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Monday, 23 February 2009

Gap is closing between retail and institutional fund selection (Registration required)

Leading fund selectors are increasingly using the same techniques and facing the same issues regardless of whether they are picking investments for institutions or a retail client base, says Cyrille Urfer of the Abu Dhabi sovereign wealth fund.

Europe's most sophisticated fund selectors have long regarded the big US endowments, such as Harvard and Yale, as the cutting edge of investment selection and Urfer sees increasing convergence between the approaches of all leading fund buyers.

‘At the end of the day, the needs and the objectives of these different groups of investors are not that different,’ points out Urfer, the former head of selection at LODH in Geneva who is now CIO of equities and fixed income at the Abu Dhabi Investment Council.

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One emirate for all, none for one

Fears over Dubai’s ability to service its debts led Abu Dhabi finally to stage a marked response at the weekend. In a ‘lender of last resort’-type move the emirate bought $10bn of Dubai bonds to help its neighbour raise funds.

As Bloomberg reports, the market responded very positively to the action:

Feb. 23 (Bloomberg) — Dubai shares jumped as the United Arab Emirates’ central bank bought $10 billion worth of bonds issued by Dubai after the emirate struggled to raise funds amid a global credit squeeze that ended its real-estate boom. Emaar Properties PJSC, the U.A.E’s biggest real-estate developer, climbed the most in more than a month. Dubai Islamic Bank PJSC rose for the first time this week and Dubai Financial Market PJSC also advanced. The U.A.E. central bank bought half of an unsecured, $20 billion, 5-year notes issue at an annual interest rate of 4 percent.

Iranian investment rule change is overdue (Registration required)

Iran is an unattractive destination for foreigner investors for reasons other than US-led sanctions.

In September, the World Bank rated Iran as the worst country in the Middle East and North Africa for foreign investors.

Over the next few months, the Iranian authorities will probably take a small step towards improving the position of investors, by scrapping capital controls that force foreign investors in companies listed on the Tehran Stock Exchange to lock in their capital for the first three years.

MENA Sukuk Report - February 2009

"In continuation of Global Investment House coverage of capital market, we have come out with MENA Sukuk Report to provide you with the insight on the developments in the sukuk market, performance and outlook.

The year 2008 witnessed a decline in the amount of sukuk issuance, after years of massive growth. The amount raised from issuance decreased by 54.5% in 2008 to US$15.1bn, as compared to US$33.1bn in 2007. Despite that, the number of sukuk issues increased from 129 in 2007 to reach 165 in 2008.

The decline in sukuk issuance is due to the credit crunch that forced investors to step aside from the fixed income market, including the Islamic one. As evident of the credit crunch effect on sukuks, issuances in the fourth quarter of 2008 were weak when compared with other quarters in the same year. In the first three quarters of last year, the number of sukuk issuances was 139 raising US$14.3bn, averaging US$4.8bn per quarter. On the other hand, the number of sukuk issuance in the fourth quarter of 2008 was 26, raising US$0.8bn.

In order to view the full report, kindly click on the headline."

How Are GCC (and Other) Sovereign Funds Faring? An Update (Registration required)

Recently, Reuters reported that the assets under management of Kuwait’s sovereign wealth fund fell to 49 billion Kuwait Dinar ($177.6 billion) at the end of December from 58 billion Kuwait Dinar ($218 billion) in March 2008. – a face value decline of about $31 billion. Given that Kuwait had record oil revenues in 2008 (and a record fiscal surplus even if revenues tailed off in the second half) and KIA likely received record new capital, this implies that investment losses were even larger. It is significant for two reasons. One it shows that the estimates of fund performance (including those released in a recent paper by Brad Setser and myself) are on track and two, it could suggest that within limits there may be increasing amounts of transparency among sovereign investors. It also will provide an interesting test case of how the population and opposition react to the losses on the national wealth.

Unlike funds of its neighbors, Kuwait’s fund has to routinely report to its parliament and at such times information on its assets usually is released to the press. Doing so increases the robustness of estimates of their performance and may also open up channels to domestic pressure concerning how the national wealth is being managed. Domestic politics has influenced decisions in the past - Kuwait Petroleum’s deal with Dow Chemical was reportedly withdrawn under political pressure. So it will be a case to watch, as will the funds of Singapore which have also noted investment losses in response to legislative questioning.

