Executive Magazine

Education – Still a lot to learn

by Executive Staff April 3, 2008

written by Executive Staff

Lebanon is a country that puts a great deal of value on education, where the Lebanese take exceptional pride in their trilingual skills and their ability to adapt in any environment — irrefutable proof of the quality of their education.

However, despite being the second-largest item, after defense, on the national budget (11% in 2005), 96% primary school enrollment and 90% youth literacy rates, the public education sector in Lebanon is plagued by inequalities and high dropout rates, as much as 23% at the intermediate level according to a World Bank report.

High Dropout, Low Result
Most experts agree that the quality of education in Lebanon is not commensurate with the level of investment. Primary education completion rates in Lebanon are lower than in Jordan, Egypt, Algeria and Tunisia, countries with significantly lower GNI per capita.
Dropout rates are also disturbingly high. Between 2001 and 2006 enrollment in elementary public schools dropped by 12% and enrollment in the intermediate cycle dropped by 6% during the same period. During the 2003/2004 academic year, 19% of children dropped out at the elementary level, 23% at the intermediate level and a further 11% at the secondary level.
There is no tangible study on the reasons for students dropping out of school although many reasons may be attributable to it. On the side of pure economics, Lebanese public schools are not completely free, registration and books having to be paid for. In certain areas, especially rural, it may be more viable to employ the children rather than send them to school, which points to a disillusionment with public schooling in particular and a lack of awareness about education in general.
A representative from Rearden Educational, a regional firm that specializes in education consultancy, noted that parents take their children out of schools because they see more advantages to them working than continuing their education. “No awareness is made of the importance of education,” he said. “Sure, there will be short-term economic repercussions to losing a part of your potential workforce, but what they don’t see is that the long-term effects are more beneficial.”
Other experts agree. There is a general disenchantment with the future, they say, a lack of hope in general, prompting these students to seek work rather than continue their schooling.
Lebanon’s performance on the international assessment arena gives no cause for joy either. In international comparative tests of mathematics and science achievement (TIMMS), Lebanon was outperformed in science by Morocco, Egypt, Iran, and Jordan. In mathematics, its students performed well below the international average and, “when adjusted for level of income, significantly below expectations.”

An Inefficient, Inadequate Sector
The problems cannot be attributed to a lack of personnel, however. Indeed, there are too many teachers in Lebanon. A quick glance at the expenditure outlays in the education sector shows that 82% of the budget is used for salaries. In the last 30 years, the number of teachers has increased by 111% while the number of students has only increased by 25%. The education sector employs around 9% of the total labor force, which translates into a student/teacher ratio of 17:1 at the primary level and 8:1 at the secondary level, well above international averages.
Educational establishments are also inefficiently used, with almost a quarter of all schools having less than 100 students.
This inefficient use of resources can be traced straight back to the source. The Ministry of Education and Higher Education (MEHE) itself continues to operate as three separate sub-sectors – general, vocational and higher education – despite their official unification under one ministry in 2000. According to the World Bank, these directorates do not have an integrated vision or a strategic development plan, thus creating gaps and duplications in organizational design, and are manned by a “disproportionate number of unqualified, temporary, or contract staff.”

Who’s Teaching Whom What?
The public education system in Lebanon is creating a vicious circle. Most students attending public schools tend to come from the poorer, more disadvantaged sections of the population. A survey of the total number of general education schools by region in 2005/2006 shows that most public schools are located in the most economically disadvantaged areas of the North and the Bekaa.
Teaching the most disadvantaged segments of the population is an unqualified teaching force: 43% of permanent and 36% of contractual teachers have adequate academic diplomas in subject matters they teach. Hiring and retaining highly-qualified teachers is a challenge, especially in view the low salary base teachers receive (starting at around $560 for teachers with an undergraduate degree, even less for those with vocational training). This means that pretty much any teacher, given the opportunity to move into the private sector locally or in the Gulf countries where salaries tend to be a little higher, does so.
In addition, the Lebanese curriculum, last updated in 1999, does not conform to new standards of teaching that are currently being adopted in most countries in the region. Schools are not properly equipped to provide students with a modern education.
Of the 1,399 public schools in the country, 35% do not have computers and more than 50% have less than 10 computers. More than 96% of schools do not have LCD projectors, Internet availability or a website. The result is a graduating labor force unable to compete on the national job front, let alone the international scene. A sad state of affairs for a country once touted as a potential informatics and technological hub in the region, and for a section of the population that is already at the lower end of the scale.
“Lebanon is as far as can be from innovative teaching methods and technological teaching,” says Rearden. “Even if the material is physically there, which it is not, no one is trained, or receives the training, to use it.”

What to do?
In order to address these deficiencies in the Lebanese public education system, the ministry has formulated an Education Sector Reform Strategy Action Plan for 2007-2009 with the following objectives:

Ensure equitable access to education services for all students
Ensure a universal and better quality basic education for all
Enhance the efficiency, effectiveness and competence level of the teaching workforce
Develop and align curricula with global and ICT trends, job opportunities and labor requirements

What Lebanon can learn from the Singapore model

In the mid-1960s, Singapore, a tiny nation with four ethnic groups and devoid of natural resources, embarked on an educational reform program under the banner “Thinking Schools, Learning Nation”, with the aim to produce a competitive labor force able to compete in the global market and in industries increasingly relying on Information Technology. The main pillars of the program included:
– Decentralizing of the educational system to allow schools to reply to local needs
– Creative thinking rather than rote learning as a cornerstone of the educational system
– Attract and retain qualified personnel in educational institutions
– Massive introduction of computers and technology in the classroom
– Ability-based merit system allowing students to be streamlined into university, technical or vocational education based on their ability.
Although not without their critics, the results have been impressive: school dropout rates were down to 4% in secondary sections in the late 1990s from 19% twenty years before, and in primary schools to less than half the 11% of the 1980s; per capita income grew to almost $27,000 from $530 in 1965. And to top it all off, Singapore has consistently ranked highest in international assessment tests since 1995.

This plan seeks to enforce the law on compulsory education at the intermediate level, provide at-risk students with the needed support, to implement a professional development and continuous training program for teachers, a content-enhancing curriculum, career counseling services based on the capabilities and needs of students as well as the needs of the labor market and available opportunities, implement an ICT literacy program in all public schools, and the diversification of higher education to adapt curricula to global and ICT trends.
These initiatives are all highly commendable but beg the question: how did the public education sector came into this state of being in the first place? Years of civil conflict, neglect and aborted reform programs have not offered the sector a promising future. Viewing the current state of a stumped government and continual political bickering, it is unlikely that the Strategy Action Plan for 2007-2009 will be seen through to its conclusion.
“There are no ingredients for reform, no financial incentives, no professional development,” explains Rearden. “Unfortunately, for us the position of the Minister of Education is a highly-politicized one. Ministers in general lack the experience and the ability to carry through a reform program.”
This is also unfortunate for the disadvantaged student receiving a disadvantaged education, as this attempt at a reform initiative is not the first to be stalled and most likely, will not be the last. “Not much has happened to public education in Lebanon since the 1960s,” said Rearden, “except that it has stayed firmly rooted there.”
Sources close to the ministry, however, disagree that the plan is not moving. They argue that several changes have already been implemented and that the Education Sector Strategy document was sent to the Council of Ministers in September 2007 for endorsement.

