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Will IR Iran realise its potential as one of the world’s largest frontier economies?. Erik L. van Dijk Fund Forum Emerging Markets London, March 4, 2009. Introduction 1. Erik L. van Dijk Implemented Consultant, specializing in GTAA, Manager Selection Markowitz – Van Dijk GTAA framework - PowerPoint PPT Presentation
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Will IR Iran realise its potential as one of the world’s largest frontier
economies?Erik L. van Dijk
Fund Forum Emerging MarketsLondon, March 4, 2009
Introduction 1
• Erik L. van Dijk– Implemented Consultant, specializing in GTAA,
Manager Selection– Markowitz – Van Dijk GTAA framework
• consists of 50+ countries; this has led to special interest in our Emerging Markets / Frontier Markets work
• See also:– Financial Analysts Journal, March/April 2003– http://www.cfawebcasts.org/cpe/what.cfm?test_id=748
» Webcast CFA by Seb Page (State Street)
– Advisor to AMIO
Introduction 2
• AMIO (http://www.amio.ir ; Farsi only)– Agricultural, Mining and Industry Organization of
IR Iran• Non-political• Goal is to develop/establish business and trade
relationships– Investment opportunities in Iran (for interested outsiders)– Investment opportunities abroad (for members)
• Representing some 1,000 Iranian firms ranging from small- and mid-cap (non-listed) to large, listed firms
Introduction 3
• IR Iran
– ‘’Neglected country’’ effect, similar to the well-known ‘’Neglected firm’’ effect
• Can you invest in an Islamic Republic?• Didn’t know they have a stock exchange• Isn’t it way too risky, because of the international situation?• Do they have an economy? Thought it was just oil and gas• Sorry! Embargo!
Introduction 4
• Neglected firm effect– http://www.investopedia.com/terms/n/neglectedfirm.asp
Investopedia:‘’The phenomenon of less-known firms producing abnormally high returns
on their stocks’’And:
‘’Neglected firms are usually the smaller firms that analysts tend to ignore. Information available on these smaller firms tends to be limited.’’
But also:‘’The abnormally high return exhibited by neglected stocks may also be due
to lower liquidity or higher risks associated with the stock.’’
Introduction 5
• But wasn’t neglect a US phenomenon?
– Can it be internationalized into an EM framework?• YES
– Compare V. Tripathi, ‘’Relationship between Institutional Neglect and Stock Returns in India’’, Business Analyst, Vol 1 No 1, pp. 85-92
– http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1134653
– Can we go from ‘firm’ to ‘country’ level?• WHY NOT? (but more research needed; EVD)
Frontier Market IR Iran
• These guys are big!SHOULDN'T IRAN AND SAUDI ARABIA BE IN?
COUNTRY GDP GDP PP GDP NORM Rank PER CAP Rank
I II Glob. Glob.