The numbers seem to refer to Kuwait’s future generations fund, the larger of the two pools of money managed by KIA. The other, the General Reserve Fund, is smaller, perhaps around $40 billion. It is on the one hand more liquid as its name suggests but also holds the countries holdings in domestic equity and property markets. KIA itself though was also authorized to invest in the domestic equity market to prop up prices.

Record outflows might signal bottom

Outflows from Europe’s beleaguered fund industry hit a record high in the fourth quarter of 2008 as resurgent market volatility in the wake of the Lehman Brothers collapse saw investors accelerate their rush for the exits. (PDF page 1, PDF page 2, PDF page 3)

However, there are tentative signs that the worst may be over with tumbling deposit account rates leading wealthier investors, in particular, to look afresh at corporate bond and equity income funds.

Across the continent, flows into equity funds turned positive in November and December, while in some markets, such as the UK, flows into bond funds were positive for the fourth quarter in aggregate.

Hedge funds march towards Ucits

Large hedge fund groups are expanding aggressively into the regulated fund arena in order to attract new money as investors continue to bail out of the tarnished hedge fund sector.

Brevan Howard, Europe’s largest hedge fund manager with $25bn (£17.5bn, €19.8bn) under management, will today unveil the launch of its first onshore, regulated Ucits III fund, a structure that embeds higher standards of investor protection, liquidity and transparency than lightly regulated hedge funds.

The move comes as figures show GLG Partners and Odey Asset Management, two houses that have already taken the plunge, attracted strong inflows into their Ucits ranges in the fourth quarter of 2008 even as both the mutual fund and hedge fund industries haemorrhaged cash.

The injustice of Russian justice

Russian justice was put in the dock in the trial of the alleged killers of Anna Politkovskaya. And Russian justice was found wanting.

Three men accused of involvement in the campaigning journalist’s 2006 murder in Moscow were acquitted last week in a case marred by signs of official negligence and obstruction.

Two were Chechen brothers who allegedly spied on Politkovskaya. A third brother, the alleged killer, was absent and is believed to be on the run. The third man on trial was a former policeman, accused of organising the three brothers.

Quo vaditis, raters?

Ours is an era of unmasking: many a former emperor is now seen to be naked. The same fate has befallen the big three credit rating agencies, whose deeply flawed ratings were exposed when the US housing bubble burst. We cannot live with their current practices, but nor can we live without them; their function – assessing the risk of securities – is indispensable. Reform is essential.

Ratings agencies are paid by issuers of securities and not by those who invest in them. They have traded their independence to chase the lucrative business of rating asset-backed securities which came to market in the last decade. Moody’s earnings rose so high, for example, that its profit margin beat that of all other S&P 500 companies.

It is easy to blame investors for blindly trusting the agencies; many let greed or naivety get the better of them. But even the most circumspect could not have avoided the big three. US law enshrines these state-sanctioned oligopolists’ status as “nationally recognised statistical rating organisations”. Various other rules, such as the Basel II framework, refer to ratings to define capital adequacy or the type of securities investment funds may hold.

Fears rise over Russia’s foreign debt

Western bankers are increasingly anxious about Russian companies’ ability to repay $500bn in foreign corporate debt after the government said this month it was suspending a $50bn bail-out programme as reserves dwindle.

Bankers are queuing up to meet government officials in a scramble for clarity after Igor Shuvalov, first deputy prime minister, said during a closed-door briefing this month that Russia was going to switch focus from bailing out tycoons to supporting the banking system. “The issue is how much state support will the government provide,” said one international banker involved in talks.

The policy shift has sparked a high-stakes poker game between foreign lenders, the Russian government and the country’s oligarchs as some bankers angle for state guarantees in order to go ahead with restructuring deals, while the government resists as it runs out of funds. In the middle are the oligarchs who, in order to survive, must win restructuring deals on more than $130bn of debt due this year.

Lack of funds hits IMF in east Europe

The global response to the financial crisis in eastern Europe has been hamstrung because the International Monetary Fund is too small, former officials say.

Amid strains in emerging markets across the world and calls for the European Union to take the lead in rescuing countries such as Latvia, Hungary and Romania from collapsing banking systems and currency crises, the IMF has been scrambling to increase its firepower.

Simon Johnson, a former IMF chief economist at the Massachusetts Institute of Technology, said: “We are seeing the consequences of the lack of IMF resources. Programmes are probably undersized because the IMF is worried about running out of money.”

Emaar falls 10%

Emaar, the Gulf’s largest listed property developer, yesterday lost almost 10 per cent of its market value as investors reacted to the news that its US unit, John Laing Homes, is seeking Chapter 11 bankruptcy protection.

