The Wealth Management Industry in the Middle East: Boon or Bust?

Introduction

Saudi Prince al-Waleed bin Talal al-Saud has a net worth of $20 billion. Such wealth places him first on the Forbes’ 2011 list of World's Billionaires for the Middle East region. Who manages the Prince’s money? The Prince does. The rich tend to rely on the “balanced portfolio, 401(k) and insurance” wealth management firms less and less. The Middle East’s wealthy number less in headcounts and hold more in assets. Such a concentration of wealth has made them a very attractive target for wealth management firms. The Middle Eastern affluent, rich and super-rich also tend to hold their money abroad, invest most in hard assets (like real estate and commodities) and make large- scale personal investments in foreign companies — making them a very coveted target for the likes of UBS and Merrill Lynch. Yet, the present cherry-picking model of customer acquisition will reach its limits — as the wealth spreads out and Middle Eastern banks learn how to offer Western-style wealth management services.

Middle Eastern policymakers and bankers will develop an indigenous wealth management industry which keeps the super-wealthy’s investments at home. Developing a local national wealth management industry requires letting in foreign competition, changing banking and securities laws, and growing local companies whose shares are worth buying. The first part of the article reviews trends in wealth and wealth management in the Middle East and North African (MENA) region. We show that $800 billion lies-in-waiting for ambitious wealth managers to prospect. We show that foreign wealth managers will continue to capture the lion’s share of this wealth because most local banks can not compete. In the article’s second part, we show why Turkey has succeeded in growing a nationally and internationally competitive wealth management industry — whereas Saudi Arabia’s remains less than perfect. The Turkish policy and the Turkish wealth management industry have succeeded to some extent, because they have grown the pool of the wealth. Whereas the Saudi super-rich contently send their money abroad, their Turkish counterparts use their funds to develop local industry, though they also send quite a lot abroad. In the third section, we describe how policymakers can help bring the billions abroad home by making business easier, reforming banking and securities law, and forcing local banks to become more efficient. In the last section, we describe how foreign wealth management firms can increase their assets under management in the region. These multi-trillion dollar mammoths should use their negotiating power to open MENA markets and grow local multi-millionaires.

The Wealth Management Industry in Perspective

The wealth management industry in the Middle East and North Africa (MENA) represents a roughly $800 billion opportunity. Figure 1 shows the total amount of assets in the hands of affluent individuals (with more than $100,000 in investable assets), high net worth individuals (dollar millionaires or HNWIs as those in the financial industry call them), and ultra-high net worth individuals (the UHNWIs, which have at least $30 million in investable assets). As the figure shows, wealth in the region lies mostly in Turkey and Saudi Arabia — two countries that we discuss in-depth in the next section. Egypt and the United Arab Emirates (UAE) represent a second tier for wealth management firms — with roughly $60 billion to $110 billion in investable assets in the hands of the richest 10% of the population in each country. The other countries in the region represent ancillary markets, with roughly $20 billion in assets each — or the amount of wealth required to make the top 50 in the Forbes 1000.

In the Middle East, most assets lie in the hands of very few ultra-high net worth individuals. According to the annual Merrill Lynch-Cap Gemini World Wealth Report for various years, North American and European wealth tends to spread out at roughly a ratio of $3 million to every ultra and regular high net worth individual in the region. The MENA region — despite the World Wealth’s Report’s data — has ratios closer to 7-to-1. The high concentration of wealth in the region provides wealth management and private banking firms a unique opportunity to service relatively few ultra-high net worth clients without the expense of servicing large numbers of clients. Moreover, the political uprisings in the region will likely do little to dampen accumulation of wealth in the region. Several studies — the Steiner (2010) study being the most prominent — show (rather counter-intuitively) that political uprising has little effect on foreign investment.

The rise of the wealth management industry in the MENA region has been caused by the better than average returns to oil investments (combined with their relative volatility). Figure 2 shows the way that overall equity prices and oil prices have changed in roughly the last 5 years. During the period, oil prices almost doubled at their peak in 2008 and halved again in about the same year. In contrast, global equity prices in general did not fall as much. The standard deviation (the measure of volatility in these prices and thus a proxy for risk) was 1.6 times higher for oil than for equities. Higher standard deviations for oil prices, and thus incomes based on oil, imply that the Middle East’s wealthy require wealth managers who can help them ride out these waves of uncertainty.