Iran 382.3 859.7 621.0 19 9,427 50
Turkey 663.4 853.9 758.7 16 10,553 47
Egypt 127.9 405.4 266.7 35 3,263 79
Libya 57.1 74.7 65.9 68 10,673 46
Pakistan 143.8 411.9 277.9 33 1,608 91
Morocco 73.4 125.0 99.2 60 2,889 82
Saudi Arabia 376.0 546.0 461.0 22 16,378 36
Israel 161.9 185.8 173.9 52 24,443 28
Notes;in USD; GDP: USD billions; GDP NORM = 0.5*I + 0.5*II
Sources; CIA Factbook, IMF, World Bank, Lodewijk Meijer
Turqoise countries not in MSCI Emerging Markets
Politics; General 1
• Different, but legal and political structure stable and ‘predictable’
GovernmentLed by M. Ahmedinejad
Supreme LeaderAli Khamenei
Majlis
GuardianCouncil
Assembly ofExperts
Elected; multi-party; factions
Elected
Candidates
Approved by GC
Led by A. Rafsanjani
12 member Supreme Court
6
6
Politics; General 2
• Guardian Council and/or Supreme Leader too powerful? – They have in the 30-years of the IR Iran treated their
responsibilities in a Shariah-related way, as it was supposed to be
• Direct involvement with day-to-day politics and economics has been marginal
• Shariah and other Islamic legal infrastructure components provide well-documented basis
• With respect to roles; system under development with IR Iran just 30-years young
Politics; Internal
• Currently (since 2005), conservatives dominating the Majlis and the government– Led by M. Ahmedinejad– Powerbase in the rural areas and among the poor– Political themes; Income distribution themes
• Indications that reformists will at least challenge conservatives in the coming elections (June 2009)– Led by M. Khatami and A. Rafsanjani– Powerbase in the cities– Economic themes
Politics; External
• Notwithstanding discussions about nuclear activities, new initiatives to stimulate dialogue– In Iran:
• Both conservatives and reformists indicate willingness • Partly economics-related; M*V = P*T and the impossibility to
control inflation when you earn too much (EVD)
– Abroad:• Obama Administration• Amidst financial crisis always re-evaluation of standpoints with
respect to others that have liquidity (EVD)
Economy; General
• Structure of the economy– Tilted towards Industry/Manufacturing (more than in the average EM)– Dependence on Oil & Gas still (too?) large
• But it helped the government to establish a budget surplus with revenues of $ 127.2 billion (2008) and expenditures of $ 98.5 billion (2008)
– Low public debt (25% of GDP)– Relatively high inflation (28%; see also later this chapter)– Unemployment of 12% (high, but normal in an economy that shifts from
Agriculture to Industry/Services)– In need of:
• New investments to increase efficiency• Knowledge transfer
Economy; General 1
Iran % of GDP % of LaborF GDP per worker
Agriculture 10,7% 25% 9260,9
Industry 42,9% 31% 29943,7
Services 46,4% 44% 22817,9
GDP Norm 621,0
Labor Force 28,7
Turkey % of GDP % of LaborF GDP per worker
Agriculture 8,9% 36% 7981,6
Industry 28,3% 23% 39724,7
Services 62,8% 41% 49451,3
GDP Norm 758,7
Labor Force 23,5
World VW % of GDP % of LaborF GDP per worker
Agriculture 4,6% 13% 7275,1
Industry 30,0% 32% 19275,1
Services 65,4% 55% 24447,8
GDP Norm 59531,8
Labor Force 2895,5
World EW % of GDP % of LaborF GDP per worker
Agriculture 9,2% 24% 7881,4
Industry 33,8% 22% 31587,8
Services 57,0% 54% 21702,3
GDP Norm 59531,8
Labor Force 2895,5
Notes; VW and EW denote World Value (GDP) weighted and equally
weighted respectively
GDP in billions of USD; Labor Force in millions of participants
Norm = equally-weighted average of GDP Official and GDP PPP
Economy; Real 1
• Growth economy; even amidst credit crisis and embargo
– Phases:• Phase 1: Pahlavi period• Phase 1ex: excluding 71/72-74/75 and 78/79• Phase 2: First ten years of IR Iran• Phase 3: Maturing IR Iran
Economy; Real 2
Real GDP Growth in Iran1960/61 - 2010/11f
-40,0%
-30,0%
-20,0%
-10,0%
0,0%
10,0%
20,0%
30,0%
40,0%
50,0%
60,0%
GDP Growth
Phase 1;Pahlavi period;
The Oil Story;Benefiting from the Oil Crisis, but distribution of wealth too unequal
Phase 2; Setting up a new country without support by others; ''equal distribution of poverty''
Phase 3; IR Iran grown-up;Frontier Market nr 1,
but will the world acknowledge it?
