Hedge funds eye booming Middle East

While some emerging markets might have peaked, the region is seen as not having realised its full potential yet (DENNIS B MALLARI)

Hedge fund investors plan to increase their allocations to emerging markets, according to a report – and the Middle East is expected to be the top performer among all regions.

The United States/Canada and Western Europe are expected to be the worst hedge fund performers, with China a close third.

This was revealed in Deutsche Bank's annual Alternative Investment Survey, which polled more than a thousand investors representing about $1 trillion (Dh3.67trn) in hedge fund assets. The report is regarded as the most extensive survey of hedge fund investor sentiment in the industry.

Close to 50 per cent of those quizzed were bullish about the Middle East markets, with no company surveyed indicating it was planning to reduce its exposure to the region. Twelve per cent said they would maintain current exposure levels and 32 per cent planned to increase them.

"The results are a clear indication that global hedge fund investors are extremely bullish about the region," said Penry Jackson, managing director, Global Markets, at Deutsche Bank in Dubai.

"The Middle East is viewed differently from other emerging markets by investors, largely because it is nascent, holds tremendous potential and has very attractive company valuations.

 "While some emerging markets might have peaked, the Middle East is seen as not having realised its full potential yet. We would expect to see many of the traditional barriers to entry in these markets being lowered in the medium term to enable further growth."

The types of investor most interested in the region were consultants, family offices, high-net worth individuals and wealth management companies. The Middle East and North Africa (Mena) region is a new listing in the survey for 2008 and has assets from 29 per cent of investors – mostly funds of funds and family offices.

Nearly all the investors quizzed in the survey have allocations with hedge funds that invest in the Americas, and Europe and Pan-Asia are close behind.

When asked what regions they were most likely to allocate to in 2008, more investors indicated they would allocate to Mena and Asia, excluding Japan, than any others. And 32 per cent of investors indicated they would add investments to each of these regions.

The US/Canada appears to be the least favoured region as six per cent of investors said they would reduce their allocations there. Companies with exposure to the Mena region were not planning to reduce it – and nearly a third of investors planned to raise their exposure.

For the first time Deutsche Bank asked respondents for their predictions on hedge funds that invest in South Africa. It appears many are still cautious when it comes to this region – 68 per cent do not have allocations or a strong interest in the region.

Overall four per cent expected to add allocations, while only two per cent expected to decrease their exposure.

Globally, hedge funds investors predicted that macro, distressed and equity volatility would be the top performing strategies for 2008. Sixty-one per cent of investors said they would invest in macro investment strategies that were less sensitive to the equity markets. Appetite was also high for distressed and equity volatility, which came in second and third place, with 41 per cent and 37 per cent of investors respectively predicting these strategies will perform well.

On the other hand, funds focusing on asset-backed securities were overwhelmingly expected to be the worst performers.

The overall outlook for the year remains bearish among 80 per cent of those surveyed, with 40 per cent expecting the world economy to pick up in 2009. As a result, 30 per cent of investors are holding cash, with over half of the respondents saying they are willing to eliminate it by March 2009.

This cautious approach is reflected in the increased emphasis on risk management among investors. Those surveyed said the third most important factor in choosing a manager was risk management, preceded by investment performance and investment philosophy.

Contrasting with their bearish international economic views, most investors were bullish on the hedge fund industry. While flows of $16.5 billion are the lowest of any first quarter in four years, investors nonetheless indicated the industry will continue to grow.

Respondents in the annual survey suggested a median industry flow of $200bn in 2008, demonstrating an optimism about the hedge fund market that is at odds with their generally bearish economic outlook.

Mimicking the trend in the hedge fund industry, 58 per cent of investors said they would not opt for leverage in their portfolios under current market conditions.

The survey respondents were as follows: 10 per cent banks, corporations and insurance firms; 13 per cent consultants; 22 per cent family offices, high-net worth individuals and wealth management companies; 40 per cent funds of funds, and 15 per cent pensions, endowments and foundations.

While funds of funds remained the single largest group the percentage of consultants responding to the survey more than doubled compared to last year, and family offices this year made up seven per cent of the total respondents compared to two per cent in 2007.

About 57 per cent of the investors are located in North and South America, 37 per cent are in Europe and the Middle East, and six per cent are operating from Asia and Australia.