assets

Let the Show Begin

Waiting for my youngest son (above) to participate in his first nativity play yesterday afternoon, I tried not to look at my Bloomberg app. Or think of the roller-coaster the financial markets could embark on if we were to get a surprise from the U.S. Federal Reserve later in the day.

When my son arrived in the gym hall, I could see his excitement with dad in the front row. I arrived early just to make sure I’d get a good seat (and parking). As the older kids and teachers started their introductions, etc. I could see my son’s excitement start to wane as he sat with his classmates waiting for the show to begin.

Bump up not lift-off

Just like the millions of professional investors who literally were sitting on their hands for most the day waiting for Janet Yellen and the Federal Open Market committee at the same time. Providing us their interest rate decision so we can move on with our day. Which makes me wonder, why they don’t hold the conference first thing in the morning and help reduce the anxiety on trading floors worldwide!? One of many humble suggestions I can give to central bankers if I were to get in a room with them.

So now we finally have the much-anticipated interest rate hike in the U.S. It’s not a major move. However it’s the potential of it becoming the beginning of the end of low-interest rate environment that has some economists and “fed watchers” all excited.

But what does it mean for most investors and business managers? Based on my crystal ball and the Economist in me (yes, I do have a degree in Economics), I don’t think we’re going to be out of the low-interest rate environment anytime soon.  The U.S. economy is not healthy enough to be able to sustain series of interest rate rises based on the data I’ve seen. Sure the U.S. jobless rate is the lowest it’s bee in seven years. We’ve seen relatively good performance out of the U.S. economy over the past few years. But the U.S. is not immune to the global economic slowdown and will have to tread very carefully to avoid falling into a recession.

But it doesn’t matter what I or you think about interest rates. It is what it is. It will be what it will be. Many investors and business managers spend too much time trying to figure out what will happen. And often times what ends up happening is what we least expected. We simply need to understand the possible scenarios, what impact these scenarios will have on our assets or earnings, and take steps to mitigate the impact of these potential scenarios. Or preferably how to benefit and improve the financial position under these various scenarios. Difficult but not impossible.

What it means to you?

As an equity investor I don’t see any significant impact from the interest rate hike on my portfolio. Since most of my companies have low debt and I’m defensively positioned. However if interest rates do start to increase steadily over the next year, the already fully valued equity markets in the U.S. could see major price declines.

For the struggling pensioners and savers relying on interest income, it’s too early to start rejoicing. The quarter basis point increase or 0.25% is nothing to cheer about just yet. Over the past almost decade savers have been punished with huge transfer of wealth from savers to debtors by means of a low-interest rate. They will not see improvement in their miserable investment income anytime soon.

Business managers need to become more prudent with their accounts receivable to ensure they get paid timely and proactively monitor their clients financial positions. Bad debt is often a silent killer on balance sheets.

Key is to seriously consider what are the implications of a series of interest rate hikes next year. That would significantly increase the cost of borrowing despite interest rates still being near historical lows.

As a business manager you need to be conscious of potential change in interest rate environment and the economic instability or recession it could trigger. Be extremely careful taking on debt and on the other hand if requiring financing to do it sooner rather than later.

An interesting fact is that credit markets have been tightening well before yesterday’s interest rate increase. Goldman Sachs tracks a financial conditions index which measures and incorporate factors such as stock prices, credit spreads, interest rates, and the exchange rates to determine the impact of the interest rate movements.

According to Goldman Sachs estimate, it says that every 1% rise in the federal funds rate shows up as 1.5%  increase in the index.  The index sits at the highest level it’s been in five years since September of this year. Borrowing costs for business could increase dramatically over the next few years if interest rates continue to rise.

Get ready for a quite a show

But at least the December interest rate hike is done and dusted. Investors are in for quite a show as market participants (primarily economists) will continue their obsessive discussions of how much and when interest rates will rise next year.

Smart equity investors will ignore them and carefully look at valuations and rotate out of momentum and high-beta shares in favour of value and distressed equity. Speaking of distressed equity, energy shares which have taken brunt of the tax-loss selling may finally stabilize. Successful investing over the long-term is always about quality assets and cash flow.

I don’t know if the Santa Claus rally will transpire over next few weeks. But either way Mr. Market can now get the show on the road.

Happy holidays everyone!

Saudi Arabia Welcomes Foreign Investors

Tadawul, Saudi Arabia’s stock exchange, opened up to foreign investors. The Tadawul is not only the largest stock market in the Middle East with a total market capitalization of over US$550 billion but is one of the largest of the emerging market exchanges.

Foreign investors interested to trade on the Tadawul must fi rst register with the Saudi Capital Market Authority (SCMA). At this time only the larger financial institutions with at least US$5 billion in assets and fi ve years of investment experience will be provided access. Even then, foreign investors will not be permitted to own or control more than 49% of any Tadawul-listed company.

So clearly, the SCMA is targeting established institutional investors for the Saudi market. This will help promote market stability and reduce volatility as the SCMA stated last month that it hopes to “…raise their performance by improving the level of transparency, financial information disclosure and governance practices”.