Economy; Real 3GDP growth (real) per period
10,9%
7,4%
-5,8%
6,8%
-8,0%
-6,0%
-4,0%
-2,0%
0,0%
2,0%
4,0%
6,0%
8,0%
10,0%
12,0%
Phase 1 Phase 1 ex Phase 2 Phase 3
Economy; Monetary 1
• Inflation (approx. 25-30%)– Fisher equation MV=PT explains the story
• Building new economy without support• PT growth mainly dependent on oil and gas• Relatively large net money inflow via:
– Current Account Surpluses– Iranians living abroad
• Insufficient (still) diversification of the economy• Problems in the savings/fixed income area under new
Islamic rule– Black Market for Foreign Exchange problem
Economy; Monetary 2
• Improvements expected– 2002; multiple exchange rate system abandoned– More realistic exchange rate policy by Central Bank
of Iran– Economic growth and diversification will help
improve things– Increase in international trade and two-way
investment activity will expand the monetary opportunity set
– Better functioning savings market
Economy; Potential 1
• Goldman’s Next-11
Economy; Potential 2
• Value of Oil and Gas Reserves– Oil (proved reserves; Jan 2008; CIA Factbook)
• 138.4 billion bbl– Value at $ 45 per barrel = $ 6228 billion = 16.3 years of Iranian
nominal GDP
– Natural gas (proved reserves; Jan 2008; CIA Factbook)
• 26.85 trillion cu m– Value at $ 185 per 1000 cu m = $ 4967 billion = 13.0 years of
Iranian nominal GDP
Economy; Potential 3
• Large pool of labour– Population of approximately 70 million– Relatively young:
• Median age 26.4 years
– Population growth 0.8% per annum– Education improving, with education expenditures
equal to 5.1% of GDP (2006)
Economy; Potential 4
• Importance of IR Iran’s SWF structure– Internally
• Pension plan structure that they contemplate building• Similar to the Dutch experience in the 1950s
– Externally to help improve relationships• When wealth is based on/ helped by (illiquid) oil and gas
reserves:– Relatively aggressive investment policy in financial assets
possible, but diversification essential *– Benefits receivers abroad and domestically
• B. Scherer PhD (Morgan Stanley), Portfolio choices for Oil-based Sovereign Wealth Funds, • Jan 2009
TSE; General 1
• Stock exchange well functioning according to EM standards http://www.iranbourse.com/en/– Legal (started in the 60s, based on plans already laid down by Belgian
specialists in the 30s); 35% government-owned– Full-member of World Federation of Exchanges– Price formation (automated, order-driven; 2007 AEMS acquired from
Atos Euronext)– Short-selling prohibited– Day-trading allowed– Data availability– Foreign ownership of firms limited to 49%– Foreign funds allowed, but approval of Min of Finance required
TSE; General 2
• Exchange still small with an equity focus – (400 firms; USD 70 bn as of Mid-2008; USD 50 bn
as of Feb 21, 2009)– Also: Islamic-style corporate bonds– And: Project-based participation certificates with
fixed income like component during time till completion and profit component at maturity
TSE; General 2
Firms on TSE
0
50
100
150
200
250
300
350
400
450
1967 1974 1978 1979 1981 1990 2009
Year
# of firms listed
TSE; Analysis 1
• TSE is not an oil exchange
• Manufacturing and (since its privatization round in 2008) Telecom Iran (TCI) dominate
