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28 March 2024

Region's hedge funds still have good reasons to be bullish on growth

The hedge fund industry in the region is in its nascent stages. (EB FILE)

Published
By Shveta Pathak

Hedge funds industry in the region is expected to grow 10 to 20 times in the next five years, fund managers and analysts told Emirates Business.

The assets under management (AUM) for hedge funds are now estimated to be a small portion, about $1 billon (Dh3.6bn), of the total market capitalisation of more than $64bn in this region.

"The small size is due to the fact that the industry is in its nascent stages. We expect the asset management industry to grow to $150bn in the next five years supported by growth in GDP and government spending, oil revenues and so forth," said Haissam Arabi, CEO and Fund Manager at Gulfmena Alternative Investments. "In line with that you would expect hedge funds industry to increase its share to three-five per cent market share. Hedge funds industry would grow at a faster than expected rate, the growth may be 20fold in the coming five years."

Hedi Ben Mlouka, Managing Director of Duet Group, said: "Derivatives and short instruments are three-year old in the region, so the hedge funds industry is at its early stages here which explains in turn the limited AUM so far. I expect it to increase at least tenfold in five years as the Mena talent-pool develops and more instruments become available to alternative funds."

Fund managers, however, face fresh challenges.

"The challenge here is to face this lack of confidence among investors by recreating demand around the hedge fund industry by establishing a good and linear track record," said Kamal Fayad, General Partner at Evolvence Mena Hedge Fund.

Patrick Merville, Chief Executive Officer, Man Investments, said: "Transparency and control over the assets have become a key criteria for institutional as well as private investors. Investors now take a far more critical look at how their money is being managed than they used to."

"I think globally fund managers are offering more transparency to investors in terms of risk management and return profile, and more acceptance of managed accounts," said Jeffrey Meyers of New Edge.


Did the hedge fund industry in the region have any impact on the global happenings such as Bernard Madoff fraud?

Fayad:
We have to face the fact that globally, hedge funds are actually suffering. Investor behaviour has changed during last year of crisis. About 30 per cent of hedge funds have closed, above 3,000, mainly because they followed the market trend, declined between 40 and 60 per cent, which was unexpected.

Mlouka: Directly, I would say they have not been affected as none of the Mena hedge funds as per my knowledge was involved in a scandal directly or indirectly. However, clearly investors are now much more careful and demanding in terms of transparency and understanding the fund's investment and risk management process which is leading to a much more detailed due diligence process. I think this is a great development for the industry in the long run.

Meyers: I think everyone was impacted by the global credit crisis, the overall impact in the hedge fund industry was a re-evaluation on investment managers and a more stringent approach to allocating with managers.

Arabi: They were affected on many fronts. Hedge fund investors were among the ultra-high networth individuals, family offices including big institutions as well as sovereign wealth funds. They were affected in different ways. First, the hedge funds went down so investors were affected in terms of depreciation in assets. Second, due to gates they didn't find ease of getting out of those funds. With situations such as Madoff even big institutions found themselves exposed to the tune of $400 million and fund of funds were also affected.

How is the performance of Mena hedge funds YTD. Has it been better than global hedge funds.

Fayad:
As of October 2009, Evolvence Mena hedge fund YTD is plus 10.51 per cent. The average of all other hedge funds of the region is plus 13.92 per cent. But what you have to look into is that, compared to the other funds, people did not lose any money with us. We are way above the high water market. As of end-2008, our YTD was minus 2.58 per cent. The average of Mena hedge funds was minus 36.71 per cent.

Numbers talk by themselves. The main reason is we are acting as a hedge fund. Now, it is very important to go back to basics by acting like risk-averse investors, and also by adapting ourselves to the market in a way of diversifying our portfolio. Risk-adjusted returns with a multi-strategic approach are our day-to-day work.

Mlouka: Mena hedge funds performance year-to-date [and I only include here, the ones who are absolute returns driven] was about 10 per cent on average and has therefore lagged global hedge funds only marginally. I think, this was probably due to the fact that other emerging markets have rallied much more than Mena markets so far this year, making the trend much clearer and easier to capture for hedge funds which may explain this underperformance.

Arabi: The performance was much in line with other funds globally. Global hedge funds were up 15 per cent to 18 per cent year-to-date.

What steps are fund managers taking to deal with fresh challenges being faced by hedge fund industry?

Fayad:
We have to admit that globally, the name hedge fund lost a lot of credibility. The challenge here is to face this lack of confidence among investors by recreating demand around the hedge fund industry by establishing a good and linear track record and by behaving as real hedge fund managers and not risky investors. We have to go back to basics by acting as a capital-risk fund.

Mlouka: Fund managers in the region are certainly strengthening their risk management, their investment process and probably putting more effort in distinguishing themselves from long only funds, by focusing on delivering returns that are less correlated to equity markets [although many of them have already actually succeeded in protecting capital to a big extent during the downturn – contrary to long-only funds in the region].

