News Column

Year of the hedge fund? GCC investors hope so

June 16, 2014

Dubai likely to become a major player in a dynamic sector

With assets managed by hedge funds expected to grow beyond $3.3 trillion next year, Dubai may be set to become a player in this dynamic space.

The mixed performance of global markets from the start of 2014 has created numerous and varying opportunities for hedge fund investment managers. The uniquely nuanced landscape of capital markets forecast for the remainder of this year has led many key industry participants to surmise that 2014 will be the year of the hedge fund.

Indiscriminate gains throughout 2013 across global equity markets have heralded a phase shift as the world economy continues to strengthen. Consequently, we have seen expansions of institutional investor mandates into the alternative investment sector with particular growth in demand for hedge fund investments being recorded for 2014 to date. Driven by significant inflows, mostly stemming from 'smart money' allocations from institutional investors, hedge funds are forecast to grow at an accelerating pace to reach a record level of $3.3 trillion assets under management (AUM) next year according to Boston Consulting Group.

Institutional investors are forecast to reinforce their commitments to hedge funds with 57 per cent planning to grow their allocations in 2014 according to an in depth survey recently administered by Deutsche Bank. Institutional investors now account for approximately two thirds of industry assets, compared to approximately one third during the pre-crisis economy.

Equity long-short and risk-based strategies are the most sought after at present; 39 per cent of investors are now embracing a risk-adjusted approach to asset allocation, up from 25 per cent in 2013. Risk-based approaches allow for the effective removal of historical constraints on the allocation to absolute return strategies, allowing equity long-short managers to compete with long-only and fixed income absolute return funds within the overall risk budget.

In the post-recession climate, investors are increasingly discerning and are seeking the best managers for their capital. Many are steering flows into hedge funds that are uncorrelated to global benchmarks perceived as able to generate excess returns as other markets suffer downturns. Allocations from the UAE and wider Gulf region are expected to grow as savvy investors seek the best risk-adjusted returns the international marketplace has to offer.

Hedge funds have drawn capital from across the Gulf region as a result of a combination of interrelated factors. Within the UAE, the most notable contributing factor has been stellar equity market performance. Dubai's equity benchmark (DFMGI) has gained 31 per cent year-to-date and, according to research conducted by HSBC, the recent upgrade of the UAE to emerging market status by MSCI may attract $1 billion of inflows to the UAE stock market from foreign index trackers alone.

"We are expecting the upgrade of the UAE and Qatar to substantially improve foreign institutional fund flows and lead to increased participation from a sophisticated group of investors," said Elliot Carol, portfolio strategist at Dalma Capital. "These inflows are expected to bring additional benefits to the UAE by providing a more diverse base of liquidity sources, with additional funds allocated by a range of foreign retail and institutional investors."

On a broader scale, the UAE market performance is backed by the country's strong economic fundamentals GDP growth exceeded four per cent in 2013 and government infrastructure spending combined with low interest rates resulted in an elevation in domestic corporate earnings. "Despite robust economic fundamentals, investors should be wary that 60.3 per cent of the year-to-date returns of DFMGI are the result of multiple expansion, with only 39.7 per cent the result of actual earnings growth," said Ryan Mahoney, portfolio manager at Dalma Capital. "That means this year's bull run has been built more on increasing expectations for the future than increased earnings."

The financial services industry has grown rapidly in the Gulf region over the past five years and interest from investors is growing at an intensifying pace. The favourable climate in the Gulf region suggests that it is poised to further establish itself as a global financial centre as the year unfolds. Since its 2004 inception, the Dubai International Financial Centre (DIFC) has gone from strength to strength becoming a premier asset and wealth management hub in the Middle East. The number of registered firms operating within the DIFC increased by 14 per cent in 2013 and totalled 1,039 by the year-end.

Further inciting growth in the Gulf hedge fund industry will be proposed regulatory changes. As a key growth area for the region, the positive impact of the financial services industry to the wider economy is attracting increasing regulatory and government attention. The Dubai Financial Services Authority, regulatory body for the DIFC, has announced proposals to establish a new fund class specifically designed with the aim of attracting hedge funds into the region.

Overall we can expect to see a continuation of these trends with economic fundamentals and market conditions forecasted to strengthen in the GCC region and investors worldwide continuing to seek out hedge funds for their investment allocation.

The writer is a risk officer at Dalma Capital Management Limited, a DFSA regulated hedge fund manager in the DIFC.

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Source: Khaleej Times (United Arab Emirates)

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