Solid as Iraq

By Kathryn Gaw

7 Nov 2011

Iraq’s fund market is one of the most surprising success stories in recent years. Torn apart by three decades of extreme political unrest, internal violence and two controversial Gulf Wars, the process of rebuilding is attracting significant interest from investors across the world and fund managers such as Godvig, FMG, MerchantBridge and Invest AD have been quick to cash in.

Centring around the equities opportunities available on the growing Iraq Stock Exchange (ISX), a slew of Iraq funds are now eyeing the next big investment stories in the market, with private equity, money markets and property representing attractive options. More significantly, foreign investors are starting to take notice. FDI has increased from just a few billion dollars per year to more than $50bn at present, according to FMG Fund Management's Henrik Kahm. It is no coincidence that this figure has risen as inflation rates have dropped (from a peak of between 30% and 40% to a more manageable 5% at present), meanwhile the oil industry has shown signs of long-term stabilisation and the risk of political violence has started to even out. All in all, the Iraqi economy looks set to keep moving at a steady pace and Iraq-focused funds are starting to build up largely positive track records. Godvig’s Babylon Fund has returned +41.66% (as at 30 June 2011) since inception while Invest AD’s Iraq Opportunity Fund was up +26.13% (as at 27 July 2011) since its inception last October. Sustained positive performance is a rare beast in today’s Mena markets, so it is no surprise that similar launches are widely expected. “Interest is definitely building,” says Kahm. “If you looked at the market a year ago, you would have found three or so funds and I think one year down the road, you will probably have 10.”

“I would say it’s never been as easy as it is right now to run an Iraqi fund,” adds Björn Englund, CEO of Godvig Capital and fund manager of the Iraq Babylon Fund. “The challenges were much, much bigger here a couple of years ago but nowadays it’s much easier. The ISX has opened up towards foreigners both on the communication side and on the legal side. It is clearly much more accessible nowadays.” Indeed, the accessibility of the ISX has been key to Iraq’s new investment appeal. Prior to 2008, foreigners were unable to invest directly into the stock market, but there are now less restrictions in place, and listed equities make up the vast majority of Iraq fund portfolios. “By July 2011, we had 91% of our AUM in companies listed on the ISX,” says Englund. “Our view is that it is a much better investment opportunity to invest through the ISX instead of going through private equity deals. What you gain working directly through the stock exchange is clear regulation, liquidity and more information about the companies.

You also get a bit of a stamp of approval investing through the ISX.” The exchange is currently valued at between $2bn and $3bn, but three upcoming telecoms IPOs are set to revolutionise the ISX, adding at least an extra $1bn to its value in the coming year.

However, despite this new wealth of opportunities, the ISX is very much still an imperfect frontier vehicle. Almost 60% of the listed major securities have been suspended over the summer, creating some liquidity issues. There is no major market-tracking index and an over-issuance of shares led the ISX to stop tracking sector indices last year. The fact that Iraq is not yet listed in the MSCI or S&P frontier indices creates further benchmarking problems for fund managers. Reporting issues are also threatening to keep some major investors at bay. “A lot of international institutional investors think this is a great investment story, although there are some legal considerations from their point of view that don’t allow them right now to take the step into Iraq,” says Englund. “There are no custodian banks and this means that Iraqi banks, even if they have foreigners as owners, are not allowed to do stock custodial agreements with the US or Europe, etc. For institutional investors sitting in Wall Street or London, that is a no-go area until sub-custodial agreements are in place.”

However, these are still early days for the market, and a number of new laws are intent on improving access to the country’s financial market for both local and foreign investors. A SME financing law was passed in 2010 and an Islamic finance law is currently being drafted. “Islamic banking wants to separate from conventional banking and have its own regulation which is compliant with Shariah law, not just applying the same rules of the conventional. “Another new concept is allowing for establishment of SME financial companies and funds,” says Khaled Saqqaf, Al Tamimi partner and head of the law firm’s Iraq office.

