Executive Magazine

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

Capitalist Culture

USA – Primary mistakes

by Michael Young April 3, 2008

written by Michael Young

As the US primary elections wind down, with some dozen left between April and June, largely absent from the debate has been the matter of democracy in the Middle East.

Even the Bush administration, with democracy as its rhetoric centerpiece, has largely ignored the practical implications of this when dealing with its autocratic Arab allies. Given the rise of Iran in particular, the US has systematically played down human rights abuses and political under-representation, believing now is not the time to embarrass governments whose priority is, like Washington, containment of the Islamic Republic.

Rather than focusing on democracy and how the US can spread its values overseas, the candidates, particularly the Democrats, have started from a premise that American efforts to push its values onto others has harmed America’s image overseas. So, for example, Hillary Clinton argues on her website that “America is stronger when we lead the world through alliances and build our foreign policy on a strong foundation of bipartisan consensus. [I] will lead by the words of the Declaration of Independence, which pledged ‘a decent respect to the opinions of mankind’.”

Barack Obama also supports “bipartisanship” in US foreign policy, but also proposes talking to America’s foes, such as Iran and Syria (unlike the “Bush-Cheney approach to diplomacy that refuses to talk to leaders we don’t like”), and wishes to employ American diplomacy proactively. His campaign website promises, for instance, that he will “stop shuttering consulates and start opening them in the tough and hopeless corners of the world … [Obama] will expand our foreign service, and develop the capacity of our civilian aid workers to work alongside the military.”

There is certainly much to be said about hostility toward the Bush administration around the world. Some of that antagonism may be justified, though one has to wonder whether Iraq factored disproportionately into the thinking of many. After all, Washington has not behaved any more unilaterally than its predecessors when dealing with such crises spots as Lebanon, Afghanistan, North Korea, Iran, Venezuela, Palestine, Kosovo, even Iraq after the initial phase of the war ended.

Indeed, one might argue that when it came to Iraq, but also Afghanistan, Lebanon, and Kosovo, the Bush administration’s willingness to be hard-nosed made all the difference in liberating previously stifled peoples. It is undeniable that the Iraq war could have been managed infinitely better, savings tens of thousands of lives, and that Afghanistan is far from stabilized; but without the US, Saddam Hussein would still be in power, to the chagrin of a majority of Iraqis, and the Taliban would, similarly, be imposing their mad, medieval designs on Afghans. Few are the Lebanese who regret the Syrians’ departure, and it is largely thanks to American backing that Kosovo’s independence has become a reality.

In contrast, those who speak about “improving America’s image in the world” seem less clear about what this means in practical terms. No doubt being hated is a problem for any country, particularly so powerful a country as the United States that needs to build international coalitions to forward its preferred agendas. But is there any sign that “being loved”, or even just being “liked”, makes much difference globally? Not really. Why is it that Americans alone seem so keen to raise this odd question of affection, when most other states pursue their interests without bothering about whether they are liked or disliked?

What the Bush administration has gotten wrong, and its successor will likely get wrong too, is that the only credible benchmark for global influence is respect, therefore success, not popularity. In focusing on affection as the goal in improving America’s image, policy thinkers ignore that no powerful nation is ever truly liked. America’s condition will not improve because Arabs or Asians tell Pew researchers in a year’s time that they admire America more than today. America’s condition will improve when the foundations of its admired capitalist culture are strengthened. These include a defense of open markets and open minds, a rejection of despotism, and a reliance on the soft power of persuasion and example, in addition to a willingness to use hard power when this proves unavoidable.

To expect the US, or any state, to be absolutely consistent in its behavior is asking too much. Politics doesn’t work that way. But to have no guiding principle to base action on can be almost as damaging as appearing to fail in one’s aims. That’s why the Bush administration has paid so heavily for its efforts in Iraq, Afghanistan, and elsewhere. It is seen as a loser, whether this view is fair or not.

All the US candidates should remember this when they issue vapid proclamations about America’s image in the world. To be cliché: there is no success like success, particularly in the defense of liberal values. What all the candidates should be doing now is determining whether their foreign policy options will actually meet this standard.

Michael Young

April 3, 2008 0 comments

By Invitation

A Universe Apart

by John Defterios April 3, 2008

written by John Defterios

The Great Eastern Hotel near Liverpool Street train station was designed with the City of London financier in mind. Its minimalist interior, clean lines and discrete atmosphere create the right setting for business people to work on a deal or attend a mid-sized forum.

I escaped into the Great Eastern in late March for a few hours at a gathering of Egyptian ministers and business people to discuss the outlook for the region’s most populated country. The talk inside the meeting room was about robust growth of 7%, foreign direct investment hitting a record $11 billion dollars and re-positioning Egypt to capture more than its fair share of Gulf petrol dollars.

On the way over to the meeting, I read my morning paper with headlines reacting to the Federal Reserve’s orchestrated bailout of Bear Sterns and yet another drastic cut in U.S. interest rates to help cushion the blow of the slowdown. This was followed by rampant rumors in London of an imminent collapse of a leading retail bank. The rumors sparked an investigation.

Inside the foyer I took time for a few interviews to sound out my views that we are not living in one global economy right now. “It really does seem like two parallel universes,” said Marwan Elaraby of Citadel Capital the Egyptian investment bank.

“You drive around Dubai or the more frontier emerging economies of the region, you would never guess what is happening in the world economy. What is happening on Wall Street or the City of London seems like a universe away,” added Elaraby.

The dollar continues to tumble; oil continues to surge; prices everywhere for staples are skyrocketing. Despite the rosier economic outlook, protestors in Cairo demanded that President Hosni Mubarak do something about the cost of bread. History buffs know from Roman times that economic growth alone does not deliver votes, but affordable access to bread certainly does.