Merville: After the financial turmoil in 2008, the investment environment in the traditional as well as the alternative market has changed dramatically. Transparency and control over the assets have become a key criteria for institutional as well as private investors. Investors now take a far more critical look at how their money is being managed. Man's managed accounts initiative is, simply put, just the answer to what investors are looking for at the moment. They demand transparency, control and liquidity; things that managed account can provide. We at Man have been working with managed accounts for more than two decades now, so this is really nothing new for us. We were able to increase our assets under managed accounts by half over the past six months, and we're aiming to further expand the platform.

Meyers: I think globally fund managers are offering more transparency to investors in terms of risk management and return profile, and more acceptance of managed accounts.

Arabi: Hedge funds have to deal with issues not only during the credit crunch but also post-credit crunch and post-Madoff. The top [issues they face are] in terms of regulation, higher transparency investors seek, cost of operations and pricing.

Investment managers have to make sure they are using independent and regulated ISPs which is in the form of independent custodian and accountant. Reporting and risk management would be among the top things. Hedge fund managers need to invest a lot more towards IT and IT solutions for reporting.

Besides, investors will want a lot more transparency. Each investor might be looking for specific risk criteria that they want to monitor for the fund they are investing in. Pricing of hedge funds too is under pressure. There has to be a lot more to justify, aligning the pricing with the kind of strategy – a market- neutral strategy, all strategies will need to look at examining the pricing structure. Higher cost of operations is another challenge.

Are you expecting stricter regulations on hedge funds in the UAE and Mena region? Is there a need for it?

Fayad:
We don't expect stricter regulations on hedge funds in the UAE and Mena region. All we are afraid of is the reluctance of potential investors to believe in this new market, considered as an emerging one. Confidence is coming back step by step, and it is our work to make them believe again in a company such as ours that can provide them with a different management and especially a safe environment in every way.

Mlouka: Stricter regulations that would bring more transparency, disclosure and certain operational requirements, in terms of administration and custody of assets for instance, may make sense although no real weaknesses have yet been spotted in the regional funds. In terms of instruments and investments, any restrictions would be very disappointing as the region badly needs more [not less] professional money and liquidity providers such as hedge funds.

Merville: It is still difficult to say how the new regulations will affect the hedge fund business in specific. Time will show to what extent these new regulations will have an impact on our regional businesses in their respective jurisdictions. Due to the fact that Man already is a highly regulated company, listed on the London Stock Exchange and a member of the FTSE 100 Index, we are currently not worried too much about the implementation of new regulations. Unlike the smaller players, we will have considerably less trouble adapting to these regulations.

Meyers: I do not think there is a need for stricter regulation, although there should be some basic rules that are followed globally and it is up to each region to determine if there are potential "local" issues that might need to be addressed. I think it makes sense to have open communication between local fund managers, the banks and some of the regulatory bodies. It is important that regulatory agencies should be aware if there is any potential "stress" on the financial system.

Arabi: We don't expect stricter regulations. Within the entire region the DFSA or DIFC is a world-class regulatory official. Hedge funds fall under investment management. In some cases they are quite under regulated. But before we get to discuss hedge funds they have to look at the entire asset management industry and revamp all the laws and legislation regarding the industry, until they go and register for the hedge fund.

We should not expect much to come out of the region but if anything we should see measures for the investment management industry as a whole. Bring it to modern times, all of which necessitate revamping of our rules and laws.

Hedge funds in this region have an estimated only about $1bn assets under management. Is it due to the fact that industry in this region is relatively in its nascent stage? What kind of increase in volumes do you expect in five years from now?

Fayad: The fact that hedge funds in the region have an estimated only about $1bn assets under management is mainly because industry in this region is relatively in its nascent stage. It is a new market, an emerging country. In a very short period of time, Dubai and even entire UAE have become a world financial centre, where companies from all over the world have actively participated to that growth.

The market is still very young and even if the potential is big, investors are still reluctant to invest. The financial crisis did not help to increase the amount of money invested in the region. The economy depends a lot on the price of oil. Profits made from it have to be in part reinvested in all types of infrastructures. Price of oil is expected to grow in the next years, so will the industry. We do believe in that and will do our best to follow that trend.

Five years from now, we expect our volume to be multiplied by 10 [objective of $500bn].

Mlouka: Derivatives and short instruments are three-year old in the region, so the hedge funds industry is at its early stages here which explains in turn the limited AUM so far. I expect it to increase at least tenfold in five years as the Mena talent-pool develops and more instruments become available to alternative funds. The opportunities in the region are great: it is no longer just an oil play and there is no doubt about that.

Meyers: I think this region has enormous potential to grow in terms of assets under management mainly because this region is going to be the liquidity source to those types of investments. One could easily see the AUM in this region be more than $30-$40bn in five years. I think as long as hedge funds in this region can provide solid infrastructure and good risk adjusted returns they should greatly benefit as attention continues to shift back to alternative investment vehicles.

Arabi: The small size is due to the fact that the industry is in its nascent stages. I think asset management industry has been very low in comparison to Malaysia or India where it is 14-15 per cent of market capitalisation. We are here about six per cent relative to market capitalization of Mena market.

We expect the asset management industry to grow to $150bn in the next five years supported by growth in GDP and government spending, oil revenues and so forth.

In line with that you would expect hedge funds industry to increase its share to three-five per cent market share. Hedge funds industry would grow at a faster than expected rate, the growth may be 20fold in the coming five years.

 

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