Legacy of turmoil

Despite these movements, for many investors Iraq represents a risky prospect. Politics is never too far from the scene in Iraq, although the situation appears to be stabilising now. “Politics are messy in Iraq but they are also messy in the US,” says Kahm. “They managed to come together in a coalition government and they are making progress, albeit slow-paced. It’s a troublesome situation, so to speak, but I guess that’s the way it is when you’ve just recently managed to get a democracy going.”

However, it is this very turmoil that has set the stage for Iraq’s burgeoning financial sector. “There have been several years of war for Iraq, and the infrastructure and main services have been destroyed or out of date,” says Saqqaf. “So all of these are being tended to now by the government and are supported by funds, or there are funds that are investing in sectors.” To this end, private equity is a big business in the country. Egyptian private equity giant Citadel recently closed a deal with the Iraqi government to build a new oil refinery with a capacity of 150,000 barrels per day. “Most of the foreign capital so far that has entered Iraq has been through private equity,” says Englund. “But for those of us who have open-ended funds, private equity is an area in which we should move cautiously. We want to be able to sustain and be around, even in the worst kind of conditions. Just like in war, we want to be able to diversify and spread out.” While there is certainly still room for improvement across the market, the signs are very encouraging. “I still think that there are great opportunities in Iraq,” adds Kahm. “It probably has one of the world’s most under-valued and under-researched stock markets and there are great opportunities for further returns.”

As well as an expected rise in the number of Iraq funds in general, fund managers are thinking laterally about the next big opportunity in the market. Englund reveals that Godvig is launching a small investment company, which is domiciled in Sweden and invests into the North East Kurdish area of Iraq. “The Kurdish area is much smaller, but that’s where the growth is the strongest and it is also the most open towards foreign participation,” he says. “There are a lot of interesting big deals within this little area of Iraq that we are building a new investment product around and we expect to have within six months, $4m or $5m in the investment company.”

But this is just one example of the market’s potential. “Currently the financial services industry is expanding and progressing in a speedy manner, so I would say it is going to be one of the most interesting parts of the region for the fund investments,” says Saqqaf. “The security issues are improving and the financial markets are improving as well. I think it is going to be a very interesting market within a couple of years.”


Great IPO expectations

Three telecoms companies are set to transform Iraq’s equities market in the coming year. Zain, Korek and AsiaCell were required by Iraqi law to launch initial public offerings (IPOs) on the Iraq Stock Exchange (ISX) by 31 August as part of a 15-year, $1.25bn operating licence, which they secured in 2007. However, the deadline passed without any activity, and market experts believe there will still be a bit of a wait.

“We expect it will happen probably sometime during next year or within the year,” says Henrik Kahm, analyst with FMG Fund Management. France Telecom recently bought a 20% stake in Korek, valuing the company at more than $1bn, while AsiaCell and Zain are thought to have a market cap of approximately $2.5bn together. A triple listing could more than double the current value of the ISX, and fund managers are keen to take advantage of the anticipated growth. “If I had a wish list of things that I wanted to have changed, first of all I would like to see more IPOs on the stock exchange,” says Björn Englund, CEO of Godvig Capital and fund manager of the Iraq Babylon Fund. “That will be something that a lot of foreign investors will take notice of and that’s very good because foreign participation on the ISX has tripled since a year ago. If the telecom companies list on the ISX, we expect it to triple one more time, so that’s quite important.”

However, a short delay in the three listings may not be an altogether bad thing. Kahm adds that he expects the IPOs to be listed one by one at different times of the year to maximise their buying potential, but could add a welcome shot of liquidity to the market over time. “In Iraq you at least have some kind of breadth and depth in the market,” says Kahm. “You have 85 stocks that are listed and typically 30 of them are trading, so there’s quite a lot to choose from but the volumes still range from $1m to $10m per day. Hopefully, we will see better volumes if any of these IPOs go through.”