Finance is Confidence

Middle Eastern players are not ignoring the red-lights of concern flashing on Wall Street, quite to the contrary. They are hoping to minimize the impact. As co-founder of Beltone Financial, Aly El-Tahry noted: “Finance is confidence. As long as you don’t have a catalyst or something that diverts the present expectation from this negative mood, we’ll continue to have uncertainty.”

For Egypt that may translate into a drop of up to 1 percentage point of growth this year according to the country’s Investment Minister Mahmoud Mohieldin. While he acknowledged the challenge, the 42-year-old minister added some bigger picture thoughts on what this might eventually mean.

“I’m much more concerned about the policy formulations in the future because the kind of extreme pragmatism that we’re witnessing today could be justified in the short term by uncertainty, by requirements of having to make and to do some quick actions to fix problems,” said Mohieldin. The Worldcom fiasco led to Sarbanes-Oxley. This severe credit crunch he worries may lead a new White House occupant to move into action to limit trade or the flow of financial investments.

Let’s hope not. We, however, have heard very little from the three remaining presidential candidates on what they would do about the Doha trade round, sovereign wealth funds or the sinking dollar.

Meanwhile, back in the foyer of the Great Eastern, the talk remains on creating new opportunities. Egypt is in the midst of creating a new industrial investment hubs and expanding IT centers. For that to come off the ministers know that skills need to match the demands of companies such as Microsoft or Oracle who already have a presence there.

With this economic boom underway in the region, the players are looking to India and China for inspiration, not Wall Street or the City of London .

April 3, 2008 0 comments

Financial Indicators

Global economic data

by Executive Staff March 21, 2008

written by Executive Staff

GDP

In terms of total GDP, the United States is, by far, the largest member country. Japan is the second largest economy followed, at some distance, by the four large EU members — Germany, United Kingdom, France and Italy. The next four largest are Spain, Mexico, Canada and Korea. These rankings have not changed significantly over the period shown.

Per capita GDP for the OECD as a whole was close to $30,000 per head in 2005. Five OECD countries had per capita GDP in excess of $36,000 — Luxembourg, Norway, United States, Ireland and Iceland. Half of the 30 OECD members had per capita GDP between $28,000 and $36,000, while 10 countries had per capita GDP below $28,000. Turkey, Mexico and Poland had the lowest per capita GDP. Note that both GDP and PPPs contain statistical errors, and differences between countries in per capita GDP of 5% or less are not significant.

Also note that in the tables, the OECD total excludes the Czech Republic, Hungary, Poland and the Slovak Republic.

Education

In 2003, taking into account both public and private sources of funds, OECD countries as a whole spent 6.3% of their collective GDP on their educational institutions. The highest spending on educational institutions can be observed in Denmark, Iceland, Korea and the United States, with more than 7% of GDP. Seven out of 29 OECD countries for which data are available, however, spend less than 5% of GDP on educational institutions.

In all the countries, public and private expenditure on education increased by 5% or more between 1995 and 2003 in real terms. However, the increase in spending on education between 1995 and 2003 tended to fall behind the growth in national income in eight of the 21 OECD countries. Most notable differences are observed in Austria, Canada, Ireland, Norway and Spain where the proportion of GDP spent on education decreased by 0.4 or more in percentage points between 1995 and 2003.

It should be noted that growth in GDP masks the fact that there was a significant increase in real terms in spending on educational institutions in almost all of the OECD countries from 1995 to 2003. In addition, the size of the school age population shapes the demand for education and training, and national levels of teachers’ salaries also affect the share of expenditure on education.

Quality of life

On average, across the countries for which data are available, around 7.7% of teenagers were neither in school nor at work in 2004. Differences across countries are large: in Denmark, Germany, Iceland, Luxembourg, Netherlands, Norway and Poland less than 4% were in this situation while the shares exceeded 10% in Portugal, Spain, the United Kingdom, Mexico and Turkey.

For the OECD as a whole, there has been a decline in the percentages of teenagers who are neither employed nor education, but the decline has been most marked for females. The fact that young people, and particularly females, spend more time in education than they did a decade ago has contributed to this.

Several features of the labor markets and training systems affect the ease of transition from school to work. OECD reviews of youths’ transition from school to work have identified Nordic and English-speaking countries as those where this process is smoother than in countries in Continental and Southern Europe countries.

Access to household computer

Penetration rates are highest in Iceland, Denmark, Japan, Sweden, Korea, the Netherlands, Luxembourg, Norway and the United Kingdom where 70% or more of households had access to a home computer by 2005. On the other hand, shares in Turkey, Mexico, the Czech Republic and Greece were below 40%. Between 2001 and 2005, the percentages of households with access to a home computer increased particularly sharply in Japan, the United Kingdom and Germany.

The picture with regard to internet access is similar. In Korea, Iceland, the Netherlands, Denmark, Switzerland and Sweden, more than 70% of households had Internet access by 2005. In Turkey, Mexico and the Czech Republic, on the other hand, only about one-fifth or less had internet access by 2005.

Data on internet access by household composition — with or without dependent children — are available for most OECD countries. In general, they show that households with children were more likely to have internet access at home in 2004.

