By Damian Hampson – Cash needy investors have hit the hedge fund industry hard with many managers experiencing significant redemptions during the first half of 2009. In exclusive interviews with Alternative Latin Investor, Brazilian fund managers have voiced their concerns about surviving the current worldwide economic downturn.
One such manager, Otavio Vieira of Safdie Private Banking, expects to see large contractions affecting Brazilian funds.
“Assets under management will drop a lot, in 2010 there will be perhaps only 30-40% of assets under management when comparing with 2008 and this is causing many funds to close down,” Safdie said.
With investors pulling out of funds as they look to liquidate their assets, Latin American hedge fund managers are actively seeking new sources for potential clients. In the pre-credit crunch days, Latin America’s commodity rich nations were beginning to attract serious interest through BRIC and Agro funds. However, rather than waiting for commodities to rise again, Latin American fund managers are looking east for a source of customers that could bear fruit. Alternative Latin Investor has been speaking with several Fund managers based in the Middle East to find how their Latin counterparts can attract valuable new clients in the region.
To date, the direct effects of the financial crises experienced by most developed economies in the Middle East have been relatively mild, when compared with other regions throughout the world, as banks and investment companies in the Middle East were not large holders of sub-prime mortgage backed securities. However, regional sovereign funds have taken some losses on their investments with global financial institutions. Additionally, Arab stock markets have not been immune from the credit crunch, with stock indices in Gulf Cooperation Council (GCC) countries showing significant declines of between 30-60% in the final quarter of 2008. According to the U.S.-based Council on Foreign Relations, early analysis points to sovereign funds with high allocations to equities, emerging markets and private equity may have lost as much as 40% in portfolio value between December 2007 and December 2008. However, foreign funds continue to have significant reserves.
In speaking with various fund managers and leading financial figures in the Middle East, Alternative Latin Investor has discovered that any interest in Latin America has been limited to certain BRIC funds and Agro investments. Albert Barretto, product manager at First Gulf Bank in the UAE says Latin America has yet to engage the region.
“Interest is negligible because there has never been any kind of Latin American fund focused on investors here,” he said. “Major focus on the past couple of years has been on the emerging markets and new emerging countries, and in Latin America, only Brazil has been getting interest from investors. Other than that the other countries have not been able to get much attention from clients.”
Admittedly, the pre- and post-credit crunch scenarios are now poles apart, but there are those in the Middle East that believe Latin America is the destination of the future. In May 2008, Ithmaar Bank, a Bahraini Islamic investment firm, and two other regional firms, Kuwait based Al Safat Investment Company and Bahrain based Arabian ventures, launched a USD$500 million Sharia-compliant property fund to invest in Latin America.
“We’re all in the Middle East and North Africa region, but not Latin America,” said Khalid Abdulla-Janahi, chairman of Ithmaar Bank. “You’ve got to diversify your investments, you can’t have them all in one place.”
In the current worldwide economic climate, attracting alternative investments from the Middle East has to be viewed as a long-term strategy. Investors in the region are pulling out of alternative investments as they seek greater liquidity and Dr. Aziz of BMB Islamic says trends indicate a greater confidence in more local investment vehicles.
“The recent phenomenon in the global market and Madoff has affected the sentiment very significantly. I think people are looking into those opportunities but more of it is happening on the regional side. For example, if a hedge fund manager or for that matter a private equity manager wanted to offer a fund, unless they have some sort of association with the region, say particularly in the Middle East for example, then their ability to sell that product in the short run would be rather limited.”
Latin American hedge funds suffer from a lack of exposure and presence in the Middle East. The overwhelming message coming from coming from their contacts in the Middle East is that there is not enough information or exposure on Latam products available.
Albert Barretto at First Gulf Bank thinks if Latam has the right pitch, it will eventually succeed.
“The general allocation and education about Latin America is not as high as Eastern Europe and South East Asian economics, but that has to be brought into the limelight a little bit more,” said Barretto. “Once [investors] can see what is available then the interest will come out.”
Sharia Compliant Or Bust
However, greater exposure to clients is only one factor when looking to tap wealthy Arab clients. Increasingly, Muslim investors prefer products that satisfy their religious beliefs, and Barretto feels it’s essential when looking for an opening.
“Sharia compliance would be the best way to get in because you have to break the mindset,” said Barretto. “Once you are inside the mind…then you bring your other products from your shelf because the brand alignment has to be there, it’s the most important thing.”
Latin American fund managers looking into the possibilities in the Middle East cannot fail to take notice of the increasingly significant role Islamic banking is playing both in the Middle East and throughout the world. According to the World Islamic Forum, Islamic banks can now boast assets of more than US$ 1 trillion and it’s estimated by the IMF that there are now more than 300 Sharia compliant financial institutions, compared with just one in 1975.
Islamic banking is a system of banking consistent with the principles of Islamic law (Sharia) and its basic tenets are of sharing profit and loss, the prohibition of charging interest and it is forbidden to invest in industries contrary to the teachings of Islam such as alcohol and gambling. Excessive leveraging, which has been one of the strongest reasons for the global crash, is not permitted in Islamic banking.
