Opportunities in $3.5t global hedge funds

The UAE can capture the best market share in the $3.5 trillion global hedge fund industry by encouraging local fund development through domestically managed funds prior to investing elsewhere, according to a top industry player.

Howard Leedham, chief executive of Dalma Capital Management, said the UAE — with the Abu Dhabi Investment Authority, or Adia — is rapidly emerging as a world’s leading hedge fund investor. However, the nation is currently not reaping all of the potential rewards of their investment because most hedge funds are being managed abroad.

“In many cases, Emirati investors must travel to New York, London or Geneva to access hedge funds and meet their managers. Of the few hedge funds that have established a presence in the UAE, most operate only a sales office where investors cannot meet the people who actually manage their money,” Leedham told Khaleej Times during an interview in Dubai recently.

Dalma Capital Management established in the Dubai International Financial Centre, or DIFC, last year and became a licenced asset manager, regulated by the Dubai Financial Services Authority, or DFSA, in 2014. The company has representatives in the European Union, the United States and the United Kingdom and it is a member of the Alternative Investment Management Association.

Leedham, who joined Dalma Capital in 2013 and has led the company through its DFSA and Malta FSA regulatory approvals, said UAE investment in local hedge fund managers such as Dalma Capital, Jadara Capital and a handful of other firms will be an essential element in order to consolidate the development of the UAE as a global investment hub.

“The reason is these locally-based asset managers, who are on the ground in the UAE, contribute significantly to the domestic economy via the knock-on economic benefits of their use of multiple UAE service providers and the entire sector network that employs the citizens and residents of the UAE,” he said. Excerpts from the interview:

How are investors in the GCC are following the lead of the Adia, the world’s largest hedge fund investor, by increasing their allocation to hedge funds?

The Adia is the world’s largest investor in hedge funds, with over $47 billion in commitments to the asset class, according a recent report by Preqin, a research firm. This same company indicates investors in the GCC, including family offices, ultra-high net worth individuals, endowments, pensions and wealth managers are increasingly following the lead of the Adia and the other sovereign wealth funds of the region in seeking increasing access to hedge funds.

Growth in hedge fund activity will improve the economies of the UAE and the greater Gulf region by enhancing market efficiency, resilience and liquidity while attracting the world’s brightest investment management talent. What do you say?

According to academic research conducted by the Centre for Hedge Fund Research at Imperial College in London, growth in hedge fund activity has a number of beneficial effects on markets. According to their findings, hedge funds are important liquidity providers in markets that they are active in, often providing liquidity at times when they are most needed. Practical evidence suggests that hedge fund activity has beneficial effects for price discovery, the efficient allocation of capital, financial stability, shareholder value, diversification and the broader economy.

How cam risk-conscious investors utilise hedge funds to reduce risk in their overall portfolio?

Diversification is very likely the only free lunch offered in the world of finance. Through efficient diversification, investors can increase their long-run, risk-adjusted returns by reducing the correlation of their returns.

While return “correlation” may seem a mysterious concept, it is actually quite simple in explanation and something practically all investors will have experienced. Correlation is demonstrated when investor looks at their financial statements and sees all or most of the numbers printed in the same color. When times are good, all or most of the numbers are green. When times are bad, all or most of the numbers are red.

One of the most important characteristics of hedge funds is that they often generate returns that are “uncorrelated”. Lower correlations to an investors overall portfolio suggest that an asset is an efficient diversifier and can improve the investors risk adjusted return — this is where hedge funds deliver.

Furthermore, hedge funds have demonstrated outperformance over equities and bonds over the past 20 years. This has become particularly evident during periods of recession — when hedge funds have outperformed significantly and have often provided safe haven for investors when other asset prices are reeling.

How can the UAE capture market share as the hedge fund industry grows its globally-managed assets to an expected level $3.5 trillion in 2015?

The UAE can capture market share in this attractive industry by encouraging local hedge fund development through domestically-managed hedge funds prior to investing elsewhere. Additionally, global investment institutions often stipulate those regulatory jurisdictions in which they can invest. The UAE has an excellent funds regime under the DIFC but even local institutions have yet to stipulate DIFC jurisdiction as pre-requisite for consideration of investment.

How do you see the outlook for UAE markets after joining the emerging-markets ranks this year?

The emerging market ranking for the UAE is likely to have numerous positive effects on the region’s markets. The upgrade provides indicates international recognition of the transformation of the nation’s economy at an institutional level and the UAE’s progress and development achieved over the past decade.

Gains in confidence in the UAE market are logical as the globally-renowned MSCI classifier signals to investors that market conditions are stable, sizeable and managed competently by financial policymakers. This indication of investable and sustainable technical market conditions to global investors stands to increase capital inflows, which have already ramped up through 2014 as part of the index inclusion, this trend should continue over the coming years directly as a result of the emerging-market ranking.

Credit Suisse believes that over a five-year horizon up to $4 billion of capital could be re-allocated to the UAE, while JPMorgan predicts short-term net inflows of $442 million and the impact of the status upgrade is likely to be exponential over the coming years.

Crucially, the quality of capital flows is forecast to improve as a greater number of informed, long-term investors will be participating in the UAE market. IPO activity is also likely to be stimulated as potential listing companies are able to attain the desirable market conditions.

Do you think the UAE has the potential to join developed markets by 2018? What challenges and issues does it need to address to achieve that status?

Focused ambition is driving the UAE towards achieving developed status by 2018 — with economic policy and financial intermediaries actively steering the UAE market in this direction. Market participants, who recognise the UAE’s potential to act as a strategic financial hub for the Middle East and Africa region, are pushing for the UAE to play a more pivotal financial role on a global platform through achieving higher international rankings. Financial institutions worldwide are supportive of the potential move as executing transactions in the UAE allows for effective investment management combined with reduced constraints as compared to western markets.

The UAE market has the financial infrastructure and development plans in place to potentially reach developed status by 2018 and the market is increasingly acting as a supportive platform for a wider range of international financial institutions and clients. Policy around foreign ownership will almost certainly have to be adapted to meet globally acceptable levels — which authorities may struggle to execute. The ability to manage increased inflows and the success in strengthening corporate governance and transparency standards will be critical.

The significant challenge over the next four years will be the UAE’s ability to set in place sufficient operational capabilities to meet MSCI developed market status standards. The ability of UAE market institutions to meet stringent global banking rules and regulations may also prove challenging.

Saudi authorities have become active to join the emerging market index in the coming years. How would this revamp the region’s markets?

If Saudi Arabia were to become classified as an emerging market it is likely to jump ahead of the newly-classified UAE and Qatar markets in terms of the consequential improved market activity. Inclusion in the MSCI EM index will lead to a sizeable inflow of capital investment from equity funds worldwide that are tracking the index.

Currently, the market capitalisation of the Saudi Arabian market exceeds half a trillion dollars and international investor interest will continue building as the region considers allowing foreign direct access to its listed companies. As the largest economy in the region and with its plans to invest hundreds of billions of dollars over upcoming years Saudi Arabia is positioned to diversify outside of oil dependence and investors are keen to participate in the substantial growth opportunities this expansion will create. These inflows will stimulate IPO listing activity within the Saudi market leading to a revamp in market depth and future potential.

— muzaffarrizvi@khaleejtimes.com