Will You Buy Stocks in Post-Sanctions Iran?
The financial media is abuzz with news about Iran.
Many investors are wondering: If and when sanctions are eased in the first quarter of 2016, will Iran’s listed equities present an attractive investment opportunity? On one side are the Iran optimists who are describing this as a “once in a lifetime opportunity.” On the other are the Iran pessimists who are saying, “not so fast.” Let’s take a brief look at the two camps’ lines of reasoning on the political, economic, and stock market angles.
The Iran optimists are not deterred by the bitter past or Iran’s curious form of government. They believe that in politics there are no permanent friends or enemies, only permanent interests. They say there are numerous instances of implacable foes overcoming past animosity, including the United States and Vietnam. China too has a system of governance alien to Western democracies, but it hasn’t stopped investors from investing in China. With the current geopolitical situation in the Middle East, Iran is beginning to look more like a potential ally of the West in defeating the DAISH in Iraq and Syria. In fact, some are already debating whether Iran will become the new Saudi Arabia — a key regional partner — for the United States. There is a perceptible pro-business shift in Iran’s circles of power, so now is the time to invest. Investing isn’t about political point scoring or making history, it is about making money, these optimists say. And investors can’t make money without assuming some risk.
The Iran pessimists say that it takes time to overcome a history of mistrust and poor governance. In Iran and the West, generations have grown up on a steady diet of toxic propaganda directed at each other. If Americans see Iran as part of the Axis of Evil,” Iranians remember the US-backed overthrow of Iran’s democratically elected prime minister Mohammad Mossadegh in 1953, support for Saddam Hussein’s Iraq during the brutal Iran–Iraq War of the 1980s, and the shooting down of an Iranian civilian Airbus with 290 passengers, including more than 60 children, in 1988. Iran wants the sanctions lifted, but investors in Iran will have to deal with a system of government that is opaque and altogether foreign to them. The pessimists say that the opening of Iran is a process not an event, and that decades of hostility and poor governance cannot change overnight.
The optimists are quick to point out that Iran is blessed with an abundance of natural resources, including 18% of the world’s natural gas reserves and 9% of its oil reserves. And Iran is nowhere near capacity in terms of exploiting these resources. In addition, Iran is among the 20 largest countries in terms of area, has a population of 80 million — about the same as Turkey — and very favorable demographics. Wages there are comparable to those in Vietnam. Its economy is reasonably well diversified, its industrial sector has made some progress despite the sanctions, and it is the largest automobile manufacturer in the Middle East. The easing of sanctions could release many billions in Iranian assets currently held abroad, giving the economy a quick boost, and Iranians living overseas will also send capital back home to spend and invest.
The pessimists, on the other hand, observe that oil prices are down by half, sharply reducing oil revenue as well as the incentive to invest in the sector. Iran is littered with state-linked monopolies. It is rated 118th for ease of doing business, and there are major differences in how business is conducted in Iran compared to OECD countries. The political, economic, and military systems of Iran are intertwined, and the country’s elite Revolutionary Guard run its own business empire, creating policy and reputational risk for foreign investors. Another challenge is that influential charities control a large proportion of assets, and will not be welcoming to foreign competitors. The Iran pessimists note that the Iranian central bank is far from independent and the country has serious problems with corruption and property rights. And if all that’s not bad enough, the sort of legal protections foreign investors would like are far from in place.
The Stock Market
The optimists argue that Iranian equities are investable and have great potential. The Iranian stock market cap is close to $85 billion, which is much larger than that of many other countries and not that far from that of Saudi Arabia, which has the largest market capitalization among the Gulf Cooperation Council (GCC) countries. The market is liquid, dividend yields are in doubt digits, and P/E ratio is among the lowest in the world. Should Iran joins the MSCI Frontier Markets Index, it would be the second largest market, just behind Kuwait. Moreover, the Iranian Rial is also likely to be undervalued. What more could an investor want?
The pessimists maintain that if Iranian equities were so attractive in the wake of easing sanctions, the market would have been bullish. But it is not. In 2014, Iran’s stock market fell by as much as 21% when stock markets in the West were posting gains. Also, if there is a popular backlash against foreign investors, both investments and careers could be jeopardized. There are no foreign institutions offering custodial services in Iran, so who are investors going to trust with their client’s money? In fact, so far even the modus operandi of investing in Iranian’s equities remains unclear. Iran’s stocks carry a lot of risk.
Poll Results: Pessimists in Majority
To get some insight on the issue, we polled CFA Institute Financial NewsBrief readers to see what their take was. It turns out that Iran pessimists are in the majority, with 51% of the 598 respondents saying they either disagree (28%) or strongly disagree (23%) that Iranian equities will be an attractive investment opportunity for foreign investors should sanctions be eased. Only about 6% “strongly agree” that Iranian stocks will be a good bet. It is interesting to note that nearly a quarter of the respondents are “undecided” and could swing either way.
If the economic sanctions on Iran are eased in 2016, will its listed equities be an attractive investment opportunity for foreign investors?
Going through these competing narratives, my sense is the pessimists aren’t making a case against investing in Iran so much as counseling against rushing into it. Where the pessimists differ from the optimists is that they want to see more certainty and front-loaded structural reforms from Iran. But for investors who want to make money in Iranian equities, delay is not an option. If there is any alpha to be had, it could be squeezed out by the early movers. By December 2016, we will probably know which faction was more correct in its assessment. But if the optimists are proven right, they will likely owe a thank you to the pessimists. After all, by emphasizing the risks over the potential returns, the pessimists may have helped create the alpha opportunity anticipated by the optimists.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.