March 21, 2008 0 comments

Banking & Finance

Money Matters by BLOMINVEST Bank

by Executive Staff March 21, 2008

written by Executive Staff

Regional stock market indices

Regional currency rates

Qatar Buys Back its Stakes at Credit Suisse

According to Qatar’s Prime Minister, the natural gas rich country is buying back its shares at Credit Suisse and is planning on spending $15 billion this year to purchase shares in European and US banking institutions. The purchase deal that is still going on has not yet reached the 3% threshold at which the Swiss Stock Exchange regulations stipulate the disclosure of the acquirer’s name. The Qatari Investment Council, an emerging GCC sovereign wealth fund, has also revealed plans to set up funds in Finland and Malaysia, similar to the one that was established in Indonesia last month, at $1 billion each.

Libya Plans on Creating Energy City at $3.8 Billion

The Gulf Finance House of Bahrain signed a $3.8 billion deal, this month, with Tripoli’s Economic & Social Development Fund to create an energy business district. The project that will be built on a 528-acre site in Sabrath (west of Tripoli) will be known as ‘Energy City Libya’. Energy City will provide a full range of facilities to local and international oil and gas companies within a mixed commercial, residential and hospitality services. In addition to reviving the country’s infrastructure, the Libyan government is hoping to attract foreign direct investment into the country, especially from Gulf nations.

IMF Forecasts 5.7% Growth of the Tunisian Economy

The International Monetary Fund (IMF) has projected a 5.7% growth for the Tunisian economy from 6.3% in 2007. The main driving force of this decline has been the low demand from Europe for Tunisian exports as a result of the increase in oil prices and commodities. However, the IMF has predicted a cushioning of the slow economic growth with the revival of foreign direct investment into Tunisia. The Tunisian government is aiming at supporting the economy by introducing banking reforms and liberalizing trade practices. The IMF is expecting budget deficit and inflation to hover around 3% of GDP and 4% respectively. However, the 3% budget deficit seems underestimated given the government’s subsidy for fuel and essential commodities.

March 21, 2008 0 comments

Cover story

More than chrome

by Executive Staff March 21, 2008

written by Executive Staff

All over the world, the iconic American motorcycle, Harley Davidson, is a passionate affair. Having, over the past two decades, changed its image from the machine for lawless bikers and heavy metal rock stars to a “statement of freedom and uniqueness” by well-respected individuals. Harley Davidson has matured and the company now also draws its clients from middle-aged professionals in the middle-to-upper management echelons. Steeped in history and tradition, in the Middle East, Harley Davidson has had several high-profile devotees, first and foremost the late King Hussein of Jordan, famous for his rides in the desert, his son now continuing the tradition.

No other motorcycle in the world gets the same devotion as a Harley Davidson. For enthusiasts, it is more than a muscle machine decked out in chrome. “Harley Davidson has a story — it’s the spirit, the people, and the way of living,” explained Marwan Tarraf, general manager of Bikers Inc., the Harley Davidson dealership in Lebanon.

Saudi Harley rider Abdelmenem Addas, owner of a Heritage Classic, banker, teacher and activity officer for HOG (Harley Owners Group) Saudi Arabia, described the culture of Harley Davidson by saying that firstly it represents the idea of “American freedom” — of traveling down an open road with the wind in your hair — and second, there is the idea of brotherhood and team spirit. Many of the region’s riders have either lived or studied in the US where they were first introduced to the Harley culture, or are expatriates living in the Gulf.

No lawlessness here

However, the region’s riders are far removed from lawlessness. Addas insisted, “We obey the strict traffic rules such as wearing helmets, signaling, and keeping space between bikes.”

Performance-wise, Harley cannot compare to other motorcycles on the market — but what it can offer is a unique experience. Its special V-engine, which gives the motorcycle its signature look and sound, also provides a feeling specific to the brand. “I bought one five years ago and loved the feeling,” said Karam Attallah, general manager of Lebanon’s Gefinor Finance and owner of a ‘04 Road King Classic.

Harley Davidson is also a marketing phenomenon with apparel and accessories designed for biking and casual wear. In addition, the logo can be found on items ranging from mobile phones to limited edition Ford Trucks. In recent years, the spirit of Harley Davidson has been used to sell everything. It’s based on the idea of community, Tarraf explained, “When you buy a Harley, something changes in your life. You then belong to a specific interest group that wants to share this with other people.”

Public perception of the motorcycle also plays into it. “It is how people perceive you that makes you want to own one,” said Ahdi al-Hunaif, rider and author of the Kuwait Chopper blog, “how everyone warms up to you on the streets, how kids wave to you at a traffic light, how old men ask you questions and give you the thumbs up.”

Money — as in, having it — also plays a role. “Harleys are not cheap,” explained Tarraf, “so buyers tend to be upper-middle class. There are people who own five bikes and never ride and then there are others who save for years and ride their bikes everyday.”

While the average Lebanese rider is around 35 years old, global statistics indicate that Harleys are mainly popular with the over-45 crowd, with incomes hitting $80,000 and above. However, with so many statistics, the reality is extremely varied. As Tarraf related, “We have a rider who used to sell fish in California and came back. He went to hajj, prays five times a day, his wife wears a veil and he has a Harley that he loves. He lives in the south, has to drive over two hours for a one-hour ride and rides back. Now he meets with a guy like Karam, and their lives are so totally different, but they share a passion for Harleys.”

On the low end, a new Harley costs around $15,000, and prices then can climb up to $60,000, although the average price is about $20,000. The two top selling models are Soft Tails — such as the Fat Boy, popular for city riding — and Road Kings — the larger touring class made for road trips and traveling.

“Usually, people who don’t know much about Harleys come and ask about the Fat Boy. But once they get to know Harleys better, they begin to want to buy a bike that suits their usage,” said Tarraf.

Another popular category is the Sportster family, which are smaller motorcycles that some who have touring motorcycles buy as a second bike. A recent addition is the V-Rod, a speed bike, created with a Porsche-designed engine for greater performance.