Emaar has taken impairment charges and write-downs for goodwill of about Dh4 billion (US$1.08bn) since it bought the US home builder for $1.05bn in June 2006. But dealers said it was still unclear whether some of the debts held by John Laing Homes could further weaken Emaar, whose share price has dropped by 85 per cent in the past 12 months.

“There are questions that need to be answered right now,” said Yazan Abdeen, a funds manager at ING Management. “Investors are wondering about the financial obligations that Emaar may have towards its US unit... Who will pay its debt?”
Although Emaar may strike a compromise deal over how much of John Laing Homes’s debt it would have to shoulder, nothing has yet been agreed. “It may be immaterial, or it may be material, the bottom line is nobody knows,” Mr Abdeen said.

New body to tackle financial crimes

A newly created special body will prosecute cases of bribery, money laundering, abuse of power, embezzlement and the misuse of funds in the capital city.

Finance Public Prosecution will specialise in financial crimes in public and semipublic organisations.

“The new body is specialised in investigating financial crimes and referring those cases to relevant courts in accordance with the laws concerning public fund-related crimes, such as breaches of trust and abuse of public office,” Yousef al Ibri, the Abu Dhabi attorney general, said in a statement.

Strong financial position to help UAE steer clear of recession

The collapse in oil prices will ally with lower crude output to depress the UAE economy and revenues but its strong financial position will prevent the country from sliding into a recession, a key Saudi bank said yesterday.

After making big leaps in the past few years, the UAE's gross domestic product is expected to contract in nominal terms and grow by less than one per cent in real terms, the Saudi American Bank (Samba) Group said in a 22-page research.

Its fiscal situation will also be a victim of lower crude prices and production but the balance is expected to remain in surplus and could only revert to a deficit if oil prices dip below $40 through the year, Samba said.

How Worried Should We Be About Dubai? Update: Is the Bailout Underway? (Registration required.Complete article below)

note: this piece was primarily written Feb 18 but I have appended an update which describes the Dubai's February 22 capital raising - $10 billion in 5 year bonds purchased by the UAE central bank (the first tranche of a total of $20 billion to be raised) - and suggesting implications of the purchases. This is the most significant step that Federal authorities have taken to support Dubai and avoid the default of its institutions, which could have negative effects on Abu Dhabi, the rest of the UAE and the GCC as a whole.

In recent weeks CDS spreads on the debt of Dubai’s largest State-linked vehicles like Dubai Holding etc shot up dramatically after Abu Dhabi announced a unilateral recapitalization of its banks. The cost to buy protection on the 1 year bond has doubled since late January and now stands at 1073bps. The jump in the 5 yr has been less sharp but stands at over 1400bps. Since Dubai has limited sovereign debt (about $10 billion and may be climbing given the likely fiscal deficit) these large state-linked companies provide a proxy for the perceived credit worthiness of Dubai’s government. Ie people are worried about Dubai's ability to support its banks, its property sector in the fact of the most severe global recession and the first real test of the Dubai model (economic diversification from hydrocarbons towards services) Given Dubai’s debt stock ($80b or 148% of GDP, see Moodys recent research for a breakdown), its vulnerability to global liquidity and the worsening outlook for its domestic property market (despite the ability to control supply), it is perhaps not a surprise that the outlook for the emirate seems much more precarious, particularly in contrast to its cash rich neighbour, Abu Dhabi. Given the links of Dubai's debtors to the government, and the effect that their vulnerabilities could have on the UAE federation, it has widely been assumed that the UAE govt (or rather Abu Dhabi) would come to the aid of Dubai when the crunch came. However, there has been more uncertainty than some expected. Key tests are ahead in coming months as Dubai adjusts to a world where leverage remains scarce. Around $20 billion of the outstanding debt ($80 billion) comes due in 2009, including several large syndications like that of Borse Dubai which was having trouble rolling over its $4b loan that expired at the end of February. Breaking views notes that the $4b capital needed is a test case as allowing the institution to implode would have broader reverberations. It now seems that the UAE federal government might be coming to the rescue. Meed suggests that it will loan Borse dubai $1b to make up the shortfall from private investments. So far (feb 17) Borse Dubai only managed to secure $1.25 billion of commitments from commercial banks, although some further commitments from banks could bring the final bank tranche to $1.5 billion. Even the capital that Dubai attracts will come at a higher cost. Borse Dubai might have to pay 430bps above Libor rather than the 130bps the maturing loan carried.