Saudi Arabia’s Tadawul All-Share Index (TASI), since being made accessible to foreign investors, has made litt le progress as global markets have been ratt led with the Greek debt crisis and the collapse of the Chinese stock markets. Despite the global pressures, the TASI continues to be one of the best performing indices in the world with a solid 13.2% return year to date.

The relatively strong performance of the TASI may help the Saudi market attract foreign investors. However, investors will likely be cautious given the depressed petroleum prices which will continue to put a strain on regional economic growth. In addition, the civil unrest and Saudi military action in neighboring Yemen adds increased geopolitical risk to Saudi markets.

Several firms including the world’s largest asset manager, Blackrock, are already planning for a Saudi Arabian exchange-traded fund to be listed either in Europe or the US. This would enable smaller financial institutions and retail investors to participate in the Saudi markets. It is also just a matter of time before the MSCI benchmarks add Saudi Arabia to its emerging market indices and direct billions of dollars in investment assets to the market.

By Suhail Ahmad, published in the Islamic Finance News Issue 29, Volume 12 on July 22, 2015

Private Equity and Venture Capital Investing in the Islamic World

Article featured in the IFN 2015 Guide (pg.44) and feel free to download the complete guide from our web-site at http://wp.me/p3PTEh-bQ

IMPROVING GLOBAL MARKET FOR ISLAMIC PRIVATE EQUITY AND VENTURE CAPITAL

Islamic private equity (PE) remains a very small component of the global PE marketbut showed signs of strength last year with an increase of mergers and acquisitions(M&A) activity in the Middle East hitting a four-year high. Islamic venture capital(VC) continues to face an uphill battle in the region but demonstrated signs ofimproved market perception and attention. SUHAIL AHMAD writes.

Global alternative investment assets reached US$7 trillion in 2014 according to Preqin’s 2015 Global Alternatives Report. PE including VC was the largest component of alternative assets with US$3.8 trillion under management, an increase of 12% over the previous year.

Review of 2014

Aggregate capital raised by PE and VC firms worldwide in 2014 was a strong US$495 billion, with 85% of the activity in North America and Europe. PE returns as measured by public pension fund holdings reviewed by Preqin Performance Analyst remained strong at just under 20% for the year and clearly beating other alternative asset classes such as real estate and hedge funds with the latter closing out 2014 with a measly 2.9% average investment return as measured by the Barclay hedge fund index.

The Middle East witnessed some strong deal-making with publicly announced M&A across the Middle East increasing 23% to reach US$50.3 billion last year, the highest amount since 2010. Despite the strong M&A activity in the region, international private equity firms were not as aggressive as expected and inbound M&A activity declined 30% last year to US$4.2 billion, according to Thomson Reuter’s data.

One of the region’s largest PE firms, Dubai-based Abraaj Capital had an active year teaming up with the US-based TPG Capital to bid for Saudi fast-food chain Kudu, although it lost out to multinational cereal giant Kellogg in a bidding war for Egyptian biscuit maker BiscoMisr.

The sector in 2014 also saw the successful fundraising of the largest PE fund since 2011 with Gulf Capital of Abu Dhabi closing its largest and third private equity fund; GE Equity Partners Fund III with a US$750 million raise. Although Gulf Capital is not a dedicated Islamic PE firm, the closing is a positive development for the region and should spur more activity in PE in the coming years.

In the VC space we expect 2014 investment levels to improve over the US$29 million in funds raised in 2013 according to the MENA Private Equity Associations 4th Venture Capital in Middle East and North Africa Report. Similar to the regional PE data, it is unclear how much of the VC deal flow was Islamic but nevertheless the VC sector in the region continues to remain embarrassingly low compared to the rest of the world which had total VC investments of US$86 billion last year including the closing of 273 new VC funds!

Preview of 2015

PE firms will be increasingly interested in the Middle East region as investors look at diversifying geographically, better valuations than in the US, and capitalizing on the growth opportunities of the young demographics of the region.

Interestingly, a series of interviews of 75 corporate executives across the Gulf Cooperation Council (GCC) in the GCC Investment Outlook report late last year revealed only 45% of respondents think that the opening up of GCC stock markets to foreign direct investments will be one of the main drivers for investment in the region. However, 51% of respondents do believe PE transactions will increase significantly in 2015.

Small mid-sized enterprises (SMEs) and start-ups that do not have access to traditional Islamic banking credit options for a lack of collateral or operating history are desperate for an increase in venture capital options in the region. The 10th World Islamic Economic Forum (WIEF) held in Dubai last year had a lively panel discussion on the role and future of crowdfunding to fill the VC void in Islamic finance. The discussion and increased interest in crowdfunding is a positive step and will help increase awareness of VC as an important tool for positive socio-economic development in the region.

Conclusion

Islamic PE and VC have an opportunity to substantially contribute to the economic growth in the region by supporting businesses of all sizes reach the next level. However, it will continue to be a challenge for the industry to differentiate itself from conventional PE.

However, there are encouraging signs for VC with the growth of crowd equity funding which is inherently compatible and mutually reinforcing with Islamic values of building and supporting local communities, encouraging risk and wealth sharing, promoting real economic activity, and equity ownership over debt. These goals should be near and dear to all investors and participants in Islamic PE and VC.