Show Me The Money
There is no shortage of assistance to the Lebanese educational sector, although exact figures are difficult to come by. Following the Summer 2006 war, aid and soft loans from the World Bank and the European Union, American-based IT companies and several Arab countries poured in to rebuild damaged schools, reform the system and create a networking system in schools.
The problem is not the money, say experts, but how it is disbursed. Aid also tends to be in the form of technical assistance, the drawing up of networking plans, teacher training sessions or, as in the case of the World Bank loan, assistance with a reform program.
“Some critics say it would be better if the money was going to, and distributed by, NGOs rather than the government, for the fact that NGOs just pay where there is a need, whereas in the government, it ends up going through this whole system and payment becomes a whole delaying issue.”
The government will have to work very hard to push through a successful educational reform program and revamp the image of the public school system as being an inadequate, free-for-all institution. In the meantime, it is the future of a whole population that hangs in the balance. For the sake of Lebanon, one should hope it succeeds.

April 3, 2008 0 comments

Lebanon

Energy – Stifling Solar, Waffling Wind

by Executive Staff April 3, 2008

written by Executive Staff

In theory, Lebanon is well positioned to take advantage of renewable energy technologies. Its sunny climate would allow for the widespread use of solar thermal collectors to heat water and its varied geography provides several prime areas for wind farms. A developed renewable energy infrastructure in Lebanon could bring millions of dollars to Lebanon through the Kyoto Protocol’s carbon trading system, and yet Lebanon lags drastically behind its European and Arab neighbors in renewable energy production and lacks a national renewable energy strategy.

Lebanon currently imports 99% of its energy needs from countries rich in oil and gas. Skyrocketing oil prices in recent years without subsequent rises in electricity costs have pushed the country’s government-owned energy provider, Electricité du Liban (EDL), further into deficit while the service quality has worsened. Indeed, in 2007 EDL reported a record-high $1.2 billion shortfall, while power cuts extended to every region in Lebanon, sometimes for as long as 18 hours per day.

Yet despite EDL’s poor performance, the initiatives that have been launched to tap Lebanon’s renewable energy potential have been almost uniformly small in scale, largely because of the technical difficulties and disincentives that bar non-governmental organizations from entering the market. Most notably, EDL actually sells electricity well below market cost, which discourages renewable energy initiatives. Additionally, according to Wael Hmaidan, the executive director of environmental NGO IndyAct, “there is a huge waste of electricity in Lebanon due to inefficiency and low levels of awareness.”

Need for regulation to adapt

Equally importantly, Lebanon lacks a functioning feed-in law that would allow private entities to produce electricity by renewable technologies and then sell it to EDL by connecting directly to the national power grid. Leaders in renewable energy technology, such as Germany and Japan, have laws that compensate private citizens for providing energy to national grids, in addition to the tax breaks that individuals and companies receive to offset the start-up costs of switching to renewable energy.

The learning curve of renewable energy

It is often private citizens who bring renewable energy to Lebanon, and the windmill that currently stands on a cooperative game and agricultural farm in Qab Elias, a village in the eastern Bekaa, is one such example.

This windmill came to Lebanon from an academic laboratory in the Netherlands in the late 1990s. Realizing that it would need extensive work before becoming operational in Lebanon, the Dutch research center sold the windmill to the Lebanese farm at an attractive price. The hope was that the technology developed at Qab Elias would then serve as a prototype for other farms in less-developed countries looking to produce wind energy.

As such, a team of Lebanese engineers, agricultural experts and renewable energy enthusiasts, led by Ramzi Abi Said, worked to convert the windmill for independent electricity production, rather than to be plugged onto the national electricity grid, as it was originally designed. In doing so, they also reduced the amount of electricity that would be produced from 1000 volts DC to 380 volts AC. At that time, such conversions were still in their infancy, and it was the first time that such engineering was undertaken in Lebanon.

Despite the project’s novelty and the team’s efforts to involve state actors, no national government authority ever came to observe the windmill. Likewise, even academic institutions that initially had expressed interest in examining the windmill’s conversion and use never launched a formal study.

The windmill now channels electricity directly to underground pumps that serve to irrigate the farm. Yet the team soon learned that Qab Elias was not the ideal place in Lebanon for creating wind energy. Since consistent wind speeds of 8 meters per second are needed to produce electricity, it is only operational during the summer months in the early morning and for approximately 4-5 hours in the afternoon.

Even with its limited use, Abi Said stressed the importance of the Qab Elias windmill. “The experiences we gained and the mistakes that we learned from gave us the know-how to further develop the technology in Lebanon.”

Technically speaking, Lebanon does, in fact, have a feed-in law, but it stipulates that a regulatory council must be created to monitor non-governmental bodies supplying electricity to the grid. Yet this never happened. The Ministry of Energy was temporarily given the power to regulate private energy production, but its mandate expired in November 2007, before any real progress was made. It thus remains illegal for any entity other than EDL to supply energy to the national grid.

In the absence of a government program to promote renewable energies, the private sector and local NGOs, in cooperation with international partners, have taken the initiative to develop Lebanon’s renewable energy potential.

Ahmed Houri, a professor of chemistry at Lebanese American University (LAU), cautions that any renewable energy solutions must be economically effective in order to be adopted by consumers or pursued by the private sector, especially without a government incentive program. The most cost-effective and technologically mature options are thus solar thermal collectors to heat water and wind power, which are both already in wide use in countries whose climate and geography resemble Lebanon’s. For example by 1999 in neighboring Cyprus, 92% of homes heated their water through solar technology, whereas Houri found that in 2003 only 2.8% of Lebanese household were equipped with such technology.

According to Jean-Paul Sfeir, the owner of Solarnet, a company that installs solar thermal collectors, since 2005 demand in Lebanon has exploded. Since then his business has expanded by more than 30% each year, and will likely grow significantly faster this year – perhaps by as much as 70%. Private homes, large apartment buildings, hotels, hospitals, orphanages and convents have all expressed interest in converting to solar power to heat their water.

Sfeir credits this recent growth to the maturing Lebanese market and the high price of fuel. “By 2005, Lebanese companies installing solar water heaters had been operating for several years and had perfected their skills. At the same time, the high price of oil on the global market pushed people to explore renewable energy technologies,” Sfeir said.

Yet despite the recent solar technology boom, Lebanon still lags far behind its neighbors. Without government mandates and incentives for solar water heaters that exist in other Mediterranean countries, high installation costs mean that solar technology remains a luxury. A solar water heater typically costs between $1,000 and $2,000 to install, putting them out of reach for most Lebanese families.

Improving access without government

The private and NGO sectors have, however, played a major role in making solar water heaters accessible to middle and low-income households. Banks, including the Crédit Libanais and the Lebanese-Canadian Bank have offered low-interest loans for water heaters, and HSBC is currently giving solar

water heaters to customers with new home loans. International donors have made renewable energy a cornerstone of their development programs in Lebanon, with the Chinese, German and Spanish governments all partnering with local municipalities and NGO’s to bring solar energy to poor communities, including those that were most affected by the July War. The Salah Ghandour Hospital in Bint Jbeil, for example, now heats its water through solar technology.