These dramatic changes in the sources of Middle Eastern wealth — and relatively lack-lustre returns on equities in global equity markets — probably drove the Western broker-dealer to enter Middle Eastern markets more aggressively, rather than to wait for the Middle East’s ultra-wealthy to come to them in Europe. On the figure, we show some of the many announcements by foreign broker-dealers who increased staff or investments in wealth management offerings in the Middle East or both. As of 2012, most of their major global banks offer wealth management and private banking in the Middle East.

Global investment houses have expanded their offerings in the Middle East. Such entry — particularly by foreign wealth management firms — exacerbates an already existing tendency for investors in the MENA region to invest abroad. Middle Easterners send roughly 70% of their wealth overseas, as opposed to the US and Japan’s 3% and Western Europe’s 25% (Maude, 2006). More recent estimates by the Boston Consulting Group place the off-shoring of wealth management-related assets at about 50% (Becerra, 2011).

Yet, academics and policymakers know very little about whose wealth specifically goes where. Figure 3 shows that estimates for the Middle East region indicate that both the number of wealthy individuals grew — and the amount of wealth grew about 10% in 2009 and about 5% in 2010. Of that increase, most wealth management watchers (like the Boston Consulting Group and Merrill Lynch-Cap Gemini) place most of that money in Switzerland and the UK. Yet, IMF data fail to show exactly who invests these funds and from where. According to available data, Emirati, Turkish, and Qatari investors place the largest amount of their portfolios in Switzerland. Yet, the IMF data, showing $1.5 million in placements, fall far short of the estimated $500,000 in Swiss accounts. Such data suggest that the IMF needs to collect better data (rather than anything specific about wealth management clients from the region).

The limited data available suggest that these wealth management firms are increasingly trying to operate directly in MENA countries. Figure 4 shows that foreign banks have increasingly been participating in Middle Eastern markets. At the beginning of the decade, foreign banks comprised only about 10% of the total market by assets. Banks coming from the Arabian Peninsula from the member countries of the Gulf Cooperation Council comprised about 27% of assets. By the end of the decade, foreign banks made significant progress — taking about 20% of the market. Such a trend suggests that Western banks are seeking to capture a larger share of the Middle Easterners’ wallet — moving from wealth management to a broader range of banking services.  We do not know that all these banks offer wealth management. But, as wealth management comprises the most attractive banking sector, we can deduce that a fair share of this increase owes to foreign interest in finding wealth management and private banking customers.

If foreign wealth management firms (particularly in the UK and Switzerland) have managed to capture the local market, then local wealth management services remain extremely under-developed. VRL (2010), a private consulting company, has indentified the 32 banks in the region in their profile of wealth management services in the region. Yet, looking at their balance sheets, much of their growth still comes from plain vanilla banking. Figure 5 shows that the less glamorous business-as-usual banking led to faster growth of assets under management (the goal of every banker) than wealth growth in the region (and faster than wealth managers could attract that wealth) for 2003–2008. As shown, Arabian Peninsula banks grew their assets by about 25% over the second half of the 2000s. Assets under management by private bankers and wealth managers increased by about 12%, according to Merrill Lynch-Cap Gemini estimates. Wealth grew in the region as a whole by about 10%.

Could these trends suggest that investments in plain old banking in the region could yield higher growth rates and larger volumes of assets under management than playing in an increasingly crowded wealth management sector? In the UAE and Qatar (two already highly developed financial markets), banking assets grew by about 35% (as more of the middle class became affluent). These patterns, judging by past data, seem unlikely to change in the near future. Our two comparator countries for the next section — Turkey and Saudi Arabia — saw banking assets grow (as a percent of GDP) by almost double the estimated growth rate of wealth in the region. Both these growth rates far exceed the growth rates which appear in the wealth management industry estimates.

Non-competitive banking sectors across the region provide one explanation why local banks remain under-developed…and why foreign banks hold off from making large-scale investments in Middle Eastern wealth management service offerings. Anzoategui and co-authors (2010), in a study of the MENA banking, describe prevailing market conditions as “monopolistic competition.” Figure 6 shows a popular measure of competitiveness — known as the H-Index. An H-Index looks at the extent to which banks pass along increasing costs by raising fees. Only banks that do not compete at bare-bones profit margins of a highly competitive market have the luxury of absorbing parts of these cost increases. An H-Index measures the extent to which a bank absorbs these cost increases rather than passes them along. The Anzoategui et al. data show that only UAE (and maybe Omani) banks likely operate in a highly competitive environment. Kuwaiti and Turkish banks seem the most insulated. Other authors corroborate these findings. Abbasoglu et al. (2007) find that Turkish banks became increasingly monopolistic in the 2000s — with falling H-index values from roughly 0.6 to 0.3.

