July 2011

INSTITUTIONAL INVESTORS: All funds are different, except when they’re not

EggsAs the Gulf funds industry evolves, research is helping categorise different client types to help investment managers develop their strategies. Nick Fitzpatrick looks at the latest findings about how to approach corporate and sovereign funds.

Target returns are high and time horizons are short for many corporate and family-office investors in the Gulf, with some looking for 14% on their investments.

Research released recently by Invesco Middle East found that the target investment returns of corporates – which are defined as diversified family groups operating across multiple sectors – are calculated with reference to the current and projected returns of their own businesses.

Personal wealth held by families can often merge with their businesses too, but Invesco – in its second Invesco Middle East Asset Management Study – found there is a trend towards better governance structures.

Meanwhile, family offices also have return-expectations linked to business investment returns, but advisers say that individuals are willing to accept below-corporate returns in return for greater security or diversification.

Invesco’s research suggests that asset managers could treat corporate investors and family offices acting for high net worth investors as similar client types. Their share of the mutual and hedge funds market is similar. Together they occupy half of that market, with the other half made up of retail, expatriate investors and certain other institutions (but excluding sovereign funds).

Yet despite the fact that corporates and family offices are likely to remain important to the local asset management industry, their preference is to make direct investments in tangible assets.

Invesco, which is headed in the Middle East by Nick Tolchard, found that corporate assets are almost exclusively concentrated in property, shares, private equity and cash, while more than 15% of family office investment is allocated to a combination of commodities, bonds and hedge funds.

Tolchard tells Funds Global: “The corporate and ultra-high net worth investors that invest via family offices represent a lower contestability to asset managers than their share of assets suggests as they prefer direct and higher returning assets.

“However, this is still an important opportunity for fund managers relative to the mass affluent market.”

He adds that the funds industry needs to make sure its products appeal to the right segment.

Property never dies
The short time horizons are a manifestation of many Gulf Co-operation Council (GCC) investors’ demand for control and transparency – except for sovereign wealth funds (SWFs), whose time horizons are longer.

Related to time horizons appears to be a preference for tangible assets and direct investments. Eighty-seven per cent of GCC investors and their advisers in the Invesco survey agreed that GCC investors had a particularly high exposure to tangible
assets and more than one-third said this was a cultural preference.

“Property gets sick but never dies” was an Arabic phrase used to support this notion. Gulf investors had a 14.8% exposure to the asset class; for expats it was 9.5% and sovereigns, 7.5%.

Many prefer direct access rather than through fund structures. Some reasons for this may be market timing and a lack of fund manager three-year track records prior to the financial crisis.

Tolchard, who points out that there is a huge home-market bias, says: “The local securities markets are very narrow and have limited capacity to absorb the capital surpluses generated within the region available for investment. Historically, the local markets also move in line with the oil price so tangible assets which are often less volatile have been seen as safer local assets.”

However, although private equity has also been a staple investment in the Middle East and North Africa (Mena) region along with property, other research suggests that geopolitical volatility is challenging the private equity industry there. Geopolitical problems and a lack of exit opportunities were viewed by respondents to a survey by Terrapin – the organiser of Private Equity World Mena conference – as two of the greatest challenges currently facing the Mena private equity industry.

Nevertheless, the survey still found that more than 75% of respondents felt that Mena investors would either increase or maintain their allocations to private equity within Mena and global markets in 2011 – though around 17% thought investors would decrease private equity investment in the region.

Dissatisfaction with private equity firms was also found; 35% said they were unsatisfied with their general partners.

The survey was mainly of private equity and venture capital companies, but also included sovereign wealth funds, private banks, and consultants.

Inflection point
Geopolitical problems were also found to be behind the short time horizons of the Gulf investors in the Invesco survey, although there was also a diversity of other responses, including investor inexperience and the level of market maturity.

The average GCC investor time horizon in the Invesco survey was 2.2 years, which compares to 5.1 years for the expatriate market and 6.7 years for sovereign investors such as SWFs, or state pension funds.

It is the second year running that Invesco has produced the research and it appears to confirm that short time horizons are a feature of the Gulf investment landscape.

“There is a significant reality gap for GCC investors,” says Tolchard. “But we think the market could be at an inflection point and people will have a longer-term attitude next year. This is because they are seeing the unrest in the region and realising that they have to be more internationally diversified with their investments.”

SWF categories
The Invesco research also tries to fathom how asset managers should approach the SWF industry and the firm has found that these types of funds that are based in the Gulf have a broad range of investment preferences making it hard to categorise them.

The fact that they are exclusively driven by state investment objectives – as opposed to pension funds, which are guided by liabilities or pure investment returns – does not make it easier to understand their needs; in fact, it adds to the complexity.

But Invesco believes it has found a way to categorise this select bunch of influential investors to make more sense of how investment managers should tackle them.

SWFs fall into one of four types. First, the “development agencies” that focus investments on local development projects; then there are the “policy supporters” that invest internationally to drive foreign or local policy; next are the “diversification vehicles” which again invest internationally but this time to diversify state wealth and preserve it for future generations; and finally the “asset managers” that, more similarly to some of the region’s pension funds, tend to focus just on risk-adjusted investment returns.

Invesco spoke to SWFs and other bodies associated with them, such as those in consortium investments, to draw up the profiles.

Although some SWFs may sit in between these profiles, the majority do fit into a single category. This means the framework helps to explain SWF investment behaviours without resorting to treating each as an individual entity.

The investment objectives inevitably define what type of investor they are. For example, while SWFs as a whole are long-term investors, “policy supporters” and “asset managers” will consider much shorter-term investments. As for risk, only “diversification vechicles” are low risk, conservative investors, contrary to the popular view that all Gulf SWFs have small risk appetites. “Asset managers” are the most aggressive with target returns of more than 8% and often in the double digits.

©2011 funds global

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