The long and short of it

13 Jun 2011

Mena FM (MFM): What does Mena’s hedge fund market look like at the moment?

Haissam Arabi (HA): There are two types of investors who invest in hedge funds: institutions and ultra-high-net-worth individuals, and they are generally allocating to the global hedge fund industry. Within that, the bulk probably comes from the investment authorities, who are typically the most sophisticated when it comes to investing in hedge funds.

As for the rest of the market, they’re really not exposed to alternative investments. Those who do typically allocate to overseas asset classes, whether it’s in market-neutral strategies, emerging markets, long/short all- American equity strategies, multi-strategies or macro strategies. From the regional liquidity pool that is invested in hedge funds or alternatives, 95% or more is geared towards that kind of overseas asset class investing within the alternative space.

Another 1% or 2% is regional hedge fund managers based out of the region that are looking at introducing alternative or hedge fund strategies to Mena asset classes, predominantly to Mena public equities. Within that, there is no more than $500m in hedge fund strategies that focus on Mena equity markets. In terms of local manufacturers, there’s about $65bn and over 600 funds that are managed or run out of the region today, and no more than $200-300m of that can really qualify as hedge fund strategies.

MFM: How would you go about setting up a hedge fund in the Mena region?

HA: It’s not any different to setting up an ordinary fund. However, to be a manager and operate in the region you have to be regulated. And that’s a good thing for investors. You will have to use independent, regulated service providers such as administrators and custodians. In some cases it might require a minimum capital requirement to get a licence to manage money, but beyond that, the fund itself is not forced to be listed or domiciled in the same place.

So typically what you have are fund managers who are based and licensed as investment managers in the Mena region, but most of the funds are domiciled in Cayman, the BVI or Luxembourg, for instance, and they are no different from any other fund. There are no separate directives at this point for hedge funds.

MFM: How would the introduction of shorting change things?

HA: Today, shorting is only available on a few markets through synthetics, which you can do with prime brokers. It comes at a high cost and with a high cost of commission as the inventory is scarce. If you wanted to do something along the lines of a beta-neutral strategy or a market-neutral strategy it would be very difficult.

Take, for example, Saudi Arabia: it is more than 50% of the universe, but there’s not a single instrument, not even a synthetic short that you can use. Nasdaq Dubai is the only one which really has something which is considered a forward market, but you’re talking about just four or five stocks; the liquidity is not there. If markets are to develop, if innovation is to happen, if these capital markets are to grow and mature, these instruments and the concept of short selling have to be introduced.

MFM: What does short selling mean in the Mena region today? Does it happen at all?

HA: The only way it happens is through synthetic shorts. There are only four or five hedge funds so it’s available, but the market is still very thin. It is very institutionally based, whereas high-net-worth and ultra-high-net-worth typical investors who go on the stock exchange don’t have any access to shorting. This will change a lot if shorting was to be introduced.

These are very much frontier-type markets, extremely volatile and one-way driven with a herd mentality. When the markets are hot, everything goes up and you can’t find any stock. If you were to allow secured lending and short selling, you would actually be doing the markets a big favour. The introduction of shorting would reduce the chances of asset price bubbles, and gives you a two-way flow, more orderly trading in the markets. It improves the overall liquidity and I think it will be in the best interest of the market. They have to look at it from a market solution and market development perspective. I think the market needs it more than we do at this stage.

MFM: To what extent do shorting and hedge funds go hand in hand?

HA: 100%. If you don’t have the ability to put in too many uncorrelated trades to create an alternative strategy, then the classical way which hedge funds started, which is the ability to go long and short simultaneously, is your starting point. No hedge fund can really be called a hedge fund if they can’t short, so you would need that for the industry to grow and mature.

Once derivatives or short selling are introduced, the players will be educated, awareness will be raised and that will give rise to hedge fund managers because they would have created the understanding and the need for that product, instead of just having a market which is still to this day entirely traditional in the way that its invested.

MFM: How would you like to see the hedge fund space to develop?

HA: I would like to see smart, institutional regional money, investment authorities and the local bodies in this part of the world, to take a better look at what hedge fund managers are capable of doing in terms of actually coming up with new strategies and new ways of capturing alpha, while reducing risk and volatility in a portfolio. If they’re not going to buy into the concept of alternative investments when investing in Mena markets, then why would foreign investors buy into it?

So what I wish for is to see a bit more support from government authorities and their own local management capabilities and trying to give a bit of a boost for alternative investment managers. I would also like to see international allocators for alternatives really give to this part of the region. Foreign allocators have already started looking at the region, so it is definitely on their radar, and family offices have typically invested in the region in classical traditional long-only strategies.

I’d like to see more interest coming from international investors that typically allocate to alternative strategies.