While households and businesses are limited to solar water heaters, the private sector is seeking to capitalize on the carbon-trading market created by the Kyoto Protocol, which requires industrialized countries to cut their emissions by 5.2% below 1990 levels by 2012. Rather than limit their emissions domestically, countries can buy carbon credits by sponsoring a renewable energy project in the developing world. Although still relatively immature, carbon trading was a $40 billion industry in 2007 and is expected to grow to $63 billion this year.

Sustainable Energy Systems (SES) is the Beirut-based Middle Eastern partner of EcoSecurities, an Irish company that trades carbon credits. EcoSecurities allows industrialized countries to buy carbon credits from its portfolio of 400 renewable energy projects in 27 countries rather than sponsoring individual projects in developing countries whose precise annual results are unpredictable. Such projects include electricity production by wind farms or biomass generation. These projects can create jobs in developing countries and significantly reduce their energy costs, all while improving their environment.

The process for presenting such a project to the United Nations for approval is extremely laborious. SES thus submits applications for renewable energy projects on behalf of national governments, managing the UN bureaucracy and using its resources to complete third party reviews of projects more quickly. “There are so many new projects that just waiting for project review by the Designated Operational Entity (DOE) can take six to eight months,” said Salah Tabbara, SES’ general manager. “But because we have so many projects around the world, we have a certain priority with the DOEs and can often have our projects reviewed in between four weeks and three months.” Several projects have already been submitted to the Lebanese Ministry of Environment for approval, but none has moved forward because of the country’s continuing political crisis.

Political deadlock stalling growth

The government’s current paralysis has also affected other private sector initiatives. Lebanon Winds is prepared to invest approximately $100 million in a wind farm in Akkar that could produce 2% of Lebanon’s total electricity at low, stable prices. Although it has signed a memorandum of understanding with the government, it cannot sign a purchase agreement with EDL until the current political crisis is resolved. “Our principle obstacles to beginning production are administrative,” said the company’s Robert Debbas.

Even with the enthusiasm of the private sector and international donors for renewable energy, Ali Darwish, director of the environmental NGO Greenline, is “almost certain that this is all a lot of fuss about nothing.” Until there is direct governmental intervention, projects will remain small in scale and isolated in location. And even though international donors are excited to fund renewable energy projects in Lebanon, they are often unwilling to pressure the government to change its energy policies substantially. “NGOs can lobby, can build initiatives and can apply pressure to make things move,” says Darwish. “But at the end of the day, NGOs cannot replace the government.”

April 3, 2008 0 comments

Lebanon

Agriculture – Organic growing pains

by Executive Staff April 3, 2008

written by Executive Staff

For almost a decade, global demand for organic products has seen a steady increase. According to UN figures, in 2006 the global organic market stood at nearly $40 billion, making up 2% of food retails. By 2012 it is expected to reach $70 billion. Organic produce is usually 20-50% more expensive than non-organic, yet despite this, since the late 1990s the organic market has achieved exponential growth of about 20-25% a year. The increased demand for organic produce has enabled some local farmers to increase their incomes nine-fold.

In Lebanon, organic farming has seen growth inline with the general global increase; however, the 2006 Summer War dramatically slowed it. According to the Association for Lebanese Organic Agriculture (ALOA), 10% of organic farms in Lebanon were contaminated by cluster bombs and the general follow-on effects of the war, such as lost harvest and incapacity to prepare land for the next season, have only just subsided in 2008. Consumption of organic products has also been hurt through the current political deadlock, the general economic slowdown and a severe lack of awareness and understanding of what ‘organic’ actually means.

How to define organic?

In Lebanon, organic processing is mostly focused on the production of foods typically used in Lebanese cuisine, such as olive oil, oregano mix, orange blossom water, and traditional Lebanese jams and recipes. One of the main obstacles to the growth of organic produce is the confusion that reigns among the public over the definition of organic.

People commonly confuse baladi products, which are locally grown, with being organic, and supermarkets in Lebanon often put organic products near diet products, leading many people equating the two.

Souk el-Tayeb, a weekly farmers market in central Beirut, is often thought of as being an organic market. However, Kamal Mouzawak, one of the market’s organizers, is at pains to stress that this is not the case. “People don’t understand what organic means. It is not just ‘clean’. For food it has a certification process.” He went on to state that at Souk el-Tayeb there is a clear separation between the 15 certified organic and the 32 local non-certified producers. Organic produce has to comply with a strict set of rules and regulations and something can only be called organic if it has the required certification.

Organic farming can best be described as a holistic approach that aims at producing food within an environment ecologically balanced between the soil, the plants and the animals, and not simply as replacing synthetic pesticides and fertilizers for organic ones. As much as possible, organic farmers must try and rely on crop rotation, green manure, compost, biological pest control and so on. For a product to be called or certified ‘organic’ the whole cycle must be organic.

For instance, to make organic apricot jam one cannot just use organic apricots but the other ingredients and even the packaging must be organic. Also for a farm to be organic it must not only ensure that it uses organic techniques but that the land next to the farm is free from contamination and the chemicals it uses are not seeping into the organic farmland.

The significant hurdle to organic production in Lebanon is that the foundations of organic products lay in the concept of its strict rules and regulation that are embodied in the process of certification. Yet, in Lebanon, due to the current political deadlock, the necessary laws have not been passed to ensure that certification is placed within the framework of the law. Lebanon does have two local certifiers, Libancert and IMC, that are re-certified by international organic bodies. But without the requirement of certification being enshrined in law, legally in Lebanon anyone can call themselves organic. Roula Fares, general manager of LibanCert, said that, “many farmers are calling themselves ‘organic’ because they think reducing the amount of pesticides and fertilizers they are using makes them organic.”

Training farmers to understand what an organic approach to agriculture involves has been an essential part of the effort by civil society groups that are eager to see organic farming grow in Lebanon. Rami Zriek, professor of agriculture at AUB and one of the first to help develop the organic sector in Lebanon, said that one of the problems of organic farming in Lebanon was the fact that it was not born by the farmers but parachuted in by well-meaning individuals. The repercussions of this are that many of the farmers are not committed to organic farming beyond an economic rationale, putting organic sector at the mercy of the market.

But problems exist at an even more basic level. As a report by the Ministry of Environment states, the majority of farmers in Lebanon lack basic agricultural training and the high rates of illiteracy among them have also made effective communication and training difficult.

The need for capacity building

Many of the local and international civil society organizations have established workshops and various other training programs to provide training for the more knowledge-intensive methods of organic farming. But Corinne Deek, of the German Heinrich Böll Foundation, said that in reality the only farmers that can move towards organic agriculture are the relatively well educated, ‘elite’ ones. As she said, “Organic farming needs significant capacity building but no one is doing it.”

Others object to this point of view, and particularly Zriek who strongly disagrees with the idea that it is hard to train local farmers into becoming organic growers. His argument is that there is a traditional body of knowledge, passed down from generation to generation, that can still be drawn on to help farmers become organic, and that the report by the Ministry of Agriculture should be taken with a pinch of salt. “Farmers [in Lebanon] are highly trainable and workable. Skills and training are not the limiting factors to organic farming in Lebanon, but marketing [is].”