Unlike some of its neighbours (especially Abu Dhabi) Dubai’s growth was primarily debt financed, making it more vulnerable to the global liquidity crunch and more local liquidity tightening triggered first by the withdrawal of speculative capital and – later by the fall in the oil price. Although Dubai has little oil, it was clearly a petrodollar recycling hub. It accounted for much of the UAE’s external debt stock (some of Abu Dhabi’s state investors accounted for the rest ). Dubai based banks likely also absorbed most of the bank lending to the UAE. Moodys vulnerability indicators show that the UAE is among the most vulnerable in the MENA region (if much less vulnerable that Eastern European countries that are being forced to rapidly and painfully adjust).

Data from the BIS (see chart below) show that loans extended to the UAE first tapered off and then fell in Q2 and Q3 of 2008 (the most recent data) This is consistent with the outflows of short-term capital once dirham revaluation was taken off the table that contributed to a local credit crunch as well as the the escalation of credit crunch on a global scale and a reluctance to lend to the Gulf as the oil price began to fall. Of remaining loans, UK banks are most exposed. Looking at shifts in the UAE’s central bank reserves details the scale of this flows. The UAE’s reserves doubled to almost $100 billion but have subsequently fallen to $44 billion at the end of Q3 (most recent data). No wonder the project finance costs and domestic interbank rates shot up.

Liabilities of BIS banks to UAE
The following gives an outlook of how net flows of funds (deposits abroad - loans) of the UAE compare to the rest of the GCC. the UAE has consistently borrowed more from foreign banks than it has borrowed abroad for the last 18 months. Despite the drop in loans extended to the UAE, it continued to be a net borrower from the international banking system - unlike for example Saudi Arabia or Kuwait.

Dubai is experiencing a property bust. Prices and volumes have been falling for some time and even efforts to control the supply (by merging and providing capital to the main mortgage lenders or pulling back on projects have had limited effect.) The secondary market in particular has dried up. Meanwhile with a number of foreigners losing their jobs will be another blow to consumption and property markets. It has been widely assumed that oil-rich Abu Dhabi would come to Dubai’s aid in one way or another, providing the needed capital and solidifying Abu Dhabi’s role within the power structure of the UAE. It seemed likely that federal institutions were taking the upper hand – including the central bank. In fact the first UAE government responses to the financial strains on UAE banks seemed to be evidence enough. But the next stage has been less unclear.

Moreover the structure of some of the liquidity provided including the temporary ‘repo window’ still created disincentives for banks to take advantage of the funds – likely because authorities wanted to force regulatory changes to stem the significant credit growth. While most UAE banks received long-term deposits back in the fall from the central bank, they remain undercapitalized given the loss of whole sale financing and the fact that the property bust is undermining the quality of underlying assets – property, credit card debt etc. Standard chartered suggests that UAE banks need an additional $27 billion to be adequately capitalized. Other institutions like a permanent repo window and other tools to control the money supply are also needed. These capital needs persist despite Abu Dhabi’s injections to its banks, however, the support of the emirate’s government does add to the stability of financial institutions there and reduce the risk of systemic risk. Abu Dhabi provided capital injections to five banks operating in the emirate in the form of 5 year deposits. Yet allowing a default of a major state-linked banks could have broader reverberations in the region.

Why hasn’t Abu Dhabi made more funds available to Dubai given that the uncertainty undermines UAE asset quality and the “UAE brand”? One explanation might be politics between the emirates. Reportedly Dubai has not actually asked for funds, perhaps fearing a loss of autonomy. However, doing so within the federal structure would be less politically tricky even if the ultimate source of the funds would be Abu Dhabi. However, even Abu Dhabi’s stock of liquid assets might not be quite as high as it might like. In a recent paper, Brad Setser and I argue that the funds of the Abu Dhabi Investment Authority (ADIA) may never have been as large as some observers thought (we peg its peak at close to $480b early in 2008 and suggest it may have suffered valuation losses that took its AUM down as low as $300b (see this post for more recent calculations that suggest the GCC's foreign assets fell to $1.16 trillion by the end of January from $1.19 trillion in December - and if February ends anywhere near Friday's close, a similar $30 billion loss is likely). The calculations are based on an index based portfolio so we might be a bit off. However, given that liquidity is at a shortage and Abu Dhabi may also run a fiscal deficit, it may prefer to preserve its capital for investments prioritized for domestic development.