• Financials are important, but the two main banks Melli and Saderat are state-owned
TSE; Analysis 2
Industry MCAP %
Post and Telecommunications 7078.3 14.1%
Basic Metals 7001.4 14.0%
Financial Intermediaries 4363.5 8.7%
Cement Lime and Gypsum 4235.6 8.4%
Motor Vehicles and Auto Parts 4159.5 8.3%
Diversified Industrials 3320.6 6.6%
Metal Ores Mining 2915.3 5.8%
Banks Credit and Other Financial Institutions 2719.6 5.4%
Chemicals and Byproducts 2416.8 4.8%
Refined petroleum products and nuclear fuel 2126.2 4.2%
Transportation 1617.4 3.2%
Pharmaceuticals 1465.8 2.9%
Investment Companies 1422.5 2.8%
Real Estate and Construction 1219.9 2.4%
Technical and engineering services 1028.2 2.1%
47090.6 93.9%
Source; TSE Feb 21, 2009
TSE; Analysis 3Firm Industry MCAP of Total
Telecommunications Iran Post and Telecommunications 7078.3 14.1%
Esfahan's Mobarakeh Steel Cy Basic Metals 2799.3 6.1%
Iran National Copper Industries Cy Basic Metals 1652.1 3.6%
Saipa Cy Motor Vehicles and Auto Parts 1557.7 3.4%
Islamic Republic of Iran Shipping Lines Transportation 1293.1 2.8%
Parsian Bank Banks Credit and Other Financial Institutions 1173.2 2.5%
Chadormalu Mineral and Industrial Cy Metal Ores Mining 1163.0 2.5%
Omid Investment Cy Diversified Industrials 991.7 2.1%
Iran Power Plant Project Management (MAPNA) Technical and engineering services 940.0 2.0%
Civil Pension Fund Investment Cy Diversified Industrials 932.3 2.0%
Gol-e-Gohar Iron Ore Cy Metal Ores Mining 864.1 1.9%
Ghadir Investment Cy Diversified Industrials 844.9 1.8%
Khouzestan Steel Cy Basic Metals 828.7 1.8%
Khark Petrochemical Cy Chemicals and Byproducts 785.9 1.7%
Iran Khodro Industrial Group Motor Vehicles and Auto Parts 765.2 1.7%
Eb Bank Banks Credit and Other Financial Institutions 638.9 1.4%
Fars and Khuzestan Cement Cy Cement Lime and Gypsum 633.6 1.4%
Karafarin Bank Banks Credit and Other Financial Institutions 496.2 1.1%
Butane Industrial Group Machinery and Equipment 495.5 1.1%
19 Firms > 1% of total market cap 25933.7 56.1%
TSE; Analysis 4
• Return analysis– Not totally insensitive to the credit crisis, but interesting
returns when considering that they have been achieved during a period in which the rest of the world ignored opportunities in Iran. And it wasn’t only the crisis, but also the IPO of TCI
– Currency outlook has improved substantially since the multiple exchange rate framework has been abandoned in 2002
– Attractive risk profile (see also below)
TSE; Analysis 5TEPIX in Rials 1998-2009
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
Nov
30
1998
Mar
31
1999
Jul 3
1 19
99
Nov
30
1999
Mar
29
2000
Jul 3
1 20
00
Nov
29
2000
Mar
31
2001
Jul 3
1 20
01
Nov
28
2001
Mar
31
2002
Jul 3
1 20
02
Nov
30
2002
Mar
31
2003
Jul 3
0 20
03
Nov
30
2003
Mar
30
2004
Jul 3
1 20
04
Nov
30
2004
Mar
30
2005
Jul 3
1 20
05
Nov
30
2005
Mar
28
2006
Jul 3
1 20
06
Nov
29
2006
Mar
31
2007
Jul 3
1 20
07
Nov
28
2007
Mar
30
2008
Jul 2
9 20
08
Nov
30
2008
TSE; Analysis 6
• Interesting risk profile– EM-like returns after correcting for Rial depreciation– Normal volatility for frontier / EM market– Low (and relatively stable; see appendix) correlation and
beta with rest of world
1998 (12) - 2009 (01); Monthly data