Organic produce in Lebanon is no doubt still a niche market. According to Rania Touma, president of the ALOA and general manager of Healthy Basket, although there are no exact figures, organic produce accounts for less than 1% of the current market for food produce in Lebanon. Healthy Basket sells much of its produce on the basis of a Community Supported Agriculture (CSA). The CSA aims to create a strong bond between producer and consumer, with the central idea being that the consumers purchase a share of the farmers harvest at the beginning of the season.

At Healthy Basket, 50% of their produce is sold on the basis of CSA in which customers pay a month in advance for four weekly baskets of produce. Zriek, however, thinks that there is problem with this system for Lebanese customers in that, with organic farming, the farmer can only produce a limited array of produce and not all year round, whereas Lebanese customers want all the produce every week.

Zriek added that in Europe and the United States, the CSA concept includes the consumer going to the farms and picking up the produce, helping to establish a bond between the consumer and producer that the industry relies upon, but in Lebanon the tendency is for people to want their goods delivered directly to their door. Healthy Basket overcame these local demands by engaging different farmers in different locations to obtain a wider array of produce and to ensure that, as much as possible, produce is available all year round. In a local twist, the ubiquitous Lebanese scooter service was adapted for the delivery of organic produce to the customer’s door.

Competition in the region

However, organic producers have not managed to convince the hospitality sector to go organic and many Lebanese customers cannot accept that some produce will not be available all year round or are unwilling to pay the extra premium for organic products.

In 2005/06 Healthy Basket had begun to export some of its goods, but strong organic markets in Saudi Arabia, Morocco and Egypt pushed out Lebanese produce. Touma explained that, compared to the rest of the region, in Lebanon production is expensive because there is little subsidy from the government, and during the initial years, organic produce is very costly to develop.

However, Zriek pointed at an essential difference between the regional organic agriculture sectors, saying that “Lebanon is lucky in that its citizens eat the products that are produced here, as opposed to Morocco and Egypt where the best produce is exported to Europe and elsewhere,” resulting in a situation where despite having well-developed organic agriculture and high quality produce most of Egypt’s and Morocco’s citizens eat sub-standard produce. “Exporting high value crops and importing low value is not the philosophy of organic agriculture.”

Organic agriculture as a philosophy has also often been talked about in terms of reducing rural poverty, the vulnerability of rural woman and increasing food security. World Vision, a Christian relief and development organization, began two large organic farming projects in Lebanon at a cost of $14 million. According to the organization, these projects are “a response to the struggling agricultural sector in Lebanon because it creates sustainable job opportunities for struggling Lebanese farmers and improved incomes for their families, as well as for others involved in the harvesting, processing, marketing and sale of high quality organic produce and products.” World Vision claims that around 700 farmers have participated in the projects and 18,000 people have directly benefited from the program. Although many cynics wonder how organic farming, being as knowledge-intensive an industry as it is, can help the poor, Zriek is among those who concur with the World Vision approach and its benefits, and claims that the very ethos to organic farming is poverty alleviation.

He dreams of a day when the whole of Lebanon will be completely organic but warns that this can only ever be realized if the government takes a more active role. “Currently only civil society is putting its mind to achieving this dream and this is not enough.” But in Lebanon, dreams are rarely realized through government. It is through the dynamic and resourceful private and civil society sectors that the country has survived and thrived. If organic agriculture is to prosper in Lebanon and go beyond global trends, then the civil society groups must create a second awakening for Lebanese consumers and convince them of its benefits.

April 3, 2008 0 comments

Lebanon

Beirut Stock Exchange – Struggling for momentum

by Executive Staff April 3, 2008

written by Executive Staff

When the Beirut Stock exchange reopened in 1995 there were high hopes that it would regain its position as a center of Middle East trading. The bourse was originally established in 1920, second only in the region to the Cairo and Alexandria exchanges of Egypt. As a consequence of the tumultuous civil war years it was forced to close in 1983, during which time other regional bourses grew strongly, particularly fuelled by oil wealth in the GCC, and they have largely outstripped Beirut’s former reputation. Although the market cap of the BSE grew from $8.3 billion at year-end 2006 to $10.9 billion by year-end 2007, it still lags far behind the likes of Kuwait Stock Exchange with a market cap in excess of $70 billion.

The BSE does have some solidly performing stocks, but is still struggling to gather momentum, with only 11 listed companies. Even at this, Solidere alone represents a large proportion, accounting for 34.7% of market capitalization on December 31, 2007, and 65.1% of market share by value transactions over 2007. However, Fadi Osseiran, chairman of Blominvest Bank that runs the Beirut Blom Index, explained that the banking sector is now beginning to match Solidere, with the two taking a roughly 40-40 split of value transactions. He hastened to add, though, that Solidere’s two listed instruments are still by far the single largest component of the BSE, followed by Bank Audi, something that will not change until there are new listings.

Attracting more IPOs

Unfortunately, few see the climate as particularly favorable for initial public offerings (IPOs). In 2005 the Ministry of Finance and the BSE commissioned a study on how to encourage companies to list and identified 50 potential IPOs. Nonetheless, as Dr. Fadi Khalaf, chairman of BSE, explained “those companies that were thinking of listing have postponed their plans due to the current situation.” Any IPO is a trade-off between encouraging investors to buy and raising capital for the listing company. Khalaf believes that in this case “the problem has not so much been a matter of investor confidence, just that when you start an IPO, you don’t want any surprises, related, for instance, to the political deadlock we are experiencing.”

Some believe that more could be done to entice companies to list. Osseiran pointed out that one can use “the stick and the carrot.” Being more stringent on banking regulations by cracking down on banks that lend to companies with insufficient capital, he believes could “force companies to seek capital in other places” — namely an IPO.

However, the main setback of late to growing the BSE’s market cap was the falling-through of the planned privatization of Lebanon’s mobile telecommunications licenses, which were to have been listed on the BSE. Khalaf commented that the BSE “had been hoping the privatization would take place for some time — you need maybe 100 small IPOs to be equivalent of a few billion dollars of privatized market capitalization.” The privatization of the mobile licenses and listing of the new companies had been hoped to raise upwards of $5 billion. As he pointed out, “in stock exchanges all around the world, including developed countries, what has really boosted the exchanges were privatizations.”

Privatization of the BSE itself is also an issue, currently the exchange runs under the auspices of the Ministry of Finance. Finance Minister Jihad Azour is clearly in favor of privatizing the exchange, stating “our objective is to have capital markets that are privately owned and managed.” Plans were under way for its privatization under a draft law that was being considered by parliament, which since it is not currently convening, is unlikely to be passed anytime soon. An independent regulatory body should also come hand in hand with privatization. In the view of Osserian “a regulatory authority is of utmost importance, without it the stock exchange has no father or mother to defend it. Unless you set up a capital markets authority you will not find the driving force for the BSE.”