Another reason for the under-development of local banking (and thus an indigenous wealth management industry) may be due to the lack of profitable investment opportunities in the region. Banks must take savings — including the savings of ultra-high net worth individuals — and place these funds into profitable investments. Yet, according to regression analysis by Hasan and Dridi (2010), bank profitability in the MENA region has decreased as bank investment portfolios grow. Looking at time series data for the MENA region from 2007 to 2009, they find a statistically significant negative correlation between banks’ investment portfolio sizes (as a percent of total assets) and bank profitability. They also find a positive relationship between bank profitability and the percent of real estate and construction lending in banks’ portfolios (which hind-sight tells us resulted from the economics of bubble financing). These results — when taken together — suggest that MENA banks in countries discussed by the authors tend to destroy value when they invest in MENA markets.

These results may explain why most MENA-based investment funds and the wealth managers that use these funds do not invest in the MENA region. In a recent study, Mako and Sourrouille (2010) analysed the level of inter-MENA region portfolio investment. Investment companies, in 5 out of the 11 countries they looked at, have significant investments in the MENA region. Of these, Bahraini investors hold the most, with $276 million or 23% of their portfolios. Saudi Arabia — the largest economy in the region (outside of Turkey) — invested only $71 million in the MENA region in 2009 (or less than 1%). On a similar scale (through a much larger proportion), the UAE funds invested $92 million in the MENA region, representing roughly 12% of invested funds.

The contrast between the MENA region’s two largest countries (excluding Israel) provides some insight into the opportunities and potential pitfalls of expanding wealth management services in the Middle East. Turkey represents an example of a successful locally grown wealth management industry. Saudi Arabia represents an under-developed wealth management industry — one which foreign banks still spirit away funds rather than invest them locally. Such wealth management practices have led to a lack of funding to expand Saudi markets for locally-produced affluent, high and ultra-high net worth individuals.

Comparing the Region's Two Key Private Wealth Prospects: Turkey and Saudi Arabia

Comparing Turkish and Saudi wealth creation provides a fascinating glimpse at (and forecast of) the future of wealth management in both countries. Both economies have organised family interests which control large shares of the economy. However, in Turkey, these family-oriented interests focus on local productive economic activities which generate wealth. In Saudi Arabia, these family interests tend to invest resource gains abroad.

Saudi Arabian companies (and the ultra-high net worth individuals that own and control them) tend to invest less in diversified and high-tech sectors, which will create a larger class of affluent bank clients. Figure 7 provides an extremely unrigorous (though illustrative) overview of the differences in investment behaviour between Saudi Arabia and Turkey. The majority of Turkish economic activity (as measured in percent of GDP) focused on services rather than industry in 2010. In Saudi Arabia, most productive enterprise (the result of previous investment decisions) still centres around industry, particularly the oil sector. Saudi Arabian business — at least according to the World Economic Forum — ranks 42 places above Turkish business. However, such competitiveness will likely increase the wealth of Saudi Arabia’s existing wealthy — rather than create more dollar millionaires. Looking at the high-tech and R&D-based industries, which have made many of the US’s and Europe’s millionaires, provides a clue about the way future economic growth will translate into future private wealth clients. In 2007 (the latest year data are available), Turkish high-tech exports outstripped Saudi ones by a ratio of roughly 8-to-1. Turkish companies’ R&D expenditure — investment needed to promote sustainable growth and economic diversification — eclipsed Saudi expenditure by about 13-to-1. Turkish patents and scientific journal articles outnumbered Saudi ones by about 7.5-to-1. Keeping in mind the usual caveats about arguing using selected cases, Turkish companies seem to make the types of investments which much of the literature suggest lead to higher and more wide-spread incomes. 

Such differences in the sources of wealth in the two countries have created rather different distributions of wealth in both countries among ultra-high net worth individuals (the richest according to the popular press stories we reviewed). As shown in Figure 8, Turkey’s richest are about one-eighth as rich as their Saudi counterparts despite having an economy roughly 1.6 times as large. Naturally, drawing conclusions from popular press accounts of the rich-and-famous provides little scientifically credible evidence. However, from a practical perspective, the wealth manager who wins the Bin Laden family’s account will have almost 8 times more assets under management (and the associated fees) than the one who lands the Zorlu account.

A look at Turkey’s and Saudi’s richest families reveals other trends of interest to wealth managers looking to land accounts like these. Unlike in Turkey, many of Saudi Arabia’s largest companies are not public. The lack of public disclosure poses a particular peril — given improved know-your-customer requirements in the major financial institutions. Turkish wealth comes from diversified companies, whereas (except for Saudi Basic Industries) most of the companies that make Saudis extremely rich focus on narrow economic sectors. Both the Kingdom Holding Company and MBI International Group and Partners make a strong point to highlight their London connections on their website.

