How to make money in the Middle East

By Tatyana Shumsky, Forbes.com

In the last five years, gross domestic product in GCC countries has risen an average of 7%, according to Koon Chow, senior emerging markets strategist at Barclays Capital in London. In 2008, GCC countries should post 6% growth - a modest slowdown but much better than estimated global growth rates of 3.7%, as measured by purchasing power parity.

Including GCC interests in your portfolio adds a protective layer of diversification. Economists say Middle Eastern economies are decoupling from the US because so much of their growth is focused internally. That means they're protected from America's economic slowdown, since domestically focused industries won't be damaged by softness in U.S. demand. Meanwhile, oil revenues reinvested into local economies should help keep out Western credit-crisis woes.

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Citigroup Middle East and Africa equity strategist Andrew Howell pegs the region's correlation to world markets at about 40%, which means the GCC is unlikely to follow US equities' downward trend. Other emerging markets have a 90% correlation, making GCC investments a better bet.

Poorer but still fast-growing countries in the Middle East, like Egypt, are a valuable part of any region-wide investment strategy.

T Rowe Price's Africa and Middle East fund has 27.7% invested in the United Arab Emirates, 20% in Egypt, 17.1% in Qatar and 12.6% in Oman. Smaller holdings include equities from South Africa, Bahrain, Jordan, Lebanon and Nigeria.

The fund is up 3.29% in the year-to-date, much better than its S&P-linked equity Index 500, which is down 7.28%. You can buy into the actively managed equity fund with just $2,500 to get sizable exposure to the region.

Industry growth

Construction, real estate, telecommunications, banking and finance are some of the fastest-growing industries in the region.

Local investors support these industries by directing oil wealth into domestic share markets, which desensitises them to negative global trends. This makes GCC equities more appealing and likely to deliver above-average returns, says Barclay's Chow.

Accessing Middle Eastern equities, though, can be a challenge. Markets like the UAE and Qatar limit foreign ownership of listed local companies to 49%, while Saudi Arabia's equities remain closed to foreign ownership, says Andrew Howell, a Middle East strategist at Citigroup.

HSBC global emerging market equities analyst Alex Tarver warns that U.S. investors may find Gulf markets less transparent and efficient than what they're used to, and would do well to employ expert analysis before they put their money on the line.

These stumbling blocks have led to the creation of Middle East North Africa funds, many of which add risk and subtract reward. MENA funds tend to be heavily weighted toward North African equities, which are easier to access than Middle East stocks but boast less promising economic performance.

To avoid disappointment, Morgan Stanley Chief Investment Strategist David Darst suggests checking country allocations to ensure balanced exposure to both regions before adding a fund to your shopping list.

'You'd want to know it is 'X' amount Morocco and 'X' amount Egypt, which are not the same as Abu Dhabi and Saudi and Dubai,' says Darst.

Shariah compliant funds

An alterative investment route is to explore the world of Islamic finance through Shariah-compliant funds. These mutual funds pick their investments in accordance with the religious rules that make up Shariah law, eschewing investments in industries deemed unethical, including gambling, alcohol and pornography.

They also stay out of much of the financial sector, which is considered too close to gambling - a quirk that has kept them protected from the West's recent sub-prime lending crisis.

The region has also embraced sukuks, often referred to as Shariah-compliant bonds. Since interest is forbidden under Shariah law, companies enter sale-and-leaseback arrangements with trusts that issue certificates called sukuks.

Convertible sukuks take the Islamic principle of shared risk to heart by converting into shares if the company goes public, and buyers of convertible sukuks may find themselves first in line for a company's initial public offering. The instruments may seem opaque, but many sukuk issues are now listed on the London Stock Exchange.

If you're looking for low risk and solid returns, steer clear of local currencies like the Saudi riyal or the UAE dirham. In the GCC, all currencies except for Kuwait’s are pegged to the dollar, an arrangement blamed for overheating local economies and importing inflation, which is as high as 11% in the UAE and 14% in Qatar.

Analysts argue that revaluation is in order, (although the GCC governments have said it will not happen). Kuwait depegged its dinar in May 2007, shifting to a floating basket exchange system, and the move has been a boon for its economy; the dinar has appreciated 3.5% against the dollar.

If another Middle East country were to revalue or float its currency, assets denominated in that currency would automatically appreciate against the dollar. But Chow warns that even though the economic case for revaluation may be strong, investors shouldn't expect it to happen soon.

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