Biggest regional issuer of bonds

Lebanon certainly retains strengths, especially in terms of financial expertise. In the minister’s eyes, Lebanon “could easily be the regional leader in the fixed-income market.” He cited the fact that it is the biggest regional issuer of sovereign and private debt and that Lebanon’s banks are active market makers who have experience in leading eurobond issues.

Although euro and sovereign bonds have been listed on the stock exchange with a zero commission on trading as instructed by the finance ministry, they are not actually traded. According to Khalaf, “the market between banks is actually liquid, they just don’t choose to trade on the stock exchange, even with the zero commission incentive.”

There is the possibility that a new instrument may list on the exchange by the end of the year, in the form of the Blom Index. Osseiran explained that “initially we only set up the index for bench marking purposes, but this year we went live as a prelude to trading.” The form of the instrument and whether it will actually be traded on the exchange waits to be seen. As he pointed out, “we have not yet finalized the details, whether it will be a fund or a stock.” So while there may not be any new company listings, there is at least the possibility that another instrument will list in the near future.

April 3, 2008 0 comments

Banking & Finance

IPO Watch – Sector Surging

by Executive Staff April 3, 2008

written by Executive Staff

The GCC is expected to be the home to over 150 new IPOs during the upcoming two years, according to industry reports. Morgan Stanley predicts that Saudi Arabia alone is set to launch at least 110 initial public offerings over the next two years. In parallel, the number of IPOs in the Levant and North Africa region is expected to increase threefold in the same period.

In 2007 the GCC’s compounded value of funds raised through IPOs was $10.5 billion, up by 40% when compared to 2006. The action was split mostly between the UAE, which came in first place raising $5.1 billion, and Saudi Arabia, where $4.81 billion have been raised. Qatar followed as distant third with $389 million, then Oman with $156 million and Bahrain with $69 million. As such, market observers say that Gulf and foreign investors alike continue to see the region’s IPOs market as a “reliable” and a “safe” place to earn high returns with minimal risk.

The month of March supported that sentiment as it witnessed considerable activities in the IPO market when the UAE-based Ajman Bank, a shariah-compliant concern, was over 85 times oversubscribed when it closed its IPO in the first week of March. Newly established Ajman Bank, whose largest single shareholder is the government of Ajman in the northern UAE, offered 55% of its shares to the public in February, for $.27 each, valuing the bank at $272.3 million.

Offering 55% of equity and shariah-compliance as well was the IPO of new UAE insurer, Takaful Al-Emarat Insurance. UAE-based Al-Buhaira Nation

Insurance Co. or Abnic, and Austrian insurance leader, Uniqa Group, announced their upstart joint venture in mid March and said at the same time that the new firm will conduct an IPO from March 23. The firm will operate out of Sharjah and the target for funds to be raised through the IPO was around $22.5 million.

Saudi Arabia saw a generous number of new IPO announcements in March starting with Muhammad Al-Mojil Group (MMG), a construction services firm, which plans to offer 30% of its shares in an IPO scheduled to be launched on May 3, 2008, and close on May 12. Although the company did not disclose the amount it wants to raise, the IPO is expected to generate a lot of interest since the construction sector is a favorite among Saudi citizens. Another hush-hush IPO announcement came from Medina Cement, which plans to sell portions of its shares in IPO. But the company did not reveal the number of shares that would be offered and the amount it wants to raise. Medina Cement was established in 2005 with a capital of $146.9 million, divided into 55 million shares with a par value of $2.67 each.

In the meantime, three Saudi insurance providers, BUPA Arabia for Cooperative Insurance, United Cooperative Assurance Co, and Saudi Reinsurance Co closed their IPOs on March 15th. The $21.3 million IPO of United Cooperative Assurance was covered 12.56 times with demand. Based on high demand for a wave of Saudi insurance IPOs in 2007, analysts had anticipated over subscription but IPO results for BUPA Arabia’s $42.7 million IPO and Saudi Reinsurance Co’s $106.7 million offering were not in by time of writing this report.

The biggest splash in IPO-related excitement for March was supplied by Zain Saudi Arabia, which debuted March 22 on the Tadawul Exchange with a 110% leap in first-day trading, although the market overall was reeling from negative sentiment. The kingdom’s third mobile phone operator completed the subscription period for its $1.86 billion offer of 50% equity in February.

In the Levant region and specifically in Jordan, Amman-based Sabaek for Investments, a financial services firm, invited subscriptions to an IPO between March 16 and March 30. The company announced in early March that it will offer over 26% of its shares to raise around $5 million to finance operating and investment activities.

It is not difficult to understand the rationale of local and international investors’ interest in the region’s IPO market. Local experts say the recent record oil prices highs in the $110 range will improve liquidity even further and local investors have no choice but to find a new home for their cash. This home, experts agree, will be mostly in regional markets.

Executive spoke to several local experts who gave the indication that the continuing economic spiral in financial markets in the United States and some European countries would encourage the launch of share floats in the region and push investors to park their cash into those companies. This pattern is not unrestrainedly beneficial for the region’s economies, but this is the way it must happen. Oil cash inflows must be put back into the land where the oil came from and the emerging economies of the region must now move on to the final phase of becoming fully developed.

April 3, 2008 0 comments

Lebanon

Liquified natural gas – In the pipeline

by Executive Staff April 3, 2008

written by Executive Staff

In recent years, Lebanon has been promised supplies of liquefied natural gas (LNG) from Egypt. This cheaper source of energy — a pressing need in light of the oil price spike, towering around $10 a barrel — is to be conveyed to Lebanon through the Pan-Arab Pipeline. At the end of February 2008, the ministers of oil and energy of Syria, Lebanon, Jordan, Egypt and Turkey met in Damascus to discuss the nitty-gritty details of this ambitious project.

The venture, which has been in the proverbial pipelines for some years now, will allow natural gas to be transported from Egypt to the Levant and later on possibly to Europe. When completed, it will have a total length of 1,200 km and carry an estimated cost of around $1 billion. In Lebanon, explained Sarkis Hlaiss, general manager of Lebanon Oil Installations, a subsidiary of the Ministry of Energy and Water, “The pipelines, with a $22 million price tag settled in full by the government, cover a distance of 32 kilometers from the Syrian border. Lebanon’s pipeline has been finished for some time now, but we were still waiting for Syria to finalize its portion of the network, estimated at about $200 million, ending in Deir Ammar in Lebanon.”

Following the Damascus meeting, Syria’s minister of oil and mineral resources Sufyan Allaw announced at a press conference that Syria had reached an agreement with Egypt to start supplying gas via the pipeline starting March 21, 2008, after completing necessary final tests.

In Lebanon, during the initial phase the network will be connected to the Deir Ammar station, which currently meets approximately a quarter of the country’s energy demand. However, Hlaiss added that both the Deir Ammar and the Zahrani power stations boast dual gas-oil and natural gas capacity, one being a replica of the other. The power stations had initially been destined to operate on LNG, with the possibility of temporarily switching to oil, during the cleaning of the turbines.

Expanding the gas network

Of course the opposite occurred: power stations are essentially running on gas-oil, which now is not only much more expensive than LNG but also dramatically decreases the life span of turbines, according to a government source. Now that the LNG pipeline is coming, “We are toying with the idea to further expand the current gas network while connecting it to the Zahrani power station,” Hlaiss said.