Customization

Customization and modification allow the rider to become the true owner of the motorcycle. Almost everyone customizes his bike. “You can buy a motorcycle and make it look like you,” said Tarraf. “That’s where Harley succeeded most; they give you a motorcycle that has the possibility of being a work of art.”

It is also a domain where a lot of revenue is generated. Customizations can double the price of the bike, if not more. Changing the handlebars, adding accessories, paint jobs — anything up to the engine can be changed. Added al-Hunaif, “It is about showing off your latest creations, making people see what type of a person you are, because in reality, each bike shows a piece of that person.”

Dealerships in the region

The dealership is an integral part of the Harley experience offering, alongside service and customization, a social forum to interact with others who share the same passion. They also provide the safety training needed to operate the bike.

Over the years, regional dealerships changed considerably. “I’ve been riding for 15 years. I remember I used to go to a Harley dealership in the States where you’d find this bearded guy with feathers all around, very rude — he wouldn’t even talk to you — and now you go to a Harley dealership and you see a younger generation managing and people that are so nice, who answer all of your questions and try to help you out. You don’t see the old guys anymore. Harley had to clean up their image; there is a new trend because they want to sell to non-traditional Harley riders and get a wider clientele.”

In Lebanon, Harley Davidson has a long history. According to Tarraf, the first Harleys were brought to Lebanon in the 1950s, imported from abroad. Ten years later, the Lebanese police began buying the motorcycle for its force. A formal dealership was set up in 1977 only to be closed after importation difficulties resulting from the civil war. In the 1990s, after the civil war, the police began selling their stock sparking an interest that led to the reopening of the dealership in 1995. However, it closed again in 2000 and in the ensuing years, few Harleys were imported. This, in turn, prompted Tarraf to obtain the dealership license, opening his doors to old-time riders and new clients in 2007.

Originally, he expected to sell only 20 motorcycles. Demand far outpaced expectations and by early 2008 he had sold around 70 bikes — not bad for a tiny country in the midst of turbulence.

The first dealership in the UAE was established in 1989, operating out of a hangar at the Abu Dhabi International Airport. It expanded to Dubai in 1992 and since then has been established in both emirates. Sales are just under 500 bikes per year. “There isn’t a model which we don’t sell,” said Marcel Bode, general manager of Harley Davidson of the UAE. For him, it is the influx of expatriates that is growing the market, something that can be observed when looking at other GCC markets as well.

Dealerships have appeared in other Gulf states since the late 1990s, and can also be found in Egypt and Morocco.

HOG chapters

Owning a Harley makes you a part of a global club. The Harley Owners Group (HOG) was established by the company in 1983 in response to a growing need to provide a forum for riders where they can interact with other riders and organize rallies to show off their bikes. The forum went international in 1991, established through local dealerships. Belonging to a HOG chapter means that one is part of a global network of riders and has access to other chapters’ rallies. “If you are a HOG and you meet another HOG from Idaho, there’s always something to talk about,” explained Tarraf.

In the region, HOG chapters are quite active. The first Middle East HOG Rally was held in Muscat in 1999 drawing over 200 bikes. The next one saw an increase to 300 and sparked a competition with Dubai. The Middle East HOG Rally continues as an annual tradition, to which rallies throughout the region have been added.

Saudi Arabia’s HOG chapter has nearly 1,200 total members, according to Addas, activity officer for the group. Nearly 70% of its members are expatriates from the US, France, Switzerland and Germany. Even with the strict social regulations, in places such as Jeddah wives and girlfriends are able to ride on the backs of bikes. The group is very active and has been used to promote tourism in the country. Last year, a ride from Jeddah and continuing up to the Durrat al-Aroos beach resort, 60 km north of the city, was supported by Mecca’s governor, Prince Khaled al-Faisal, Jeddah’s governor, Prince Mishaal ibn Majed, the General Presidency of Youth Welfare’s Saudi Motor Sport Committee and the Jeddah Chamber of Commerce and Industry, and given a police escort. And, exemplifying that the brand has come a long way from its early days as the bike of choice for motorcycle gangs and outlaws, Harleys could even be used to promote peace and understanding in the region. One day, so Addas hopes, he will be able to organize a ride from Mecca to Medina and then ending in Jerusalem, if he could secure the authority needed. “I think it would send a message to the world that we want peace.”

March 21, 2008 0 comments

International

US-Middle East relations in light of the US elections

by Executive Staff March 21, 2008

written by Executive Staff

The US and Middle East have seen strong development in economic relations in the past couple of years with booming trade and the implementation of a number of Free Trade Agreements (FTAs). Going forward, it is likely that commercial relations will remain strong although further FTAs are perhaps unlikely in the medium term.

In the United States the political battlefield for the November elections have been partially clarified in the past month. The Republican candidate will be Senator John McCain, while the Democratic side is still being contested by Senators Hillary Clinton and Barack Obama.

During the election debates and campaigning, discussion on the Middle East has been almost entirely focused on Iraq. This is not unusual given the US military involvement in Iraq, but more surprising is the lack of discussion on other issues pertaining to the Middle East, particularly in regards to Israel/Palestine.

Although not during an electoral debate, the latest non-Iraq mention of engagement in the region was made by Senator Obama on Lebanon, and said while addressing the Senate on February 4, 2008, “the continued deadlock over Lebanon’s presidency brings further instability to an important country in the Middle East. We cannot idly stand by as an emerging democracy, whose people have long ties to the United States, teeters on the verge of collapse.”

Perceptions of the upcoming election

He added that “it is time to engage in diplomatic efforts to help build a new Lebanese consensus. These efforts should focus on the need for electoral reform, an end to the current corrupt patronage system, and the development of the economy, so as to provide for a fair distribution of services, opportunities, and employment.”

