Courtesy of The Financial Times, two interesting articles on Iran as a potential investment destination.  The first lays out the general investment thesis for Iran today:

There are frontier investment markets, and then there is Iraq. Bombings and fighting killed at least 42 people on Thursday alone, in nine or more separate explosions from Baghdad to Fallujah; yet so commonplace is the violence that the news merited few headlines. After all, at least 24 had died in explosions the previous day.

Yet despite the violence and uncertainty, fund managers and bankers are venturing in to the country, attracted by oil wealth and a surprisingly upbeat outlook for national GDP growth.

On Fridayh FMG, an emerging market and frontier research group, put out an investment report on Iraq, arguing that: “There is another more promising side to Iraq.”

In the past decade, the report notes, Iraq has tripled its oil production, posted GDP annual growth rates of around 10 per cent, and seen the market capitalisation of its stock exchange almost triple in three years.

FMG is not alone in noting this: Iraq’s own central bank is expecting 9.4 per cent annual growth in GDP to 2016, Bank of America Merrill Lynch has said the economy could triple in size by 2024, and Citi has predicted it could become a $2tn economy by 2050, as the country becomes one of the largest oil exporters worldwide. The IMF has said Iraq could gain almost $5tn in revenues from these oil exports between now and 2035.

From the investor perspective, the question is how to play it. Economic projections like that are all well and good, but how can they be realised against a background of bloodshed?

The cold reality is that the violence hasn’t had an impact on the behaviour of equities. FMG argues that over the last five years, nowhere has shown faster EPS growth rates than the Iraq Stock Exchange, although it has not yet been reflected in share prices. “We are of the view that Iraqi equities have potential for one of the greatest rallies in the developing market universe,” the report says.

As it stands today, the stock market is dominated by telecoms and banking. Out of 82 listed companies in Iraq, 21 are private banks, and this is an example of where FMG sees opportunity. It says profit before tax was up 29 per cent CAGR between 2007 and 2012 in the banking sector, yet quality banks trade between 1 to 1.5 times book value. Only 15 per cent of Iraqis have bank accounts, giving room for growth, and in a largely state-dominated sector (Rashid Bank and Rafidan Bank, the biggest, are both state-owned), the private banks are starting from a low base of just 10 per cent of the industry’s assets. FMG highlights Mansour Bank as an example of a good opportunity, having improved net income 115 per cent last year.

Although local investors account for 90 per cent of the modest daily volume on Iraq’s bourse, the market has received greater international attention ever since the listing of Asiacell last year, the largest company to be floated in the Middle East since 2008. That company now has 11m subscribers and offers a 5.5 per cent yield, but is on a trailing P/E of just 7.7 times.

The argument against investment is that the political situation may get worse before it gets better: a parliamentary election is due, and unrest is unlikely to ease ahead of it. The level of violence that has characterised the start of the year is the worst the country has seen since 2008.

Aside from frontier fund managers – the Euphrates Iraq Fund, Invest AD Iraq Opportunity Fund and Sansar Capital’s Frontier Fund being further examples – other financial services businesses are looking closely at Iraq. In October, the FT reported that Citigroup, JP Morgan and Standard Chartered were all planning to open bank branches in Iraq, and in 2011 reported that Morgan Stanley, Goldman Sachs, HSBC, Citi and BNP Paribas were sending bankers to Iraq to pitch for advisory work, underwriting and project finance. HSBC and Morgan Stanley led the Asiacell IPO, while Zain Iraq, which is expected to list this year, appointed Citi, BNP Paribas and National Bank of Kuwait as advisors on the listing several years ago.

The second examines this in more detail:

So we were struck by a new report today on neighbouring Iran with the opening line: “Iran is beyond the final frontier for portfolio investors.”

One can quibble about which frontier is further but in truth investment in Iran is not so outlandish. The nuclear deal struck between Iran and several world powers in November prompted a renewed look at the investment case for Iran, as has been the case for other markets that have come in from the cold after international isolation, most recently Burma. But in fact, even in isolation, Iran’s capital markets have grown just fine.

Tuesday’s report from Renaissance Capital’s main visionary thinker Charles Robertson follows a research visit there that led him to believe Iran will become investable, at least to frontier funds, within the next six to 18 months. This is a country, Robertson says, whose well-educated 78m-strong population is roughly the same size as Turkey’s, “with official per capita GDP of around $5,600, but which feels to us like $8,000-10,000. Tehran feels like Ankara did in 2004.”

Iran not only has a broad manufacturing base but 9 per cent of the world’s oil reserves (the Iranian & Foreign Joint Venture Investment Association reckons 11 per cent) and a large current account surplus. “Most interesting of all, there is a dynamic reform team now in charge of the government and central bank, which is undertaking the classic monetary and fiscal reforms EM investors usually like. This looks to us like a potential re-rating play that could – in an investable scenario – attract those investors who have recently invested in Saudi Arabia, like those who invested in Turkey after 2001 and Russia since the 1990s.”

When it does become investable – which will involve a combination of the removal of US sanctions and a growth in investor confidence around repatriation of funds – investors will find a mature market waiting for them. The market cap of the country’s stock markets at $170bn is, as Robertson says, similar to Poland’s, following privatisations over the past decade. The free float is around $30bn, more than the MSCI free floats of Kuwait and Nigeria, so if it were to enter the MSCI frontier index, it would account for about a quarter of it if all companies qualified for inclusion. Its daily trading volumes of around $150m are about five times those of Nigeria last year, Robertson says.

Others point to Iran’s favourable location between the Middle East, Asia and Europe, a staging point for the growing Central Asia/Caucuses region of 300m people and a lot of natural resources.

So, what’s the case against? First, there’s getting access in the first place. Robertson says there is a consensus in Iran that a deal on sanctions will take place with the US, possibly even later this year.

Once in, investors will not find everything to their liking: Robertson compares the banking sector to Russia’s in the 1990s. “We doubt the official NPL ratio of around 18 per cent is telling us the whole story.” The bond market is somewhat weird, with securities able to be sold back to the guaranteeing bank at any time and trading, if trading is the right word, at par. And many companies are owned by quasi-government funds or the Revolutionary Guard.

There are ethical questions around treatment of women, attitudes to Israel and general human rights – though there is a strong case to be made that Iran does better than Saudi Arabia on at least two of these metrics – and questions about the environment for legal redress, through there is new investment legislation in place intended to protect foreigners. A natural question arises about safety but many who go there frequently report no problem.

Some are in there already. Canton Hermidas Private Equity has launched a technology start-up private equity fund for Iran. Swicorp, a private equity and investment banking group headquartered in Switzerland, launched an open ended private equity fund focused on Iran, Algeria and Sudan back in 2005.

There are many steps to take before Iran can be considered fully linked back into the global economy and its portfolio flows, but when those steps are taken, investment in Iran is not going to look any more peculiar than many other countries that today receive frontier funds. As Robertson says, “if the situation with sanctions is resolved, it could be a serious market to consider in the coming years.