The pipeline, capable of carrying some 7 billion cubic meters of gas per year, starts in Port Said, on the Suez Canal, and then

Off-shore oil in Lebanon?

In recent months, the topic of possible oil fields off the Lebanese coast has come up in newspaper headlines. But because of the sensitivity of the topic, few facts are known. Speaking to Executive, a Lebanese government source said that up to 25 square kilometers of underwater surface have been surveyed in order to locate oil-bearing deposits, adding that “while preliminary results are excellent, one has to bear in mind that even when geological conditions are at their best, there is only a 15% chance for actual oil deposits.”

According to the source, the possible oil deposits are located at a distance of 32 kilometers away from the Lebanese shore, territorial waters stretching to 80 kilometers.

But for the time being, little more than the initial survey can be done. The exploratory drilling process, which is the only means to confirm the existence of oil deposits, would cost about $300 to $400 million and requires the participation of foreign oil companies. But as the source pointed out, “This participation can only be secured through a bidding process, after the promulgation of oil laws by the parliament, which has been closed for some time.”

runs north through the Aqaba and the Al-Rehab power station in Jordan, before ending in the Syrian city of Homs. The Lebanese government has agreed to buy some 0.6 billion cubic meters per year from Egypt but retains the option to increase the gas input to four times that amount if necessary, according to Hlaiss.

Egypt is also providing 1.7 billion cubic meters of LNG per year to Israel through the Arish-Ashkelon submarine gas pipeline, which was built and operated by the East Mediterranean Gas Company.

“Gas is an excellent source of energy, one beyond comparison with fuel, especially from an environmental perspective. Replacing fuel by gas for electricity production will allow the government to cut oil costs yearly by $200 million at the least, in light of the soaring international oil prices,” the manager pointed out. The government is also considering building another power station, in order to increase electrical production. However, the Memorandum of Understanding, which would ensure the transportation of gas from Egypt to Lebanon, remains to be finalized.

Beyond supplying the Levant with LNG, from Syria the Pan-

Arab gas pipeline will further extend to Europe. Originally, slain former prime minister Rafik Hariri, one of the pipelines architects, had envisioned linking Egypt to Europe with Lebanon acting as a platform for the gas pipeline network, a project which was abandoned at a later stage under pressure from other Arab countries. Today, it will be Syria that is the switchboard.

Still years away

However, sending LNG from Syria to Europe is still years away, as the pipeline going north to Turkish node in Kilis is yet to be put together. “Building of the Homs-Kilis pipeline section will only start in 2009, as the Syrian government is still going through the bidding process,” Hlaiss said.

Addressing rumors that Syria may block the transfer of liquid natural gas to Lebanon, to put political pressure on the Lebanese government in light of the tense relations between the two countries, Hlaiss is sanguine. “I do not believe it is in Syria’s best interest to block or stall the pipeline completion. I highly doubt they will resort to such an alternative.”

April 3, 2008 0 comments

Banking & Finance

HSBC – Middle East strategy

by Executive Staff April 3, 2008

written by Executive Staff

In early March 2008, HSBC announced that its UAE brokerage arm, HSBC Middle East Securities (HMES), had received a license from the Emirates Securities and Commodities Authority (ESCA) to operate as a broker on the UAE’s bourses and that it would start trading within the same month.

Executive met with Keith Bradley, HSBC’s Regional Head of Commercial Banking, and Charles P. Hall, CEO of the bank’s Lebanon Head Office, to talk about this new step and the HSBC’s strategy.

E What value-added does this license as a broker in the UAE bring to HSBC?

Bradley: It gives us presence and allows us to offer a range of services. There is a surge of investment in the GCC and so far trading had to be done through third parties, so we decided to eliminate the middleman and go directly onto the floor.

E Why the UAE? Why not Kuwait or Oman or Saudi Arabia?

Bradley: Most of the business is done in Abu Dhabi and Dubai. Of course, should large volumes develop elsewhere, say in Kuwait, then sometime in the future we might also think of other bourses.

E What do you think of Abu Dhabi having its own Securities Market now? Does the UAE need another one?

Bradley: One of the strengths of the Gulf is innovation. Also there is a keenness for competition, and this in turn will fuel innovation and enhance quality. I did my degree in history, and studied the renaissance period in Italy, where many city states competed with each other and in so doing created a tremendously innovative culture. Today, I see something similar in the Gulf.

E With the advent of the WTO regionally, banks are consolidating and preparing themselves for fierce competition. How do you foresee HSBC’s strategy after lifting foreign bank restrictions and you can be as aggressive as you want to be?

Bradley: Of course, we would like to open faster, and thus after WTO we’ll accelerate development.

Hall: Lebanon is at the forefront of liberalization. Next we want to go into insurance and once we do, we’ll be a major player.

E What type of banking are you looking to develop — corporate, private, retail?

Bradley: We are very committed to a variety of business streams. Corporate and private banking is now so intertwined that it is hard to see them as entirely separate sectors.

E With the liquidity and opportunities in the region, there’s also risk from political developments. How do you perceive the risk and how do you protect yourself?

Bradley: We’re committed to the region and we’re committed to Lebanon. During the 2006 War in Lebanon the bank stayed open. Even during the Lebanese Civil War we did not close. Like every other financial institution, we have a Business Recovery Plan and a Business Continuity Plan. Because we operate in emerging markets, we have experience with political risk and backup sites.

E Looking at your Lebanon profile, would you say that HSBC is for wealthy people?

Bradley: There is a differentiation of services. Local banks have more branches, larger geographical penetration, and thus are better set up for low-end retail. For historical and risk reasons we do not have the market share. Also, we are not allowed to invest in government eurobonds, and so we cannot subsidize lending. Our split is about 25% corporate and 75% personal banking.

Hall: We are very specific in targeting customers. For example, we provide them with an Internet cash-supporting system, where customers who go regional can monitor cash-flow and everything else from abroad.

E Do you have any plans to limit your presence in Lebanon?

Bradley: HSBC is very committed to the Middle East. At the Group level, the Middle East will be a key market for the next ten years. For the first time, accumulated wealth is invested locally. The main developments are in the private sector, and HSBC is traditionally a private sector bank … And at HSBC, we have the best footprint in the region, having been present and involved in the Middle East for over half a century – in Lebanon since 1946 – and thus know the region and have long-lasting and deep relationships.

Hall: I can categorically reassure you that HSBC is staying in Lebanon. Indeed, we are opening a new branch. We are the biggest player in motor finance and one of the biggest in housing.

April 3, 2008 0 comments

By Invitation

Uncodified knowledge: The Middle East‘s unique innovation opportunity

by Fabrice Saporito April 3, 2008

written by Fabrice Saporito

For many years, the developed world had a near monopoly on technical innovation. European, US and Japanese companies conducted high-end R&D in their home markets and then sold the results at home or adapted them for other developed markets. But over the last few decades, the number of companies with innovation centers outside their home market has grown, from 45% in 1975 to more than 65% in recent years, according to a Booz Allen Hamilton study.