Commenting on the perception of the US elections in the Middle East and North Africa (MENA), James Zogby, founder and president of the Arab-American Institute, thinks that an important factor for people in the MENA region regarding the upcoming elections is firstly the end of the Bush Administration. In regard to the current candidates, Zogby said that people in the region are following the Democratic candidates with great interest. “People in the region question ‘Can Obama really win?’, can an African-American, son of a Muslim really win in America? Obama as President of the United States would send a very different message about America. This is the America that they have dreamed of when they think about American values. I have had people in the region tell me, I wish I were American so I could vote for Obama!”

There is also strong support for Hillary Clinton, whose candidacy people in the region see as the return of the Clintons to the White House. Mentioning Bill Clinton’s overseeing of the Peace Process and travels to the region, both while president and after, Zogby said that Clinton had created a lot of good feelings towards America in the region.

For MENA, the US is an important commercial partner. In 2006, the US represented the most important import market for the region, comprising 9.4% of total imports. The US was also the second largest export market for the region (10.6%) behind Japan (15.4%). Of course, the regional exports are dominated by oil and gas and the leading exporters are Saudi Arabia, the UAE and Iran, who by themselves account for more than 50% of the total exports of the region.

In Lebanon, which signed a Trade and Investment Framework Agreement (TIFA) with the US in 2006, American exports have been growing steadily. In 2006, the US represented 9.2% of Lebanese imports placing it third behind Syria (11.4%) and Italy (9.6%). This was a strong increase from the previous year when the US had only represented 5.3% of Lebanese imports.

Since 2003, the US has put forward a plan to increase trade between the Middle East with the United States, entitled the Middle East Free Trade (MEFTA) Initiative. This led to the signing of a number of FTAs, and some other agreements such as TIFAs which are usually seen as a step towards FTAs.

Bringing the region together under FTAs

The US has TIFAs with Algeria, Egypt, Iraq, Kuwait, Lebanon, Qatar, Saudi Arabia, Tunisia, the UAE and Yemen, and FTAs with Israel, Jordan, Morocco, Bahrain and Oman, which in 2006 was the latest country to sign.

The MEFTA initiative aims to bring all countries of the region into FTAs with the US by 2013. Explaining the reason for US-MEFTA, President George W. Bush said in May 2003, “Across the globe, free markets and trade have helped defeat poverty, and taught men and women the habits of liberty. So I propose the establishment of a US-Middle East free trade area within a decade, to bring the Middle East into an expanding circle of opportunity, to provide hope for the people who live in that region.”

Looking at the impact of the Bush administration on commercial relations between the US and the Middle East, David Hamod, president of the National US Arab Chamber of Commerce notes a number of positive aspects.

Firstly, he noted “with support from the US Congress, pushed through three FTAs with the Arab World — Morocco, Bahrain, and Oman. This is a significant accomplishment, and there is good reason to believe that more FTAs with Arab nations will be signed in the years ahead.”

Looking at the booming US exports towards the region Hamod also gives some credit to the current administration. “There are many reasons for this, the most obvious being the surge in oil prices and the concomitant liquidity and purchasing power that this surge has created. For its part, the Bush administration has played a role in this boom by ‘talking up’ US goods and services and by undervaluing the US dollar, thereby making US exports more competitive in world markets” he said.

And the final positive note, according to Hamod, is the president’s stand against the protectionist sentiments expressed by US Congress in the Dubai Ports World issue. “President Bush threatened to veto Congressional legislation that would preclude investment by the UAE in several US ports.”

On a less positive note, Hamod also noted that the raised security concerns in the US have been detrimental to American-Arab business ties, saying “As a result of visa difficulties and concerns about ethnic profiling in the US, many of our best friends in the Arab World are no longer interested in doing business here.” This is not a good situation especially when India, China, and other Asian markets are aggressively rolling out the red carpet for Arab investors.

In the upcoming US elections all three potential remaining candidates voted in favor of the US-Oman FTA in the Senate, implying that they will likely continue the policy of encouraging FTAs between the US and Middle Eastern countries.

But there is less certainty as to the interest of Arab countries to enter into more FTAs with the US. The UAE was supposed to be next, as they officially begun discussions in March 2005, but negotiations have stalled. There were also rumors for Egypt beginning negotiations but that also appears to have been shelved.

James Zogby shares this bleaker outlook on future FTAs with the US. “The countries that signed FTAs have them, but I don’t expect any more. The Bush administration went for the easier countries. I don’t expect any others in the making.”

March 21, 2008 0 comments

Private Equity Special Report

Strategic synergy

by Executive Staff March 21, 2008

written by Executive Staff

Across the region’s private equity landscape, there are a large number of financiers, whose mixture of know-how and ability to gather capital from a solid investor base introduced new ideas of efficiency to some of the region’s most successful firms, including those whose sights are set on becoming regional champions.

When Executive had the chance to sit down with the co-heads of Investcorp’s Gulf Growth Capital (GGC) Fund, Azmat Taufique and Christophe de Mahieu, it reached the crème de la crème of the region’s private equity scene, the philosopher-financiers of the industry.

Investcorp began private equity operations in 1982 in the Gulf, and has since evolved to include a host of other assets. The firm’s latest GGC Fund is a return to its home turf, in an effort to harness the group’s synergy and experience with local partners — an essential ingredient to any regional private equity mix — in spotting deals and acting on those with the best chances for success. The particular focus of the fund is to invest in and improve greenfield projects and buyout opportunities in medium-sized firms, the newest foray of the firm. De Mahieu said the fund has “deployed more than $35 billion of the Gulf’s capital across the world.”