Dr. Aziz of BMB Islamic is one of the Middle East’s leading Islamic bankers and told Alternative Latin investor that he has been involved in high profile meetings with important players from around the world looking to learn how Sharia banking can offer lessons to the conventional side of the industry.
“I see an integration happening with Islamic banking growing more across the world in places where it has not been present or significant before,” he said. Whilst Islamic finance may provide some answers to the conventional banking crisis, Dr. Aziz is quick to warn it not a magic wand. “Islamic financing is not the future for the world but there is no harm in taking bits and pieces which stick well.”
When speaking of a product being Sharia compliant, it essentially means that the financing mechanisms within the deal have been analyzed and approved by Islamic scholars and found them to be within the teachings of Islam. For those new to Islamic finance there are two ways in which to make a product compliant:
The first manner is more commonly found in Islamic countries that naturally have greater demand for Sharia compliant products. A hedge fund can seek to establish a Sharia board of their own to analysis and approve their products. Market norms dictate that there is a minimum of three scholars sitting on any board, although the number can reach as high as seven. Presently there are no more than 400 scholars in the world and demand is very high, particularly for the top 20 who enjoy international renown and can charge up to US$70,000 per annum for their services.
With charges for a three scholar board around the US$200,000 mark, Dr. Aziz says this route is time consuming and not for newcomers.
“If you work with scholars you are talking about six months to one year (before you become compliant) and hedge funds are a complex business and there are not many of them (scholars) who understand the hedge fund business – even out of the top 20. In my view it’s not a very efficient or cost effective way of doing business,” he says.
The second route to compliance is Sharia advisory funds, which are an emerging trend liked by both scholars and funds alike. Essentially, a fund seeking Sharia compliance, but wanting to avoid the costly expense of setting up their own board, would form a joint venture with a Sharia compliant bank or fund. Advisory funds are still a fairly new option in Islamic financing but are becoming increasingly essential as the small number of Islamic scholars means their availability is severely stretched.
One fund manager in the Middle East told Alternative Latin Investor of the difficulties they had in securing a scholar.
“They are very high (the costs of scholars)….we tried to hire one for our FX funds. More than the high part of it, it’s impossible to get an appointment with them. We got an appointment after eight months and it was canceled. Until you have a contact in the Middle East its pretty hard to get around to meeting them,” said the manager.
BMB Islamic boasts a seven member Sharia board with scholars from the Middle East, Far East, Asia and Europe. Such geographical diversity means that each scholar sitting on the board brings with them Islamic followers who adhere to their teachings and rulings.
There are potentially more than 50 Sharia advisory funds in the Middle East, and many are only now waking up to their potential. Properly managed and with the right expertise, Dr. Aziz thinks the benefits speak for themselves.
“We can have a hedge fund approved by the scholars in anything between eight to sixteen weeks. We are experts both on the financial business side of the client and we also understand the scholars because we are Sharia technicians as well. Funds like us retain the scholars anyway and hence we are able to spread our costs to our clients, so it won’t be them maintaining a Sharia board of their own for US$150,000 to $200,000,” he said.
Setting Up Shop In The Middle East
Attracting investors of any type is the most difficult challenge facing many hedge funds in the current climate, but to do so in the Middle East could mean establishing an office in the region.
Speaking to Alternative Latin Investor, one fund manager explained his location decision.
“We did a lot of research and I thought Bahrain was the best place to set up office. Firstly, the financial law in Bahrain is the strongest as it follows Anglo-Saxon law, so that’s very helpful. The second thing is the cost of living in Bahrain is a third if not less of what Dubai is and it offers a much higher standard of living. The third thing is its closer to Saudi Arabia. It’s central to all of the GCC areas so it’s very helpful that way and finally fourth, it’s pretty easy to set up an office in Bahrain,” said the fund manager.
Ultimately, there is no substitute for communicating the right message to potential new clients, and our Middle Eastern source says it may take time but the rewards can be worthwhile.
“One has to realize that unfortunately the Middle East is completely relationship based. So they will have to put in a lot of work in terms of giving face time to the investors and you just have to come back. Ideal thing would be to have an office here and sit down and have a chat with them. Things don’t flow very easily for a couple of years but once you’re here for a couple of years and you’ve made some nice contacts and one investor comes in and then you’ll have a barrage of investors following – it’s just the first account that is the most important in terms of clinching the deal and after that you live off your first account basically.”
Damien Hampson is a freelance broadcast journalist and writer based out of Buenos Aires, Argentina. His current projects include writing content for Alternative Latin Investor as well as freelance work for Macro Consulting and various broadcast, correspondence and translation projects.
This article first appeared in Alternative Latin Investor. Alternative Latin Investor is the first online publication to provide information on alternative investment opportunities within the Latin American region. The publication covers hedge funds, private equity, agribusiness, real estate, forex, wine, art and other alternative asset classes. Register for free to gain full access.