understanding is critical in our ability to determine the impact that macroeconomic changes have on the earning power of our companies.

Crucially, this knowledge is leveraged in our valuation framework and gives us a good (and historically reliable) barometer of when our companies are under or over-valued by the market. As stated in previous letters, valuations are the ultimate determinant of our capital allocation reflexivity and is a key tool we rely on in making investment decisions. This has served us well year to date as it reduced the portfolio’s exposure to areas where the market was not prepared for any bad news, and subsequently increased exposure to areas where good news was not needed for outperformance.

As a result, we find ourselves in a strong position where the portfolio generates a dividend yield that is nearly the same level as the index (~4%) and trades at comparable multiples on a P/CF basis (~7x), but with vastly superior fundamentals (captured in an ROE of 18%, which is 500 bps over the index average). The portfolio is sitting on a healthy level of cash which puts us in a good position to make surgical and incremental bets when we deem that the market has overreacted (negatively) on stocks where earning power remains relatively intact. The environment remains fluid and volatile, but our barometer is beginning to signal pockets of under-valuation that we aim to take advantage of in the coming period.

We look forward to continuing to update you on the strategy in the next letter.