Yet it is not in Abu Dhabi's interest to let too large a gap in credit worthiness emerge with Dubai particularly as its banks and institutions are exposed to Dubai’s property markets. Furthermore there are risks to the property markets and financial institutions throughout the region even if most countries are more insulated. Abu Dhabi may prefer to avoid such a bust. But as Moody’s notes, the corporate sectors of the GCC have not been tested in this way in the past and do face significant financing needs.

Broader cost cutting is going on in Dubai including several mergers in the property sector and job reductions. Dubai International Capital and Dubai Group, investment focused entities belonging to Sheikh Mohammed plan a quasi merger. This seems to make sense and may reduce overcapacities. In fact these two entities always seemed to be encroaching on each others turf (investment in financials, private equity holdings etc) in a UAE that was serving as a laboratory for investment abroad, though recently Dubai group was reportedly branching into Islamic finance. Furthermore like others relying on leverage their business model has come under challenge. The sharing of back office support may be the first step to a re-merger. Needless to say, any funds and projects overly reliant on leverage should continue to be very quiet (the QIA might be one exception)

The combination of much more subdued credit growth, reduction in oil production and reduction in non-oil trade and services will keep the UAE’s growth weak in 2009. The country’s non-oil diversification has exposed it to sectors that are faltering globally (shipping, tourism, property, finance). Government support and the fact that many sectors are centralized can cushion the blow somewhat – fiscal policy is expected to be expansionary, the budgets of the UAE federal government (which spends mostly in the smaller five emirates) and Dubai show expenditure growth in 2009. Abu Dhabi will likely do so also though its budget has not been disclosed. Yet there is a broader question where will the funds come from or what price will be charged to get there. Yet given the direct linkages between the UAE’s borrowers and the national and sub-national governments, funds should be forthcoming even if they are pricey and become more so with oil at $35 a barrel.

UPDATE: As suggested above, Federal funds have been made available for Dubai at relatively affordable terms fixed 4% rate for five years with the central bank of the UAE subscribing in full to the first $10 billion tranche of the capital raising. While structured as a bond issue, this does seem to be in practice a loan and one backstopped by Abu Dhabi, through the federal structure. It might thus strengthen the federal structure which has been relatively loose. It remains to be seen what changes may come within the structure of the country and its economic institutions. These funds will not only allow Dubai's government-backed investors to meet their debt payments, but also to carry out spending plans. Given that private funds will be less available it will be government backed investment which has a more significant role in supporting growth for the rest of this year and even into 2010. As noted above Dubai plans to increase spending about 20% even as revenues are expected to fall, leading to a significant deficit.

Similarly Borse Dubai also turned inward in its search for capital in the face of unfriendly international capital markets. It received about $1 billion from Dubai authorities, and its parent, ICD which itself raised $6 billion last year, funneled money through dubai banks to make up half of the bond issue that international banks were reluctant to fund. In total, ICD provided as much as $2.3 billion of the funds Borse needed. Unlike Eastern Europe, Dubai can tap some of the latent or not so latent resources at home. This should ease some of the cost of protection on Dubai's debt, but may raise other questions about the availability of capital in the UAE especially now that the needs of liquid assets are so great.The UAE central bank had under $45 billion in foreign exchange reserves at the end of September (the most recent data), a fall of about half from the peak in March 2008, the height of speculative inflows. Central bank reserves may well be lower than $45 billion now given the continued outflows. The Central bank has subsequently provided both dinar and dollar liquidity to conventional and islamic banks. While a range of federal and Abu Dhabi institutions likely have some liquidity, the needs are mounting within the UAE.

Perhaps its wishful thinking to hope that we might see more transparency regarding some of the Gulf's pools of capital to emerge out of this heightened crisis. But releasing some more frequent information from the UAE's central bank (which releases figures on reserves et al) with about a six month lag) or new information on other pools of capital might assuage capital concerns.

Dubai to take up $10bn UAE loan

The United Arab Emirates is to lend Dubai $10bn to ease the emirate’s debt repayment schedule in an effort to rescue the struggling economy, officials say.

The UAE central bank subscribed to half of a $20bn five year bond programme launched by the Dubai government. The unsecured paper yields a 4 per cent dividend. “This program will secure the necessary funding for Dubai to meet its financial obligations and continue its development program,” the Dubai government said on Sunday.

Federal backing is designed to help restore confidence in the Dubai economy, the foundations of which are based on real estate, tourism and trade, making it particularly exposed to the global credit crunch.