Alignment

With more than $13 billion in assets and an investor base of 1,400, the GGC Fund should not lack deal flow. De Mahieu said that “[Investcorp] combines its distinctive capabilities of raising funds, with its trusted investors in the Gulf and across the world, while bringing its well-established private equity capabilities built over time in the West to make private equity investments in the Gulf and by extension across the Middle East.” According to Taufique the investor base of contacts are not just investors, “but genuine partners in the region,” to whom Investcorp looks “for ideas and for deal flow.”

The relationships with the investor base of partners and profiteers from successful deals are not the only relationships the firm is mindful of. Taufique described the firm’s cooperation with management best when he explained the host of global experience Investcorp brings to the table. Especially as Investcorp is “particularly adept at understanding what the potential conflicts are and mitigating them, creating alignment and structures and working with the teams over a period of time to enhance value that would be of interest to everyone concerned. In this sense, we would like to think that we are better at handling this.”

To enhance investments and ensure that Investcorp can achieve positive results with firms, according to de Mahieu, “there is often an alignment phase with the owner and management of a company before we launch the full due diligence process.” He explained that, “during this alignment phase, we spend a lot of time with the existing owner and management to align ourselves around the vision, the strategy, and the contribution of every party, including Investcorp, to create significantly more value. When alignment is reached, we go into the due diligence. After the due diligence, if the transaction is consummated, we work together, we change the governance, support the management, inject new capital when required and bring our operational capabilities where agreed.”

Foreign capital

Taufique noted the strong regional pull in attracting foreign capital, as seen through the FDI number for Saudi Arabia and the UAE which are both “beyond the charts. And so for a country that has a great capital surplus to attract that sort of foreign investment, there must be something positive going on.”

Within the kingdom, Taufique believes that few associate Saudi Arabia with being one of the fastest reforming economies in the world, because “there are perceptions of other constraints of different kinds, but in terms of the economic structure, there seems to be a momentum for reform, which is being recognized by institutions like the World Bank, but also by private investors.”

Future strategy

Taufique opined that “there are many more possibilities for growth capital equity investing here today as opposed to investing in existing companies and tweaking the edges. And that is the focus of many private equity players now, because that is where the opportunities are, but as things progress, you will find more and more of the region evolving into what you have seen in North America.”

With these dynamics in mind, “as the industry matures, the intermediaries will start playing a more active role as they build their expertise in the region and they build their own relationships,” which, according to Taufique, will “see a bigger flow of deals coming from the intermediaries and that will make the industry more efficient. We know what we do best and that is to invest and enhance value.”

March 21, 2008 0 comments

Private Equity Special Report

Sector focus

by Executive Staff March 21, 2008

written by Executive Staff

Across the developing world, telecom companies battle to provide populations with the most efficient services. Combining price, service, and convenience, mobile telecom firms and fixed-line businesses are looking for new ways to penetrate these nascent markets and consolidate their share to out-compete rivals. Telecom markets, especially in the developing world, present an interesting case study and a concrete example of how private equity can revamp businesses through their infusions of capital and of knowledge.

Market motions

Vying for market share has created a host of privatizations by governments in the region and has led to a series of mergers and acquisitions within the telecoms, media, and technology (TMT) industries. A. Shabu Qureshi, director at EMP Global, explained that “liberalization points to more opportunities and market efficiencies in the short, medium and long run. It removes the barriers and constraints posed by public ownership. Positive developments brought about by liberalization translate into new services, new opportunities and growth prospects.”

The case for competition is stronger in the developing markets of the Middle East and North Africa (MENA) where penetration rates and convergence are low. This leaves a huge opportunity for private equity firms to assist companies with expansion and improvements to existing models of their corporate governance. Izzet Güney, managing partner at Millennium Private Equity, thinks that TMT private equity deals will target mobile operators “mostly in Africa and South Asia, where you still have countries with only two operators and a low penetration level.”

He attributes the low level of penetration to the existence of several small operators in countries which have escaped the radar of larger conglomerates and who are focused on buying mid-sized to larger operators. The larger firms might penetrate new markets once local telecom operators are “actually larger in size.”

Güney’s experience from one North Africa deal is “to buy one small operation, maybe bring in one or two management executives, maybe on the finance side, maybe on the IT side, maybe on the tech side, and grow the operations from 50,000 subscribers to 200,000 subscribers, at which point in time it becomes a critical mass interesting enough for companies such as Vodacom or MTN.”

For local players, private equity capital offers the chance for a growth-oriented business with a strong possibility for success to become a regional player. While TMT firms are not tip-toeing around owners, they are certainly not hesitant to indicate the points at which efficiency can be improved. According to Güney, “we actually know what they want to see in place before they do an acquisition. They are interested in making sure the numbers are clean, so that is an issue of corporate governance. There is also a critical mass of subscribers, which is extremely important, because dealing with small numbers is not very helpful.”

Instead of working with very small firms, he believes “it’s more effective once you have a critical mass to get discounts on scale in terms of ordering, etc. This area of investment is going to take a large chunk of the fund’s capital.”

For Millennium and other TMT fund managers, the time to act is now and as within the coming year or two the time for investment would have passed. Güney said that, “emerging markets are growing very fast and penetration levels are growing very, very fast. What’s happening now is that the penetration in most of the emerging markets in cities is already quite high.”

Fixed-line penetration in the Arab World

Restructuring infrastructure

“The infrastructure within mobiles is also another play,” according to Güney, especially for “people who are very conscious of the bottom line and they are trying to figure out ‘how can I squeeze more money’.”

