After much anticipation and years of sanctions, Iran’s agreement with the “5+1” Nations has finally opened the market to foreign investors once again. Very few know just how large Iran is in the Global economy. With nominal GDP of $400 billion Iran is the 28 largest economy in the world and on a PPP basis its larger than Australia. The other misnomer is that the economy is based on oil, but the economy has diversified away from oil during the sanctions. Currently oil accounts for less than 20% of the GDP while the services sector con-tributes to over 60%. Compared to most emerging and frontier markets, the capital markets are extremely well developed as the stock market was established over 50 years ago and was large and liquid back in the 70s. It is relatively diversified and larger than most frontier markets and even parallels many emerging markets. In a recent report published by Mckinsey Iran has been referred to as a $1 trillion growth opportunity and yet due to the difficulty currently on investing, the country is trading at 40% discount to MSCI Frontier.
Opportunity: Multiple expansion combined with earnings growth in a diversified and extremely uncorrelated market
At less than 7x PE multiple and an average dividend yield of 11% the market is cheap and attractive. While the remaining US sanctions have slowed down the pace of Iran’s reintegration into the global banking system, the impact of lifting of UN and European sanctions in January 2016 are slowly but surely being felt by the corporate sector and the recent flurry of quarterly results show marked improvements in earnings and future forecasts. Inflation has had a massive decline and has dropped from 40% to 7.9% in the last 2 years. As a result the Central Bank is forcing interest rates down which should spur demand, production and movement from bond investments to equities. Currently there is $297 billion locked up in saving deposits and as interest rates decline, some of those savings should find their way to riskier assets resulting in lifting the markets from their current levels. Needless to say, with risk free rate coming down, PE’s should re-rate as well, all boding well for the stock market to rally. The combination of the earnings growth and the multiple expansion provide an attractive opportunity in a diversified market.
Challenges: Access and lack of sufficient information about the market
To date, US primary sanctions on Iran remain. While the remaining primary sanctions only relate to US persons, they can still impact the ability of other investor to access the market as many institutional investors have US co-mingled funds, and or, use US service providers as custodians etc. Also given the heavy presence of many of the larger European banks in the US many are still reluctant to be involved with Iran related transactions. This limits the ability of many investors across the globe to access the Iranian market. Furthermore, lack of sub-custody arrangements with European firms means that investing in Iran at the present is cumbersome for many European pension funds and other asset managers whose mandate does not include offshore funds. The Iranian market is also large and complex. Financial statements are mostly only in Farsi and accounting is a modified form of IFRS. Understanding the impact of changing regulations on various sectors could also be rather challenging for foreign investors. Furthermore, given the structure and age of the economy and its capital markets many of the traditional frontier market investment thesis may not apply to Iran. A strong local presence is key in understanding these challenges and those who would like to have exposure by simply throwing money from a distance to have exposure may be disappointed.
Homan Harandian took part in the Iran Special Focus panel at the upcoming FundForum Middle East.