The turmoil in global financial markets since last year has set an intriguing backdrop for examination of hedge funds in the Middle East region. After more than two decades of using hedge funds, private client investors from the GCC states have become familiar with their value as a source of additional returns and downside protection in their portfolios. But the financial climate has not often presented as many opportunities and challenges as we see today, according to Antoine Massad.
To anticipate the likely path that hedge funds will follow in the region in the coming months and years, it is useful, first, to appreciate the history of the local industry. For many years GCC financial markets have been steadily liberalising, with the gradual emergence of local equity exchanges and financial services institutions. The process has received additional impetus over the past few years, as soaring fuel prices have helped to drive inward investment in the region and local regulators have introduced initiatives to help them compete with international financial centres such as London, Frankfurt, New York and Tokyo.
The DIFC offers significant incentives to new participants to enter the market, including the trading and regulator infrastructure and a reputation for investor protection.
These new initiatives and the obvious dynamism of local markets have attracted a steady flow of new hedge fund firms to the region, though all currently still invest outside of the GCC. There is, however, much demand for hedge funds that invest in local markets, so this is likely to change very soon.
New Strategies, New Services
In the world stock market slump of March 2000 and September 2002, hedge funds proved their value as a diversification tool. Again, last year, we saw hedge funds outperforming stocks markedly as many investors discovered that stocks are not risk-free assets. As a result, institutional demand for hedge funds has soared in the past few years. Hennessee Group estimates that individuals and family offices account for 32% of total industry capital, funds of hedge funds 32%, corporations 12%, pensions 11% and endowments and foundations 13%.
These developments were largely mirrored in the Middle East, where sophisticated high net worth investors had been early adopters of hedge fund strategies, but institutional clients were slower to allocate.
In the region, Man Investments estimate that institutions account for approximately 35% of all assets allocated to hedge funds today, and maybe half of new money flowing into the asset class from the region, compared to less than 5% at the end of the 1990s.
Hedge funds currently offer GCC investors an alternative to local markets, allowing them to lock in profits made in rising markets to protect against losses during corrections. They can also be used to offset specific market risks, for example by trading strategies with a low or negative correlation to fuel prices.
Investors will increasingly demand investment products that match their liabilities and help balance their market exposure. That in turn is forcing portfolio managers, particularly funds of hedge funds, to develop products appropriate to the region.
The growing institutionalisation of the regionĀfs hedge fund industry is also driving a trend towards more detailed reporting, greater liquidity and higher levels of client service.
Finally, the steady evolution of the industry is creating a wide dispersion among hedge fund investors demanding a range of product choices, from secure highly-diversified portfolios with a capital guarantee to more spicy concentrated portfolios that target higher returns.
These emerging trends are putting a greater burden on investment product providers, who are increasingly investing in research, client service, product structuring and product development to meet the growing demand for alpha and diversification.
To keep pace with this changing environment and to continue to offer diversification and performance will require the depth of research, level of client service and product structuring abilities that only the very big participants can provide.
Antoine Massad is chief executive of Man Investments Middle East.