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Will IR Iran realise its potential as one of the world’s largest frontier economies?

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

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Will IR Iran realise its potential as one of the world’s largest frontier economies?

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  1. 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

  2. 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

  3. 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

  4. 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!

  5. 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.’’

  6. 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)

  7. Frontier Market IR Iran These guys are big!

  8. Politics; General 1 Supreme Leader Ali Khamenei 6 Assembly of Experts Government Led by M. Ahmedinejad Guardian Council Elected Candidates Approved by GC Led by A. Rafsanjani Majlis 12 member Supreme Court 6 Elected; multi-party; factions Different, but legal and political structure stable and ‘predictable’

  9. 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

  10. 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

  11. 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)

  12. 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

  13. Economy; General 1

  14. 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

  15. Economy; Real 2

  16. Economy; Real 3

  17. 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

  18. 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

  19. Economy; Potential 1 Goldman’s Next-11

  20. 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

  21. 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)

  22. 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

  23. TSE; General 1 • Stock exchange well functioning according to EM standardshttp://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

  24. 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

  25. TSE; General 2

  26. 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

  27. TSE; Analysis 2 Source; TSE Feb 21, 2009

  28. TSE; Analysis 3

  29. 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)

  30. TSE; Analysis 5

  31. 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

  32. 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

  33. 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

  34. 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

  35. 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’

  36. 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

  37. Appendix; 36-months volatility

  38. Appendix 2;36-months correlation

  39. Appendix 3;36-months beta

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