Egyptian capital market deepens with introduction of exchange-traded funds

One of the more interesting developments on the Egyptian Exchange (EGX) in 2015 was the commencement of trading of the market’s first exchange-traded fund (ETF). Since the 1980s these instruments have proved popular with investors in well-established markets as a useful alternative to mutual funds, for a number of reasons.

For example, although trading like a single stock with prices updated throughout the day in most cases, they offer exposure to a group of equities, market segments or styles of stock (such as green energy or sharia-compliant companies). Moreover, as passively managed instruments this diversity comes at a much lower price, with expense ratios far more favourable than those demanded by managed funds. In many cases they can also be more tax efficient, as they are not subject to capital gains levies in the same way that mutual funds are.

Limited Interest

Despite the potential benefits of ETF trading, however, the small number of them that have been introduced in the emerging markets of the GCC have failed to generate much interest from regional investors, with trading volumes remaining muted. This is partly a question of the GCC investor profile and its expectations: the large number of retail investors in Gulf markets tend to have short investment horizons and, as they are seeking reasonably quick profits, are less interested in the longer-term gains that ETFs offer. The question about how an ETF might perform on the EGX, which is by far the oldest exchange in the region, was therefore rendered a moot one.

Egypt is a relatively late adopter of the ETF concept, although international investors have been able to access Egyptian equities for some years through ETFs based on foreign exchanges, such as through the Egypt Index ETF launched by Global Van Eck on the New York Stock Exchange in 2010 and the EGX 30 Index Certificates, which have been listed by Deutsche Bank on the Frankfurt and Stuttgart exchanges since 2006. Plans to introduce an ETF on the EGX were slow to emerge, and were further delayed by the onset of the revolution in 2011, which compelled the exchange authorities to concentrate on maintaining normal operations rather than enhancing processes and instruments.

Strategy

Nevertheless, the introduction of ETFs to the nation’s bourse is a major part of the EGX’s development plan, the Proposed Strategy 2013-17. Alongside the development of a derivatives market, activating sukuk (Islamic bond) rules and enhancing the bond market, the strategy outlined by the EGX sees ETFs as crucial to its efforts to deepen the market and provide a greater array of options to investors. To this end, in March 2014 the EGX board of directors gave its approval to a new set of executive rules for ETFs, market makers and block deals, and sent them to the Egyptian Financial Services Authority for approval. As a result, in January 2015 investors were granted the opportunity to buy into an ETF on the EGX for the first time.

Beltone Financial Holding, an Egyptian brokerage, investment banking and private equity house, was granted the first licence to operate an ETF on the domestic exchange. The instrument was launched with an initial value of LE10m ($1.36m), and as it tracks the EGX30 Index, the principal index of the market, it gives investors exposure to a diverse range of Egyptian stocks. The early response to the commencement of ETF trading was encouraging: The EGX index rose by 2.53% on the first day of the new ETF’s trading, while the wider market registered a LE6bn ($818m) gain.

It is too early to judge the success of Egypt’s first domestically licensed ETF. However, its introduction is significant for deepening the market, and provides investors with a useful hedging tool as well as an easy, low-cost way to diversify portfolios.