Interview with Farhan Mahmood, CIO & Head of Asset Management at FALCOM Financial Services
Driven by the capital market reforms, the booming Saudi and regional economies, increasing liquidity and depth of the capital markets and strong future outlook, a group of prominent businessmen and leading investors in Saudi Arabia, have come together to form FALCOM Financial Services. FALCOM is a full-service investment bank licensed by the Capital Market Authority (CMA) for dealing, advisory, managing, arranging and custody.
As head of asset management, Farhan Mahmood, CFA, is responsible for developing the asset management business of the company. As the CIO, he is responsible for developing investment policies and objectives, strategic asset allocation and portfolio guidelines, performance benchmarks and risk management controls for the firm’s proprietary capital investments.
Prior to this, he was director, asset management at UBS in Toronto, where, he was responsible for identifying investment opportunities in fixed income, equities and alternative investments for UBS’ Canadian and international clients on a global basis.
Mahmood’s 14 years in the investment and securities business span a wide area of experience in global institutions where he has serviced both institutional and private clients across Asia, Europe, Middle East and North America. He has worked on both sell- and buy-sides across Asia and North America.
Mahmood received his CFA charter in 1997. Since then, he has been involved with CFA Institute in many capacities including serving on the Global Financial Reporting Advocacy Committee, the Standards of Practice Council, GIPS Investment Manager Subcommittee, the CFA Curriculum Committee and the Editorial Board of CFA Magazine. He has also served on CFA Institute’s Recommended Practices Task Force.
Mahmood has also been a member of the Company Affairs, Rules and Regulations and Derivatives Trading committees of the KSE. In addition, he has also advised financial institutions in Pakistan on Islamic finance, portfolio management and trading policies and practices.
He has authored several articles and papers and been a regular columnist for two of Pakistan’s largest English daily newspapers, Dawn and The News.
Mahmood received a graduate degree in business administration from the IBA. He then completed his MBA from the same institution in 1993.
With regards to the FALCOM Saudi Equity Fund and fund manager, how is the approach different from others and what is the overall proposition for investors?
The value proposition for investors is “risk-adjusted returns”. We aim to achieve benchmark or better-than-benchmark returns at a lower volatility. This is a proposition we feel is absent for investors in this market and we want to be the pioneers.
When choosing equity investments, we apply a bottom-up, value-oriented and long-term approach, focusing on the market price of a company’s securities relative to our team’s evaluation of the company’s potential long-term (typically five years) earnings, asset value and cash-flow potential. The fund should be thought of as a long-term investment, invested through a complete market cycle of 3-5 years. We also consider a company’s price to earnings ratio, profit margins and liquidation value.
In choosing our investments, we strongly believe in onsite visits to issuers of prospective investments to assess critical factors such as management strength and local conditions.
As well, if we believe market or economic conditions are unfavourable for investors, we may invest up to 100% of the fund’s assets in a temporary defensive manner by holding all or a substantial portion of its assets in cash, cash equivalents or other high quality short- and medium-term investments.
What are the key industries of focus for the fund and what proportions do they comprise in the overall portfolio? How are these weights determined and how often are they reviewed?
We are constantly monitoring our investments and reviewing the allocations. The process is very dynamic in nature for us. We have a strategic asset allocation plan and the tactical bets are built around those long-term allocations. We feel that investment management is all about acting swiftly and quickly to take advantage of market or asset price anomalies and our fund is positioned for this. We use a proprietary capital allocation model that uses both quantitative as well as qualitative inputs and accommodates varying levels of risk that we feel are appropriate for the fund, depending on our market forecasts.
What are the key challenges and opportunities associated with investing in the Saudi market? How does your fund manage these risks and uncover fresh opportunities?
Saudi Arabia is an emerging market and it presents the same challenges that other emerging markets present. With a GDP of SR1.296 trillion, Saudi Arabia is the largest economy in the GCC region and has the largest stock market in terms of market capitalisation. As of 30 June 2007, the Kingdom’s stock market had 95 listed companies with an aggregate capitalisation of SR1.112 trillion, or 36% of the GCC’s total capitalisation.
After hitting a record high of 20,634.86 points in early 2006, the Tadawul All-Share Index (TASI) has lost more than SR1.96 trillion in market capitalisation over the last 16 months. This is a decline of 64% in market capitalisation from SR3.075 trillion in Feb 2006 to SR1.112 trillion in June 2007. In 2006, the TASI declined 53.26%, making it the worst performer in the region.
