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TalkingPoint: Investment Funds In The Middle East « Back
November 2011
FW moderates a discussion covering investment funds in the Middle East between Pervez Akhtar at Freshfields Bruckhaus Deringer and Zeeshan Ahmedani at White & Case LLP.

FW: How would you describe the growth of investment funds in the Middle East? What impact is recent growth having on the emergence of new markets, new opportunities and fund capabilities in the region?

The MENA investment funds market has grown tremendously over the past decade, notwithstanding the slowdown since last year due to current economic and political challenges, both global and regional. According to many sources, the largest fund managers – in terms of equity raised over the past five years – in Asia are based in the Middle East. The industry has benefited from the region’s large, sophisticated and liquid LP market and the influx of talent from more established markets. The sophisticated LP market has sought to import the global best practices of their Western managers to regional managers, thereby uplifting industry standards locally. On the sponsor side, the arrival of large managers and experienced professionals has had a similar effect on the industry as a whole. Increased sophistication has also led to increased competition, creating incentives to identify new markets in the quest for returns.

Akhtar: In terms of new fund establishments, there has certainly been a reduction in the region over the past 18 months. The monetary value of deals done by existing funds in 2010 also fell further from what was a historic low in 2009. This was largely attributable to the perceived lack of quality assets combined with the fact that asset valuations were felt by many to be out of synch with the economic situation. In addition, private equity firms have increasingly had to concentrate on positioning their existing portfolios and managing risk profiles rather than new transactions with many general partners having a far higher degree of involvement in activities related to the operational management of their portfolio companies and adjusting the models of those businesses to market conditions.

FW: Are sovereign wealth funds active in the Middle East and abroad? What types of investments and sectors do they seem to be targeting?

Akhtar: In the last couple of years sovereign wealth funds (SWFs) have broadly shown an increase in deal volume but there has been a decrease in the value of their individual investments. The principal sectors that have attracted attention have been banking, insurance, commodities, natural gas and petrochemicals, renewable energy, and energy transmission. In terms of the geographic distribution of investments there is an interesting difference between investment patterns of Middle Eastern SWFs and those in Asia. The latter have been understandably active in Asia Pacific but also in North America. This contrasts with the Middle Eastern funds that, while also investing in Asia Pacific, have historically been more active in Europe, and not so active in North America, with the notable exception of the Libyan Investment Authority’s acquisition of Verenex Energy.

Ahmedani: SWFs continue to remain active globally in respect of their investment allocations. Well-established managers with track records continue to do well on the fund raising side, as well as markets and sectors that are perceived to be undervalued, such as real estate markets in the West, or present significant opportunities for return, for instance emerging Asia. Sectors we have seen of late are clean and renewable energy, technology and insurance and re-insurance industries. Regionally, there is still a perception of a general lack of depth across the industry such that the number of attractive managers in the region is proportionately less than in other regions. Many investors look to co-investments, joint ventures and direct investments as a result in order to mitigate this risk.

FW: To what extent has political volatility in the region, coupled with the continued affects of the GFC, had a material impact on the funds industry and the investment outlook?

Ahmedani: Certainly the Arab Spring has slowed growth. Statistics show that overall deal activity in the region has slowed since the onset of the political movements and that outbound investments exceed inbound investments in terms of value, though some of this is attributable to opportunities seized by regional cash-rich investors and companies in global, depressed markets. Not surprisingly, private equity capital raise is still down from pre-GFC highs and recovery has been slowed by the region’s political events. Other parts of the world have benefitted from the regional slowdown. The MENA region, for example, is home to the largest fund manager in Asia but collectively has been outpaced by East Asia in terms of total capital raised.

Akhtar: Political and social unrest throughout 2011 has, unsurprisingly, had a negative impact on MENA markets in the short term, and clearly in those countries directly affected by the unrest. Capital deployment and investments have been put on hold as well as a reduction in activity to raise additional funds. Private equity firms considering exit strategies for some of their investments have also adopted a more cautious approach not helped, for example, by the lack of liquidity of regional stock exchanges and a continued emphasis on the operational management of existing portfolios. There have also been widely divergent views on valuations, particularly those from potential buyers and sellers from outside the region. This has made deals more difficult in the current context, with 2011 seeing the general adoption of a wait and see approach.

FW: Could you provide an overview of the legal principles governing Islamic finance? What are the basics of Shariah-compliant fund structures, and are these becoming more popular?

Ahmedani: Very simply, Islamic finance is based on a number of key principles: actual or constructive possession of assets, mitigation of preventable risk, principles of fairness, certainty, equity and transparency and prohibition of certain industries – certain entertainment, alcohol, pork, defence, and conventional finance and insurance. It is also an asset-based finance with prohibition of interest and certain forms of fixed and preferred returns. Shariah-compliant funds must adhere to these rules not only at the fund level, but also at the investment level, for instance, type of investment, its financial profile and acquisition structure legally and financially. Fund structures themselves are fairly straightforward in most cases as the GP-LP structure fits very neatly in to Shariah. Hedge fund structures can be slightly trickier. Shariah-compliant funds will continue to be popular if they provide investors with access to sectors, regions and strategies that are otherwise unavailable to them. Many managers add a Shariah component to conventional strategies to tap such markets. Shariah products that can provide fixed-income like returns are currently attractive.
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