Investor risk apetite has been at rock bottom for some time across the Middle East and North Africa region, first because of the global financial crisis which burnt many and second because of the uncertainty created by the Arab Spring. Some countries and industries have offered better opportunities than others, but overall the past few years have been a bad time for fund managers in general and hedge funds have not been an exception.
However, of all investment vehicles hedge funds should possess the ability to make good out of bad times, find niches and hedge against falling markets. Their flexibility should make them an increasingly attractive option as investors seek out vehicles that can offer them some comfort against the insecurities of recent times. Hedge funds too should be a vehicle that can aim for higher returns, while others track depressed markets.
MENA Fund Review spoke to Stephen Oxley, managing director of PAAMCO (Pacific Alternative Asset Management Company) and Amin El-Kholy, managing director, asset management, at Arqaam Capital, about the appetite for hedge funds and their future in the Middle East and North Africa region.
How has investor sentiment towards hedge funds altered over the past year and what bearing have the Arab Spring and financial crisis had on any changes in sentiment?
Stephen Oxley: Investor sentiment towards hedge funds over the past year seems to be consistent with previous years - it remains healthy. The emphasis has been on protection of capital and liquidity given the political and financial instability witnessed globally. We are seeing that investors are becoming, in general, more comfortable with hedge fund investing the further from the financial crisis we move. There is also recognition that investing long-only in equities has been particularly volatile in recent years which makes hedged strategies more appealing.
Amin El-Kholy: In relation to MENA-focused hedge funds sentiment is mixed as most funds have either performed very poorly or shown a huge spike in volatility and some have closed as a result. This will allow investors to separate them on quality and we have certainly had increased interest in our hedge fund due to superior performance and low volatility. The financial crisis has affected investor sentiment globally, slowed down decision making and impacted allocations into virtually every asset class. The crisis is by far the more significant factor affecting investor sentiment.
Who is investing in MENA-focused hedge funds - local or international investors, individuals or institutions?
Stephen Oxley: We believe that since the financial crisis of 2008, the majority of investors in MENA-based hedge funds are local. This is for a number of reasons but mainly because we saw a withdrawal of capital by global investors during the financial crisis and there is evidence that this international money has not returned. This may be driven by the existence of potentially better risk/reward opportunities elsewhere. There are also MENA focused managers located outside the region that are more likely to be attracting asset flows from non-domestic investors.
Amin El-Kholy: The list includes investors from all categories but the emphasis is on institutions both international and regional.
How have hedge funds reacted to events across the MENA region in investment terms?
Stephen Oxley: It is hard to generalize as different managers have their own responses but it looks like they have been more opportunistic in their approach and investments. Additionally, a focus on risk management, political or macro risk and hedging has become critical.
Amin El-Kholy: The events of the Arab Spring seem to have caught most MENA-focused hedge funds by surprise. This is despite the fact that political risk was certainly elevated as we highlighted in our newsletter to our investors back in June 2010. As a result most were deeply in the red by the middle of the year with a few notable exceptions. As the impact of the first wave of events was absorbed focus shifted onto the crisis in Europe, which has added an extra factor into the equation. There have been few clear opportunities in the second half of the year except for the ability to accumulate investment positions at lower prices, which suits some investment strategies and not others.
The vast majority of global investors seem to have pigeon-holed MENA as an area of uneasy 'stability' under various despotic regimes with the only relevance to their investment process being in relation to occasional spikes in oil price driven by geo-political risks. The Arab Spring has added domestic politics to an equation which most global investors already found confusing. The fact is that MENA is relevant to all investors globally, even if they do not invest in the region directly. Over and above the fact that 50 percent of global oil reserves and 45 percent of global gas reserves are located in the region, 50 percent of the world's phosphate production also comes from MENA. With events in Europe putting pressure on global liquidity the role of MENA-based sovereign wealth funds gains in importance and this cannot be isolated from domestic pressures for increased domestic investment. As well as global trade flows through the region (Suez Canal and various ports and free zones), there is an increasing number of globally relevant, and often dominant, companies based in the region (petrochemicals, fertilisers, airlines). All these factors are now important to take into account and any global investor needs to increase their knowledge of the MENA region significantly.