Over time, these emerging markets have succeeded mostly by developing particular niches — wide screen television in South Korea, for example, or distributed computing in India. Now, the Middle East is at a stage of development where it too might become a home to innovation. But in a world awash in advanced expertise, which niches remain unclaimed? The answer is a kind of innovation that’s not so easy to put into a box and ship, or to attach to an email. It is a kind of innovation Middle Eastern companies are uniquely suited to developing: uncodified innovation.

Unlike the innovation that is now developed in markets such as India and China, which focuses almost entirely on technical improvements to products and processes, in fields as diverse as the automotive or chemical sectors, uncodified innovation is the kind of innovation that happens as services and products are adapted to the needs and preferences of a new set of customers.

Cracking the Code

The growth of globally distributed innovation occurred because companies have grown increasingly good at codifying knowledge. Once codified, each piece of the knowledge that made up a product could be sent to the place where the most cost-effective advances on that product might be made. This reduced the redundancy within the system and in essence avoided the need to replicate R&D centers in each market.

A similar opportunity exists now for uncodified knowledge. In other words, instead of just shipping information about a new product and adapting it to the needs of the market almost as an afterthought, one could ship critical cultural understandings about multiple markets to a single innovation centre. Such a center could ease the cultural adaptation process and indeed the entire customer service experience, whatever the origin of the ultimate customer: essentially, to use a software term, to act as a kind of middleware that translates service offerings between cultures, to help insure, for example, that a hotel chain meets the hospitality needs of its Muslim customers, or that entertainment products are designed to appeal to a Middle Eastern audience.

The Middle East at the Innovation Crossroads

The Middle East is uniquely positioned to take up this challenge. Like the successful Silk Road economy of the 12th to 14th centuries, the new Middle East economy is ideally positioned between West and East. Indeed, it might even be said to be both eastern and western, since places like the UAE are now home to people from a wide range of nationalities, motivated by a set of economic incentives no other economy can provide.

In addition, the demand for new products adapted to the unique cultural and environmental traits of the Middle East is pushing many companies to innovate their products and services. For example, the decision of Time Warner to open a studio in the UAE to develop films and video games in English and Arabic is opening up a new market that was previously untapped.

Whether that means developing video games that respect Islamic cultural values, or developing new financial products to meet the demands of Islamic customers, the core activity involved is creating services that begin by understanding the needs of the customer, not the capabilities of the technology. And that particular process of customer-centered innovation is something the new Middle East could leverage to develop products and services for consumers elsewhere in the world who also have specific cultural sensitivities but are now grossly underserved by one-size-fits all services.

Creating a truly international innovation centre

Although this kind of innovation began with the need to adapt services to Muslim consumers and the specific challenges of developing a world-class business center in just a few short years, the ultimate function of becoming a center for uncodified innovation will be to provide better service to many different peoples all over the world. In this too, the new Middle East will have an advantage, in that it can leverage its identity as a uniquely cosmopolitan region, testing service solutions on local sub-markets and ultimately exporting these to other markets.

Tapping into the unique characteristics of this emerging international innovation lab to create a truly global innovation center will require companies to both apply discipline and yet be flexible. As with any R&D, there is a process of sensing, accessing, and melding knowledge, but the key difference here will be that the essential intellectual capital being created will be not be technology or a technical process, but a knowledge of the people for whom the product or service is designed — knowledge about the customers themselves, whoever and wherever they may be.

Fabrice Saporito is a principal at Booz allen Hamilton,

April 3, 2008 0 comments

By Invitation

Orient‘s budding markets beckon equity industry

by Rend Stephan, Ahmed Youssef & Albert Khoury April 3, 2008

written by Rend Stephan, Ahmed Youssef & Albert Khoury

The private equity (PE) industry in the MENA region (i.e., the Middle East and North Africa) has witnessed significant change over the past five years, evolving from infancy stage to a multi-billion dollar growth market.

In 2003, the MENA private equity market was embryonic, with only 20 firms managing less than $3 billion in capital. In the five years since then the industry has mushroomed to more than 80 firms, with more than ten-fold growth in committed or announced funds. Furthermore, the private equity industry in the MENA region now accounts for a considerable portion of total mergers and acquisition (M&A) activity.

Behind this growth are a number of MENA-based private equity firms, which can be segmented into the following categories:

• Pure-play firms, both regional — such as Abraaj Capital, Amwal Al-Khaleej, and Citadel Capital — and international — such as Carlyle Group — focus solely on private equity and are typically wholly-owned by their general partners to ensure high alignment of incentives.

• Institution-linked firms — such as EFG Hermes Private Equity, NBK Capital Equity Partners, and Shuaa Partners — typically affiliated with regional banks or large conglomerates, can leverage their institutional relationships for fundraising, sourcing deals, issuing debt, and exiting.

• State-backed firms — such as Dubai International Capital — are owned by or linked to regional governments and possess strong networks, often at the government-to-government level, that enable them to source investment opportunities, particularly in regulated sectors.

First-movers such as Abraaj Capital, Amwal Al-Khaleej, and Citadel Capital have made a large number of investments over the last three years and several successful exits to date. First movers have built substantial knowledge, networks, capabilities, and reputations that have well-positioned them to raise greater amounts of capital and have a good view as to where it can be efficiently deployed.

Challenges of MENA private equity

While overall trends bode well for an industry clearly poised for growth, the MENA PE market remains underdeveloped in comparison to other developed and developing markets.

First, compared with other economies, the MENA region’s private equity market is small relative to its gross domestic product (GDP), with the size of the industry in MENA at less than 0.5% of GDP versus 2-3% for developed economies. This indicates significant untapped potential should the necessary investment enablers evolve to facilitate greater PE activity.

Second, PE market growth has been largely driven by a few mega-deals, with limited growth in the number of transactions over the last three years and an increase in deal size, with media transaction size increasing from around $10 million in 2005 to $30-50 million by 2007. The slow growth of transactions could indicate potential pent-up demand or simply difficulty in deal sourcing.

Third, deal sourcing remains highly proprietary, built on closed social and business networks beyond the few privatization or secondary buyout transactions. Many MENA private equity firms who are backed by high-net-worth individuals as their limited partners often source the bulk of their opportunities through their LPs, giving them a competitive advantage over their peer firms.

Finally, and reflecting the industry’s early stage of development, most PE firms have largely focused on “low-hanging fruit” deals — arbitrage, pre-initial public offerings (IPOs), and capital-restructuring plays — as opposed to more complex value creation plays, such as Greenfield investments, roll-ups, and turnarounds. While simple plays have generated returns in excess of 50% to date, this is typical of any young market dominated by first-movers who quickly exploit market inefficiencies.

Future outlook for MENA private equity

In order to capture market opportunities, MENA private equity firms will have to capitalize on three major industry trends expected to dominate this sector over the next five years:

First — Continued market growth: Significant investment opportunities in a number of sectors in the MENA region will create many opportunities for MENA private equity firms. This is particularly true in high-growth, capital-constrained markets where private equity can fill funding gaps that exist in the market. In addition, many geographic markets continue to remain “virgin territory” for the private equity industry and are now undergoing significant structural transformations, including trade liberalization, privatization, and capital markets modernization.