Private equity firms are quite engaged in restructuring the way telecom infrastructure is operated, from changing management and personnel, to specializing in pure telecom by selling off infrastructure to be run by separate entities with more experience and better efficiency.

“Some operators want to just sell a service, sell a phone, one can squeeze some money on the marketing side, maybe some on the acquisition cost, but maybe you should not own the tower” advises Güney, because “the tower is just a building that somebody else could actually run for you much more efficiently. You could lease the space, etc. That would make a lot more sense and that squeezes the costs, so it creates more free cash flow, which is what everybody is moving towards. So infrastructure to us is extremely important.”

Güney believes private equity is best to revamp telecom infrastructure because “they don’t personally have any affinity or love in keeping a tower, for example, in the mobile business. They only look very rationally at where it makes most sense in owning that tower and what the costs associated to it are.”

For telecom operators in love with their towers and network, the idea of de-merging infrastructure from operation is anathema, especially to someone who spent their whole life in telecoms and understanding the sector partly through the physical representations of its infrastructure. Pointing to Western Europe, he shows evidence of people taking issue with demerging their businesses, “but if you go to India, Indian operators are much smarter and they understand exactly where the cost-benefit will be. And they have decided, Reliance, Bharti, Vodafone, and Idea Cellular have all decided that owning a tower doesn’t make sense. Pooling and sharing makes more sense. Let somebody else run that specific area with a specific knowledge while you can concentrate on marketing your services.”

Through demerging and redistributing industry functions, private equity might be able to increase efficiency through investments in telecom’s down-market industries, including logistics and supply-chain management. Rami Bazzi, principal of private equity at Injazat Capital, believes “Telcoms are offering products for which they need support. They need to focus on coming up with the right product, the right service and make sure that they do it right, that they do it profitably. However, they need support on the operational and business side and it is very challenging to get all the support they need built in-house.”

Fixed-line subscriber base in the Arab World

Thumbnail of the telecom sector in KSA

To which telecom markets should private equity move?

According to Millennium’s Güney, there is a “big swath in the middle” of the African continent “where you do have some of the large operators that have a presence there, but not in all the countries. And what you’re hoping for is that area of Africa will grow over time, just like every other emerging market will grow and has grown so far.”

In addition to Africa, South Asia remains a particularly attractive market for private equity capital in telecom operations. In Pakistan and India, particularly, there are a number of fixed mobile operators, while penetration rates remain low. However, the challenges to increasing penetration rates from simple due diligence techniques are not the only consideration.

Because of the nature of the market and its lack of development, “even if you have been able to get a license, maybe there is still not enough frequency available because there are so many operators,” according to Güney. He believes, then, in the “physical restrictions in the ability to have additional players. But other countries exist in Asia where you might have only two operators or three operators and judging from your macroeconomic study of that country, you might have a growth there.”

March 21, 2008 0 comments

Private Equity Special Report

Private equity spotlight: Saudi Arabia

by Executive Staff March 21, 2008

written by Executive Staff

With a geographic size that dwarfs its neighbors in the Gulf in particular, and the Middle East in general, Saudi Arabia is in the sights of private equity firms who are looking to the kingdom as a potentially excellent market.

With new plans sprouting up to develop the country’s infrastructure, particularly in the transport and communication sectors, as well as down-market industries in the supply chain of goods and services, Saudi Arabia is a slow giant ripe for the introduction of management efficiency.

A slow relaxation of regulations on private equity firms is just one of a series of measures — along with building the social infrastructure of education and healthcare — where the kingdom is thoughtfully giving a thumbs-up to private equity groups looking to enter the market. This is done through obvious contacts with regulatory and other government authorities, but also with the country’s major family firms.

Having spent over a decade in the kingdom, Richard Dallas, managing director of private equity at Gulf Capital, has noticed the difference between the Saudi market and those of its neighboring economies.

Dallas believes that both the UAE and Bahrain “have been leaders in creating regulatory and economic environments that have been inviting and welcoming to foreign investment, particularly the development of the banking and financial services sector.”

Because Saudi Arabia is the biggest market in the Gulf Cooperation Council (GCC) and its economic powerhouse, the economy is “slower, more deliberate and has a regulatory scheme that is changing on a more deliberate basis.”

But the kingdom has already made significant changes. Fadi Arbid, executive vice president for Amwal Al-Khaleej, pointed out that the Saudi government shifted from its traditional policy to spend 60-70% of GDP on defense and infrastructure to the new plan whereby more than 50% of the GDP is being spent on education and healthcare. To prepare the country for an era of declining demand for oil and the possible price drops associated with it.

Wadah Al-Taha, head of strategies at Emaar Financial Services, explained that Saudi regulators “have to set criteria, they have to be careful, then they have to make a move,” attributing the caution to the relative size of the country and the potential for grave errors from a regulatory or economic misstep.

Establishing a castle in the kingdom

Culturally, however, entry into the Saudi market is a new frontier for private equity firms. They must understand how to navigate policies by deciphering them. Firms seeking entry into the Saudi market are also best served by a synergetic partnership with families in the kingdom.

The largest families are mainly sought out for their networking potential and relationships with them are cultivated through a mixture of attracting them to a specific private equity firm as an individual investor or as the owner of a company in which a private equity firm owns a minority stake.

Deliberate, careful motions are not only the way Saudi authorities move but also how new firms proceed as they seek to gain entry into the country. By doing one successful deal with a Saudi firm, a new private equity firm might establish a relationship that generates more deal flow than previously imagined.