Factor TEPIX$ MSCI WORLD$ MSCI EM $
RET 0.60% -0.06% 0.64%
VOLA 8.82% 4.79% 7.77%
BETA 0.145 1.000 1.373
TSE; Analysis 7
• Embargo analysis– Incredibly low impact, because of financial power
Iran has– Impact mitigated due to large, strong trading
partners stepping in (CHI, RUS, JAP, TUR) and even in the West you see signs of the embargo breaking down due to the credit crisis and the expected change in US policy
TSE; Analysis 8
• How to invest in Iran?– (Still) limited opportunities for foreigners in indirect investments via
funds• First Persian Fund (with Melli Bank) just started• New initiatives (e.g. AMIO-LM)
– Direct investments by foreigners in TSE• Possible, but is this the market where you want to be in directly as
outsider?• Better to exploit inefficiencies via specialist
– Foreign Direct Investments• Big projects• Interesting opportunities to co-invest
Conclusions 1
• Goldman is right; it is a Next-11 market, if we want or not
• International investments (both direct and indirect) will grow– By Iran abroad– In Iran (market attractive when looking at the return-risk
profile)
• Embargo in its current form will evaporate– And this will make increased performance of the TSE more likely than
some kind of additional correction
Conclusions 2
• How?– FDI (project financing; e.g. infrastructure or oil /
gas projects)– Fund
• Still limited opportunities– First Persian; closed-end equities fund, closed August 2008
» USD 100 mn (approx.)– Under construction; AMIO-LM
» Euro 500 mn» Mixed; equities and ‘other’
Contact
• Erik L. van Dijk– Tel. + 31 6 155 86 109– Email: erik_dijk@hotmail.com (temporary)– Website LM under construction (April 1 expected)– http://www.linkedin.com/in/evd101
Appendix; 36-months volatility
0.000
0.020
0.040
0.060
0.080
0.100
0.120
0.140
0.160
Nov
28
2001
Feb
27
2002
May
29
2002
Aug
31
2002
Nov
30
2002
Feb
26
2003
May
31
2003
Aug
31
2003
Nov
30
2003
Feb
29
2004
May
31
2004
Aug
31
2004
Nov
30
2004
Feb
28
2005
May
31
2005
Aug
31
2005
Nov
30
2005
Feb
28
2006
May
31
2006
Aug
30
2006
Nov
29
2006
Feb
28
2007
May
30
2007
Aug
28
2007
Nov
28
2007
Feb
26
2008
May
31
2008
Aug
31
2008
Nov
30
2008
TEPIX$ MSCI WRLD$ MSCI EM$
Adjustment to the new exchange rate regime 2002-2005
Appendix 2;36-months correlation
-0.400
-0.200
0.000
0.200
0.400
0.600
0.800
1.000
1.200
Nov
28
2001
Feb
27
2002
May
29
2002
Aug
31
2002
Nov
30
2002
Feb
26
2003
May
31
2003
Aug
31
2003
Nov
30
2003
Feb
29
2004
May
31
2004
Aug
31
2004
Nov
30
2004
Feb
28
2005
May
31
2005
Aug
31
2005
Nov
30
2005
Feb
28
2006
May
31
2006
Aug
30
2006
Nov
29
2006
Feb
28
2007
May
30
2007
Aug
28
2007
Nov
28
2007
Feb
26
2008
May
31
2008
Aug
31
2008
Nov
30
2008
TEPIX$ MSCI WRLD$ MSCI EM$
Appendix 3;36-months beta
-1.000
-0.500
0.000
0.500
1.000
1.500
2.000
2.500
Nov
28
2001
Feb
27
2002
May
29
2002
Aug
31
2002
Nov
30
2002
Feb
26
2003
May
31
2003
Aug
31
2003
Nov
30
2003
Feb
29
2004
May
31
2004
Aug
31
2004
Nov
30
2004
Feb
28
2005
May
31
2005
Aug
31
2005
Nov
30
2005
Feb
28
2006
May
31
2006
Aug
30
2006
Nov
29
2006
Feb
28
2007
May
30
2007
Aug
28
2007
Nov
28
2007
Feb
26
2008
May
31
2008
Aug
31
2008
Nov
30
2008
TEPIX$ MSCI WRLD$ MSCI EM$
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