From the perspective of value investing, the decline in TASI and market valuations since the first quarter of 2006 indicate that the sell-off was warranted. We are in the second year of the bear market and valuations are once again at reasonable levels. The current earnings yield stands at 7.03%. Given the Saudi equity market’s risk profile, current market valuations of a price-earnings ratio of 14.85 times and a dividend yield of 3.62% (2006) appear sustainable over the long term. We appreciate that an oil-exporting emerging market like Saudi Arabia has historically traded at a premium to emerging markets. Opportunities are plenty in the equity market and one has to take a patient, 3-year view.
We manage risk through diversification and investing in companies with good fundamentals.
How are the recent policies from the Saudi Arabian government and its regulatory body (the CMA) impacting the fund’s investible universe and overall potential?
The continuous efforts of the government to diversify the national economy and increase the contribution from the non-oil sector are paying off. Despite high oil prices and increased revenue, the share of the oil sector has been averaging around 40% of Saudi Arabia’s GDP. This diversification has reduced Saudi Arabia’s investment risk and has been confirmed by Standard & Poor’s recent revision of the country’s sovereign rating. On 16 July, Standard & Poor’s raised its foreign and local currency long-term sovereign credit ratings on the Kingdom of Saudi Arabia to “AA-” from “A+”. The country’s outlook is stable.
There is much to look forward to. Initiatives are being undertaken to improve investor confidence and market microstructure. The securities market regulator, CMA, is striving to bring new products to the financial market, improve transparency, enhance disclosure and corporate governance standards. Tadawul, the stock exchange, is working on launching a new trading platform and introducing new trading products to the market.
Given that the fund follows a bottom-up approach and seeks long-term appreciation, how frequently are allocations revised? How liquid is the portfolio and what is the typical holding period of an investment?
Our allocations are very regularly reviewed. We are aware that the equity market is going through a tough period and it is important to identify value investments. We have a strategic asset allocation plan and the tactical bets are built around those long-term allocations. We feel that investment management is all about acting swiftly and quickly to take advantage of market or asset price anomalies and our fund is positioned for this. The fund has good liquidity and investors can redeem twice a week.
The fund retains the ability to reposition the portfolio into liquid securities during adverse market conditions. Has this mechanism been back-tested to determine its efficacy (ie during recent market downturns)?
Yes, indeed. As I mentioned, if we believe market or economic conditions are unfavourable for investors, we may invest up to 100% of the fund’s assets in a temporary defensive manner by holding all or a substantial portion of its assets in cash, cash equivalents or other high quality short- and medium-term investments.
How do you benchmark your fund’s performance? Is this done from a perspective of absolute returns or risk-adjusted returns?
Although ours is a Shariah-compliant fund, in the absence of a neutral Islamic index for the Saudi market that is available freely and widely accepted, we benchmark against the Tadawul All-Share Index (TASI). We strive to produce better-than-market risk-adjusted returns.
How is the fund structured to comply with Shariah principles? How often is this reviewed? And by whom – the Shariah Board, the investment team or both?
We have a Shariah Advisory Board comprised of the following:
Shaikh Abdallah Ibn Sulaiman Almanie
Dr Mohammed Ibn Ali Al Garie
Dr Hamad Ibn Abd Al Rahman Al Junaidil
All the activities and transactions of the fund and its assets are reviewed by the Shariah Board on a quarterly basis.
How would you rate the Shariah-compliant process (ie in terms of set-up cost, time to market, etc) whilst developing this fund? Are economies of scale achievable when developing a second or third offering?
As you know, we are a Shariah-compliant institution. I would rate our Shariah-compliant process as very efficient and progressive. Surely, as we have a Board in place, economies of scale do apply.
How would you describe your investors (retail clients, private HNW clients, institutions)? What are they most interested in (growth/performance, Shariah-compliance, risk management/safety, etc)?
Our investors have invested with us because they feel we can add value to their investments. They are interested in investing in a Shariah-compliant manner and ensuring that their capital is preserved.
The bear market has disenchanted many investors and we are working towards restoring investor confidence in the mutual fund industry in Saudi Arabia.
Risk management is a critical ingredient of our portfolio management process as we believe that if we can isolate the risk prevailing in the market, our investors can benefit from the returns that are available.