Shailesh Dash, senior vice president of alternative investments at Global Investment House, explained that “family-owned businesses in the MENA region are often diversified across vertical and horizontal lines of their supply chain and, accordingly, many family-owned businesses also engage in activities that are unrelated to their primary business. As ownership and control of these family-owned businesses move into future generations, the need to capitalize assets often becomes important, as some of the successors may want to pursue independent interests or liquidate their interest in the business.”

There is a need for liquidity and a “formal capital structure in an increasingly competitive free-market economic environment, which will result in significant merger, acquisition and divestiture activity. We have capitalized on these opportunities and many times have been invited by various families to corporatize them and grow their businesses beyond their countries boundaries and helping these businesses in acquiring economies of scale.”

The help Global Investment House provides to firms comes in several varieties, including “providing liquidity to the family group as a buyer of the group’s non-core businesses or as an investor in the group’s core business, providing suitable exit opportunities by identifying regional or international partners, valuing the business and assisting in various divestment activities to create value for the shareholders of such business, and providing a framework for target identification, target screening and transaction execution to assist in making strategic acquisitions for a family group’s core business.”

KSA public equity issuance ($ million)

According to Richard Dallas, managing director of private equity at Gulf Capital, “they are very guarded and careful about making sure they do everything in an organized fashion, so that they understand the consequences of what they do as much as they can.”

The reasons for this lie not only in the special role played by Saudi authorities as the guardians of the two holiest Muslim sites and the hosts of the hajj. Although these are important factors in a majority-Muslim region such as MENA, and for the significant Muslim populations of South and Southeast Asia, the internal population dynamics are putting pressure on the Saudi state to consider the future of a people whose riches and nobility are to a large part maintained through their natural resources, or down market-related industries. Dallas said, for the authorities “job creation is very, very important. For a long time they have been very focused on providing opportunities to their younger people, so I wouldn’t say they are slower or more resistant to change. I would just say they are more deliberate in what they do. Because if they don’t, quite candidly, they would make a major misstep and I think that this deliberateness will ultimately serve them very well.”

Every major private equity firm gives due consideration to Saudi Arabia. If they do not already have businesses in the country or at least relationships through investors in their firms, regional and global private equity managers are assembling their teams to penetrate this new market. Rasmala Investment Holdings is just one private equity group that received a green light from the Saudi Capital Markets Authority to expand its service in the kingdom.

In addition to its private equity business, Rasmala will be able to operate its mergers and acquisitions and IPO advisory arms. When the group appointed Hamad Mubarak al-Huthaili as the general manager of Rasmala Saudi Arabia, the company’s CEO said that “Saudi Arabia is the largest and most important capital market.”

This appointment hints at the importance of the country’s relationship-driven business culture as al-Huthaili had previously worked for four years at the Saudi Monetary Agency, in addition to other firms in the Saudi financial sector. His experience is likely to provide Rasmala with the sort of inside deal generation necessary to sustain business with key contacts in the kingdom.

A. Shabu Qureshi, director of EMP Global, related his firm’s investment in SIPCHEM, a Saudi diversified petrochemical company. Explaining the market dynamics of the Saudi regulators, he pointed out that “what the Saudi government has done is to allow ARAMCO to controlling the upstream industry, but then to get the private sector involved in downstream investment.”

At the time of the investment, three years ago, EMP took a 23% stake in the company, which then “executed its business plan well, and was able to go for an IPO quickly. It was a very good growth story and a sort of poster child in Saudi Arabia for what the government has been able to achieve by encouraging some degree of privatization, and how some of the dynamic family groups there, in this case the al-Zamil family, have been able to take advantage of this.”

However, Qureshi admitted that “it is a bit of a challenge to penetrate the Saudi market.” He attributes success in Saudi Arabia to the fact that EMP has a “good network of people in Saudi Arabia and we know the government as well as the industrial groups. Also, the Saudi pension funds, including the PIF and the PPA have invested with us, and they have been a very big help to us.”

In addition to EMP’s investment and exit of SIPCHEM, the firm also invested in APPC, a Saudi single purpose petrochemical company manufacturing polypropylene. “It was a greenfield investment where we went in very early and just worked with the company by sitting on the board of directors. The company recently achieved an IPO and is about to begin production. Under the radar, Saudi Arabia has achieved a fair amount of macroeconomic liberalization. And then firms like EMP Global are able to help that along and take advantage of what the government has done.”

Knighthood

Having an institutional backer during its start of operations aimed at the Saudi market was important for EMP, which had the backing of the Jeddah-based Islamic Development Bank, where, according to Qureshi, the firm “had some friends we could rely on for support in the region. The IDB is important for the region as a leading multilateral institution, and we also had the support of two of the Saudi government pension funds.”

In addition to the Saudi pension funds and IDB, EMP “had some prior relationships and our local executives were very familiar with the market and the industrial groups. We don’t go in and punch over our weight. That has over time allowed us to have good relationships. We tend to look at each investment by itself and to add our best professional advice, and not to favor one family group over another. We also look to bring our international relationships to the table if they can be of use to our portfolio companies.”

The bridging of Western models and what some observers affectionately call ‘Bedouin math’ is taking root in the kingdom. Qureshi thinks that “as Western banks and investment banks establish themselves in Saudi Arabia, both parties will benefit. The Western banks will get more familiar with the Saudi market, and that will benefit the Saudi partners and families who will get better access to Western financial technology. Having people on the ground with Western technical skills and knowing how the region does business is helpful for both sides.”

Abe Saad, head of private equity at Rasmala, believes that, “the kingdom is one of the largest markets in the GCC. It hasn’t been treated as it should be on the private equity side, though.

Composition of total estimated value of projects in KSA. Total value $665.42 billion

March 21, 2008 0 comments