Dubai: Haissam Arabi sounds excited these days. He hopes to receive a licence for a regional hedge fund company shortly.
He plans to launch this year an open- ended fund with an absolute return strategy and feels that about $20-$30 million is viable enough to get started in these difficult times.
It might appear to be a contrarian move, especially now.
The global financial crisis is still unravelling. Big and small hedge funds worldwide have been badly battered and witnessed large-scale redemptions, with investors taking a much more cautious approach to investments. Although the Eurekahedge Hedge Fund Index rose 0.2 per cent through January, it's still early days to be optimistic.
Hedge funds fell, according to the Eurekahedge Report, $69 billion to $1.4 trillion as of end-January. Also, when it comes to the growth of an indigenous hedge fund industry closer home, Dubai has been struggling to translate its potential into real progress in terms of attracting not only funds to be domiciled in Dubai International Financial Centre, but also boutique fund managers launching and managing funds from here.
But as the chief executive of Gulf Mena Alternative Investments, a regional hedge fund under formation, Arabi remains unperturbed. Instead, he looks at the timing as opportune for what he says would be predominantly public equity based, macro-directional strategy.
With 35 per cent of the equities in the Middle East below book value and many of the blue chips trading around the same value, Arabi believes that it's "an absolutely beautiful accumulation phase".
"It couldn't get any more ideal to launch any strategy for that matter as long as it is equity-related, because the timing and ability to acquire cheap stocks is now a lifetime opportunity. That coupled with other factors, such as some prime brokerage opportunities and collapse of long-only managers, give me more confidence that the way of the future lies in absolute return strategy."
Arabi, however, has been beaten this past week, though the funds launched are not conventional. The Dubai Sharia Asset Management (DSAM) launched five Sharia-compliant hedge funds with $200 million in government seed money. The Dubai Multi Commodities Centre Authority owns 51 per cent of DSAM and the remaining 49 per cent is owned by US investment company Shariah Capital.
Eric Meyer, the chief executive of Shariah Capital, echoed Arabi's views on the timing of the launch, but with a different justification that has more to do the uniqueness of a Sharia financial structure.
"This is the world's best time to come out with a Sharia hedge fund," said Meyer. "The reason why I couldn't find a better time to come out is because the Islamic hedge funds we have launched are ring-fenced, basically special managed accounts here, where we are able to touch and feel all the assets," he said.
"We are really making a statement here that Islamic finance is all about a separately managed account, based on very prudent Sharia compliant business rules. We don't use leverage here, we don't use options, we don't use all these futures structures that got the West into trouble. This is about as far away from Bernie Madoff as you could get."
The issue of short selling has been overcome by allowing the Sharia investor to actually buy shares for a downpayment rather than borrow, added Meyer.
However, indigenous hedge fund growth in the region has been far from satisfactory. According to industry sources, the total asset under management for Mena (Middle East and North Africa, and majority of them are non-DIFC and domiciled in Cayman Islands or Bahrain) hedge funds has so far been between $1 and $1.5 billion. Some of the DIFC-basaedhedge funds and third-party administrators have closed shops, hit by the global crisis, leading to restrategising of their business.
But structural roadblocks remain, which have discouraged some of the existing hedge fund managers to continue and new ones to come in.
Arabi is not naive in underestimating the challenges. Other observers agree that the structural problems have prevented the rise of hedge fund managers. But they also point out Dubai is still in its embryonic stages and it takes time for any new entity to develop into a globally competitive financial centre.
The problem for the slow growth in indigenous hedge funds can be attributed to several reasons. First and most important, the Mena markets lack or offer very few facilities and instruments that normal hedge funds would seek for their investment and trading.
"There are little opportunities to sell short equities, which would offer a hedge against overall market risk. Not until the exchanges develop such hedging instruments will regional hedge funds begin to take off," said Eric Swats, partner at Rasmala Investments, the regional investment bank that was the first to launch fund of hedge funds in 2006.