Second — Separation of leaders from laggards: The second trend we anticipate is that there will be more differentiation between top quality firms and other “me too” firms. Given the capital excesses and pressures to invest/exit, there may also be some level of consolidation over the coming years. Some less performing firms may end up positioning themselves as co-investors on deals led by top-tier firms, while others will try to compensate through alternative investment classes.

Third — Increased prevalence of more complex value creation plays: In line with the previous trend, top performing PE firms are likely to increase their use of more complex value creation plays, relative to simple plays that depend most on market inefficiencies. This trend is inline with developed markets where leverage and exit multiples play less of a role than operational enhancement in creating value.

Conclusions

Clearly, the MENA private equity industry has made considerable progress over the past five years. However, much territory remains uncharted with significant potential. As firms consume the remaining “low hanging fruit” there will be an increased focus on more complex (and lucrative) value creation plays, such as roll-ups and Greenfield investments, which require greater expertise.

It will, however, continue to be quite competitive and each PE firm will need to carefully think about where and how to play to add value. Each PE firm will need to have its own unique strategy in order to become more differentiated as the MENA PE industry matures.

April 3, 2008 0 comments

By Invitation

Which investments have been money-makers in 2008? How to invest in global macro hedge funds and commodities

by Madilean Coen & Christopher Peel April 3, 2008

written by Madilean Coen & Christopher Peel

With financial markets becoming increasingly more volatile and correlated, investors have found the pursuit of positive returns and capital preservation difficult and are asking the question “Where do I invest in 2008? What sort of investment vehicle can profit from downside and upside market volatility and still provide an investor with liquidity, diversification and accurate pricing?

”The answer year-to-date has been (1) the Global Macro hedge fund strategy (+6.2% through end of February 2008 as measured by the HFRI Macro index) — a strategy that seeks positive returns trading within global financial markets using a multitude of asset classes and financial instruments which includes both long and short directional exposure to stock market indices, currencies, commodities and bond markets; and (2) investments in commodities (+11.23% through the end of February 2008 as measured by the Goldman Sachs Commodity index).

Both of these sectors are arguably best accessed via hedge funds, which have attracted the top investment talent globally over the past several years and have been the natural choice for investors seeking to generate absolute returns from long and short positions rather than long-only passive investing. Historically, hedge funds have been well-equipped to deliver superior risk-adjusted returns and offer a low correlation to more traditional types of investment. However, the huge explosion in the numbers of hedge funds over the last few years has meant investors can sometimes become overwhelmed when trying to navigate the sheer number of choices of trading strategies and funds that comprise the hedge fund industry.

Given the complexity of many hedge fund trading strategies it is no surprise that funds of hedge funds (FOHF) offer a way to invest into this asset class. These specialist money managers offer a perfect vehicle: investment into several actively managed hedge funds in a single portfolio. However, most funds of hedge funds lack a focused strategy and in fact have become more over-weighted towards equities, thus depriving the investor of portfolio diversification when it is most needed.

Data going back to 1992 has shown that the rolling 36-month correlation between the MSCI Europe, Africa and Far East index and the HFRI Fund of Funds index had risen from near zero in 1992 to over 80% by December 2007. This highlights weaknesses in both the style and the bias of many funds of funds. Put simply, many fund of funds managers have increasingly focused on investing in equity trading strategies and therefore returns may be lower in the future given the forecasted slowdown in world growth.

This is a very strong argument for a sector-specific fund of hedge funds when considering this type of investment. Investors should be diversifying away from equities and into hedge fund management styles that have performed best when equities are in a bear market phase. Additionally, they should look for a fund of funds that targets performance over size of assets under management, where the fund of funds has a high level of expertise in their chosen area of investment and can identify the top hedge fund managers and gain access to those hedge funds. For example, the most highly regarded global macro hedge fund managers have long track records (+20 years) and have demonstrated profiting from the 1987 stock market crash, the 1990 Kuwaiti oil Gulf crisis, the 1997 Asian emerging market crisis, the 2002 global stock market correction and, of course, and the volatility demonstrated in 2008 thus far.

The problem is that managers who have successfully realized positive returns in the above environments are often closed to new investment and/or have large minimum investments (often $10M plus). A superior fund of funds can source, perform qualitative and quantitative due diligence, and negotiate capacity into these top hedge funds. It will also pool client assets together so that investors may invest in several of these top single manager hedge funds — thereby mitigating single manager investment risk at a much lower minimum investment amount for the individual investor.

Global Macro Fund of Funds

Global macro hedge fund managers are typically known to utilize a top-down, thematic investment approach and pursue directional trading strategies in the world’s financial markets utilizing stocks, bonds, interest rates, currencies and commodities.

In practice, what this means is that the hedge fund manager does not restrict himself to a single market or asset class but trades on an opportunistic basis across many different markets. Successful macro fund managers apply their specialist econometric understanding of the world and allocate risk within this framework. This means that they will be looking for markets to be long or short without having to favor one style or market over another. The upshot of this is that macro funds have been proven to capture both the upside of any equity market rally, but more importantly have shown an excellent history of returns when equities have fallen out favor.

An astute reader might now ask why all hedge funds of funds are not invested in macro strategies?

The answer lies in the fact that most hedge fund of funds managers are not equipped to fully understand macro strategy. They have been wary of macro hedge funds because they are difficult to pigeonhole as equity, fixed income or commodity funds. But a fund of hedge funds that specializes in investing in macro funds can offer an excellent opportunity to gain some exposure to this non-correlated type of hedge fund trading strategy, even if the manager has a proven long-term track record and is closed to new investment.

Commodity Fund of Funds

Commodity hedge fund managers typically utilize a fundamental investment approach that combines both macro economic research and traditional supply/demand analysis to construct directional, commodity trades within energy, metal and agricultural commodity futures and option markets.

As a result of falling global supplies and increased global demand, over the past five years many of the commodity markets, from fuel and energy to agricultural commodities and precious metals have seen an incredible rally. Irrespective of the present state of the equity markets, the rally in commodities will likely continue as demand from emerging economies such as China and India seek to:

1. Improve their diets and standard of living (agricultural commodities: meats, coffee, sugar, cocoa, eggs; as well as energy: crude oil, natural gas, etc).

2. Improve their infrastructure by building new homes, railroads, airports and even cities (base and precious metals). The above will likely replace any fall-off in demand from developed nations.

In addition, commodities have traditionally acted as an excellent hedge against inflation. Commodities will therefore continue to benefit as an asset class as central banks universally relax their focus on fighting inflation as they cut interest rates to promote growth and financial stability.

Finally, the commodity markets are themselves very distinct in nature from the equity markets. They can be constrained by factors such as the supply of land on which to grow crops or the rate of discovery of new mineral deposits, they may be influenced by weather or the cost and availability of transportation. All of these factors add up to make the commodity markets quite independent of equities and an excellent asset class for portfolio diversification. However, most investors are wary of investing directly in commodities, a long-only index or even a single commodity hedge fund manager. Again, for long/short commodity exposure to the top commodity trading talent a fund of hedge funds pool focusing on the commodity sector clearly makes the most sense.

April 3, 2008 0 comments