What opportuities are there for hedge funds to increase their share of the region's asset management business and what might be the driving factors behind any increase?
Stephen Oxley: We believe that any increase would be driven by the alpha generation and hedging capabilities of hedge funds. In the current volatile market environment, flexibility can help preserve capital, reduce volatility and exploit investment opportunities. We also believe that enhanced transparency and improving governance and regulation of the hedge fund industry can help investors gain comfort with the idea of investing in alternative and hedged strategies.
Amin El-Kholy: Increased volatility and risk aversion, combined with a rise in the relative attractiveness of the region economically will increase demand for risk-savvy MENA focused investment vehicles. The opportunity lies in offering investors products which add value and are differentiated from the currently dominant, and extremely run-of the mill, long-only investment vehicles, which offer little value added over an ETF or a tracker. This will only be achieved by MENA hedge funds which have not only succeeded in preserving capital in the down-turn, but also manage to capitalise successfully on gains in bull-markets.
What catalysts to greater hedge fund investment in the region might there be? For example, could the inclusion of Jordan and Morocco into the GCC or the upgrading of Qatar and the UAE to MSCI emerging market status have an impact?
Stephen Oxley: Inclusion of other markets and upgrading of certain ones to MSCI EM status will, we believe, have a marginal impact. Although, if that were to lead to better liquidity and a deeper derivatives market then their inclusion might be a catalyst for change.
Amin El-Kholy: If there is one key to greater hedge fund investment in the region it is the increased ability to gain short access in sufficient volume. Any measures which increase liquidity and free-float would help that process. An upgrade of Qatar and the UAE would require increased free float and is likely to be positive. The inclusion of Morocco and Jordan in the GCC, without a change in the capital markets, will have no impact.
The most significant step would be the opening up of the Saudi Arabian markets to foreign investments, not through complicated and unnecessary swaps as is the case now, but through direct access.
Are investors accessing hedge funds directly or through funds of hedge funds and how do you see this developing?
Stephen Oxley: It's a combination of both and is a function of the governance capabilities and the resources of the investor. Many institutions in the region use funds of hedge funds (FoHFs) because of the research, due diligence, risk management, legal, portfolio construction and monitoring services they provide.
Some may also invest directly, usually with larger brand-name hedge funds and increasingly may target their funds of hedge funds towards customized portfolios which may be focused on particular strategies or risk profiles. Funds of hedge funds can be seen as an additional layer of cost but many investors are recognizing that because FoHFs can negotiate fees with the underlying managers, provide an important layer of governance and hopefully enhance performance (as well as doing all the work described above), the actual cost is very similar to investing direct.
What factors might be holding back hedge fund industry development in the MENA region, such as regulatory issues, lack of corporate transparency or political risk?
Stephen Oxley: Primarily it's the regulatory issues and the need for further development of the regions capital markets which are still heavily biased towards equities.
Amin El-Kholy: Certain regulatory issues, particularly in relation to access to the markets, can certainly be seen as a barrier. Corporate transparency has improved by leaps and bounds over the last few years and has in the case of most major companies crossed the requisite threshold for emerging markets. Political risk is possible to manage and turn into an opportunity by skilled managers. Good performance, despite political risks, will bring investors to the asset class.
How to envisage the development of the Shariah hedge fund industry?
Stephen Oxley: It is hard to tell as the traditional hedge fund industry locally is still in its infancy versus other areas globally.
What is your outlook for MENA hedge fund industry development in general over the coming two years?
Stephen Oxley: In general it is a positive outlook. Politically, things seem to be moving in the right direction, albeit gradually and hence this should have a positive impact on markets. This in turn should provide opportunities that hedge funds can exploit. Additionally, governments are genuinely interested in developing their markets to become deeper which should help attract further foreign capital.
Amin El-Kholy: The first development, already taking place, will be the clear separation of true hedge fund managers from closet long-only managers and the closing down of some more hedge funds which have failed to perform. This, combined with an increased interest in the region and better conditions for hedge funds to operate in the region, will result in the best funds growing in size. New hedge fund launches are also likely as well as an increase in the range of strategies offered by existing and new hedge fund managers as the MENA markets continue to develop.
© MENA Fund Review 2012