Rasmala's Fund of Hedge Funds declined by about 17 per cent in 2008, which compares to a decline of about 27 per cent for the average hedge fund.
But with prime brokerage activity in the region picking up in the last six months, albeit at a price, it has become possible to start launching absolute return type strategy, said Arabi.
"That means now funds can take leverage, can borrow, can go short, and can utilise derivative platforms for their hedge strategies," he added. "And all of it is coming at a high price. It is coming to you via prime brokerage activity and they are charging an arm and a leg for it."
Craig Roberts, chief executive of Apex Fund Services, Dubai, a hedge fund administrator, agreed. "The markets here have got a lot of development to go through & and having access to prime brokerage and other facilities have not really developed at a price that really gives people a choice."
Roberts adds that markets in the region haven't developed sufficient depth and liquidity in their own right to enable prime brokers and other providers to offer alternative investment products across a range.
"It's just a maturity thing," Roberts said. "A lot of western institutional money was coming into the market, adding a lot more depth, but unfortunately that money also got affected by the global crisis."
The price issue has not dissuaded Arabi. Instead it has given him the window of opportunity to start a hedge fund. He sees the next 12 to 18 months as a period when the trend of hedge funds will be positive.
"Although there are challenges, certainly it is not going to stop us - because we believe the potential to make money is far greater than the cost incurred to conduct our transactions," Arabi said. "I think we are in good shape, but the problems still need to be resolved," he said.
"I feel in the next 12 to 18 months we should see a rise of that - not necessarily domiciled here, but started and managed out of here."
The other structural challenges include the high start-up costs.
South African Investment Data Services, a hedge fund administrator, had opened an office in Dubai in 2006 to offer services to DIFC's first domiciled fund, Argent Financial Group. But two years later it closed down. Some of the funds launched by Argent have also been dissolved.
A cynical Ian Hamilton, chief executive of IDS, in a phone interview from South Africa said, "To have a successful hedge fund jurisdiction, you got to actually have something that adds value. And there is nothing that adds value in Dubai. It is one of the most expensive locations and also there is lack of qualified people. The high cost of living discourages qualified managers to set up base there."
But to be fair, Arabi points out, price is simply not the reason why some funds have left or closed down.
"They have been part of a global firm and they have been hit like any other hedge fund. It may have hurt them so hard that the AUM in a parent fund have been shaved to the point where they have been forced to reconsider their strategy and have for that reason left DIFC."
But he accepts there is some validity in the high-cost argument.
"That makes it difficult for a hedge fund manager that doesn't have a $1 million to start up a company. So the cost issue has to be addressed to make it more enticing for a fund manager to be based in Dubai for both - for those who want to manage money in the region or manage money from the region out for overseas Asia or emerging markets."
Finally, the issue of access also needs to be looked into, observers said. For foreign investors - whether they are long-only or hedge funds - access to certain markets such as Saudi Arabia and the UAE are still facing certain restrictions.
"It is also that a lot of stocks are restricted and access to markets haven't opened as well as it should be," said Roberts of Apex Fund Services. "There's a lot of market structure that needs to be developed and improved before you see an effective hedge fund scenario unravel here."
Those who have launched and have been managing funds from Dubai and the Middle East do see a viable hedge fund industry developing in due course. Specifically, they point to the DIFC and the Dubai Financial Services Authority's regulatory regime as something that would be welcome in a much changed scenario post-financial crisis.
"The DIFC and the DFSA, right from the beginning, said, 'We need to have transparency, we need to have regulation,' and they have given that," Roberts said.
"They have put in place all necessary controls for the next wave of hedge funds to come in to a well regulated, easily understood regime."
What are conventional hedge funds?
An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).
Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors such as high net worth, ultra high net worth, institutional smart money, family offices, pension funds.
They require a very large initial minimum investment. For instance, one of the segments they target is high net worth individuals, who are defined as those who make a investment of at least $1 million (excluding primary residence). Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year.
- Source: www.investopedia.com
