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Sovereign wealth, economic growth give alternatives industry new traction

Sovereign wealth, economic growth give alternatives industry new traction

By Simon Gray – The Middle East is bouncing back from the financial and political turbulence of the past few years and with it the region’s alternative fund industry is again gaining traction. With Dubai shrugging off its debt problems to regain traction as a financial and business centre, Bahrain emerging from the political confrontations that disrupted the country in 2011 and Qatar continuing its breakneck emergence as a regional business hub, there’s a new sense of dynamism throughout the Gulf region.

Middle East investors have been looking to alternatives for years as part of their investment portfolios. However, this trend has gained further impetus with the rise of sovereign wealth funds set up to invest cash flows from the region’s energy resources in an economically and geographically diversified pool of investments, as well as from the depressive effects of low interest rates on conventional investment strategies.

At the same time, the comparatively rapid rebound of many Middle Eastern economies – especially those rich in hydrocarbons – from the 2008-09 downturn and the massive investment in infrastructure in countries such as Qatar have made it an important investment focus both for hedge funds and private equity firms.

That’s reflected in the continuing allocation of capital to hedge funds focused on the region. According to data and research firm eVestment, inflows into funds investing in the Middle East and North Africa has held up through this year at a time when investors have been pulling money out of other emerging markets. Total assets of funds focused on the MENA regions reached USD8.2bn at the end of September, up 17 per cent from February.

In terms of locally-domiciled vehicles, some USD28bn was invested in open-ended funds of all types throughout the Gulf Co-operation Council countries at the end of 2011, of which USD18bn was in Saudi Arabia. These figures include retail funds, a significant share of fund assets in Saudi Arabia in particular, but not assets held through separately managed accounts, a total that is not publicly available but is likely to be substantial.

Funds investing in the region took in a net USD319m over the period, a core growth rate of more than 8 per cent, compared with a net contraction of 6 per cent for all emerging market funds and an increase of 2 per cent for the hedge fund industry as a whole. Strategies focusing on the Middle East also outperformed emerging market hedge funds in general, with gains of 8.33 per cent in the third quarter and of more than 15 per cent over the first three quarters of 2012, according to eVestment.

Another indication of the increased industry focus on the region was the announcement in October by the Alternative Investment Management Association of plans to build a network in the Middle East, to give the local industry a voice in engaging with investors and developing relations with policymakers and regulators. The initiative is headed by Sohail Jaffer, a partner with Germany’s FWU investment and insurance services group who is active in business development in the Gulf region from a base in Dubai.

Jaffer, a former AIMA chairman and currently a member of the organisation’s regional advisory council for the EMEA region, says the initiative has been launched in response to increasing interest in hedge funds from Middle East investors including sovereign wealth funds as well as family offices and private clients. An initial AIMA Middle East group meeting has been held in Dubai.

“There is already a significant hedge fund industry community in the Middle East, both managers and service providers,” Jaffer says. “The region’s authorities are also taking a keen interest in hedge funds and are encouraging the growth of the local asset management industry. And many investors either have extensive experience of investing in alternatives or are looking at increasing their allocations in that area.”

The fund industry has been developing over a number of years in the region, with Bahrain emerging as the main domicile and service centre for internationally-oriented business. It has produced companies such as Investcorp, which has gone on to build up global operations with offices in London and New York, offering investors in the Gulf region and worldwide a mix of private equity, real estate and hedge fund investments. The group had USD11.5bn in assets under management at the end of June 2011.

Two factors have significantly boosted the shape of the alternative investment industry in the Middle East. One is the emergence of sovereign wealth funds, a concept whose development owes much to the desire of Gulf states to spread their oil and gas wealth across a much broader range of assets, as well as to use those capital flows to stimulate new areas of economic activity. At the same time, family offices based in the Gulf have also become a significant factor in the alternative investment industry.

Given what until recently has been the small size of the financial industry in the region by comparison with its overall wealth and resources, this has been a logical target for development. Among the jurisdictions that have made particular efforts to create regional financial centres, Dubai has embraced it as part of a broader strategy to develop services for the petroleum wealth that surrounds it but of which it possesses very little itself. By contrast, Qatar, by dint of its booming gas industry and massive infrastructure investment strategy, has been able to fill its fast-growing financial district with leading international players.

Already in the middle of the previous decade Dubai was setting out its stall to alternative asset managers and fund service providers such as administrators, although the onset of the financial crisis and its impact on the emirate slowed growth for a time. As elsewhere in the world, Middle East investors have been more cautious over the past few years, and capital-raising has become slower and more difficult.

Nevertheless, Dubai has nurtured the growth of firms like Abraaj Capital, which describes itself as a private equity manager but also runs real estate and listed equity investments, and currently has USD7.5bn invested across 25 sector and country-specific funds. Investment bank Rasmala has an asset management division with portfolio managers in Dubai and Cairo managing seven funds and advising five more, as well as segregated portfolios, comprising both Shariah and conventional investments.

The region’s alternative fund industry has almost certainly benefited to some degree from other consequences of the crisis. First, the problems faced by financial institutions elsewhere in the world, particularly in Europe, have drawn attention to the greater solidity of many (although not all) local banking and financial services groups, bolstered by much more dynamic economic activity at home.

Secondly, the investment strategies developed by local players including both institutions and private individuals and families have been influenced over the past few years by boom and bust in regional property markets, which in the past were viewed as a more attractive store of value than financial assets. The dramatic collapse of the real estate market in Dubai (although it is now bouncing back) has highlighted the importance of other strategies for spreading and mitigating risk.

Finally, the Shariah-compliant financial sector, which was already growing significantly in the years leading up to the crisis, has received a significant boost from the perception that the prohibition on the payment and receipt of interest and the general shunning of high levels of debt enshrined in Islamic finance principles had spared the sector many of the problems caused by excessive leverage elsewhere.

Islamic investment principles have also gained wider currency because of their obvious dovetailing with the trend toward sustainable, socially responsible and environment-friendly investment movement in Europe and North America. In the wake of the crisis both approaches have benefited from increasing support for the view that transactions should be guided by ethical, moral and social as well as profit considerations, that money should create social value rather than just wealth, and that transactions should be based on real economic activity as opposed to financial engineering.

The Dubai International Financial Centre is seeking to capitalise on the loss of confidence in some of the established foundations of the financial industry to persuade local investment firms – and others targeting investors in the region – to establish locally-domiciled vehicles serviced by companies with substance on the ground. While Middle East managers have in the past often used Cayman-domiciled fund structures for alternatives and Luxembourg- or Ireland-based UCITS funds for retail products (as well as to access the EU single market), that could change in the future.

Qatar too is looking to build on the clout of its own sovereign wealth fund, the Qatar Investment Authority, to boost its role as an asset management hub. The Qatar Financial Centre Authority notes that while pension funds in the region are currently small by international standards, their requirements in terms of asset management and other services should grow significantly in the coming years and decades.

Meanwhile high net worth individuals and families are also seeking to invest a larger share of their wealth in local markets and through local institutions. To encourage the growth of the fund industry, the Qatar Financial Centre allows authorised firms to operate foreign funds, and in the retail market has set out a regime for Qatar-registered and foreign-domiciled funds marketed to local investors.

Amid the efforts to build international fund service hubs, it’s easy to forget countries such as Kuwait and Saudi Arabia whose global ambitions in the asset management sector may currently be less pronounced but that have bigger domestic fund industries than any of their neighbours, catering to both institutions and retail investors. High levels of domestic savings throughout the Gulf region suggest that other countries could see similar development in the coming years.

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