What does high-tech production and family wealth have to do with wealth management? Wealth accumulates from productive activity, and financial institutions store and channel the proceeds of constructive activity. A healthy local banking sector promotes internal investment, and thus, the creation of more HNWIs. A healthy local banking sector can also compete effectively against foreign wealth management companies. As shown in Figure 9, the Saudi banking sector looks just as healthy — if not healthier — than the Turkish banking sector in 2010. Saudi banks had more liquid liabilities and more deposits to cover them. Saudi banks operated in a more oligopolistic market with higher market capitalisation ratios (as a percent of GDP) than their Turkish cousins.

Saudis save more than Turks do — and they save it offshore. As a share of GDP, both Turkish and Saudi private investment equalled about 20% of GDP in 2010. Yet, Saudis saved 43% of their GDP — whereas Turks saved only 14% in 2010. Such savings translate into wealth management accounts which find their way to Switzerland and the UK. Savings — if we resort to high macroeconomic theory — signal a lack of productive investment, consumption options, or a desire to put money aside for a rainy day. Saudi authorities clearly want to save for a time when their oil-reserves run out, as evidenced by their roughly $500 billion sovereign wealth fund. The Turks want to grow their economy today.

The result is that Turkish banks have already broken into the private wealth management market, whereas their Saudi colleagues still lack internal markets to develop their business. According to the Financial Times Awards for 2011, the best private banks in Turkey were both private banks Garanti and Yapi Kredi. As for best bank in the Middle East, the best were Western banks — HSBC, Standard Chartered, and Citi. Lending patterns among banks also reflect local investment priorities. As shown in Figure 10, Saudi banks allocate a much larger share of their loanable funds on trade and public sector (areas which high economic theory would describe as transactional and not directly leading to growth in economic output).

Banks should earn profits from making loans which promote private sector productivity and lead to growth. Yet, the data suggest that Saudi bank profits stem from priviledged relations with government as much as other factors. Eljelly (2009) finds that having connections to government — in the form of state ownership — positively correlates with bank performance. In contrast, Hasan and Dridi (2010) finds that government ownership of Turkish banks has no impact on bank performance.

Nothing in the data suggests that differences in wealth management prospects between the two countries reflect banking efficiency. In other words, foreign wealth management firms should not expect to enter either market in order to exploit weaknesses of pre-existing rivals. Figure 11 shows the results of two separate data envelope analyses of the banking sector in each country that were conducted at about the same time. As shown, the top banks in both countries operate at very near best-in-class efficiency. The limited evidence available suggests that foreign banks did not improve Turkish bank performance (which already had very high levels of efficiency). In a study by Yildirim (2010), he finds that foreign bank acquisitions in Turkey did not lead to better bank performance.

The development of wealth management services looks far more promising in Turkey than in Saudi Arabia for three reasons. First, more Turks are likely to enter the affluent class each year than Saudis, giving aspiring wealth managers an increasing pool of prospects. Second, foreign entrants can not exploit the inefficiency (or incompetence) of local competitors in these markets like they might in places elsewhere in the Middle East. Third, differences in the prospects of wealth management in each country reflect fundamental differences in social preferences — between how much money each country saves, in which country they save these funds, and how they spend their savings when they decide to invest them.

Policy Advice for MENA Policymakers

How can the Qatars, Libyas and Lebanons of the region (those countries with fewer affluent savers) grow their own affluent, and thus, wealth management industries?  The data show that they should encourage local investors to increase their investment time-horizons, particularly to invest locally rather than abroad. In their book Varieties of Capitalism, Peter Hall and David Soskice (2001) argue that economic systems’ labour, product, capital, and regulatory environments must “fit together.” The Middle East generally has labour, product market, and other policies that encourage long-term planning and investing. However, as shown in the left panel of Figure 12, most denizens of their banking sectors focus decidedly on short-term results. The average Qatari, Kuwaiti, or Saudi will want large rates of return in less than 2 years. Their Western counterparts will be content to take a longer-term view — holding investments yielding half the amount desired by the Saudi for almost 3 times as long. Such preferences yield a more “patient capitalism” which has led to long-run growth. Turkish investors tend to have higher expectations for their investments, which is understandable given recent Turkish equity price growth. However, they are also willing to wait twice as long to get these returns.[1] A client who wants to change his or her portfolio every year or two represents one of professional wealth managers’ worst nightmares.