In the second of a two part series, this column outlines a vision for the future of asset management in the GCC.
The asset management industry in the GCC has blindly followed developed market dictates. The main focus is listed equities. But the GCC markets have neither the depth or breadth to allow an active strategy to flourish. A passive strategy does not need asset managers.
The only other truly active asset class in the region is private equity (PE). PE managers have focussed predominantly on what they call late stage investing: buying shares of companies shortly before they list. This strategy has performed well on a few now famous deals. However, fund performance has been abysmal.
The problem here is where is the value creation? A firm that buys a company and quickly IPOs it is not an asset management firm but rather an investment bank that is providing underwriting and equity capital market services.
So where to start? Instead of looking to developed markets and beginning with selecting a strategy, why not review current investor behaviour in the GCC?
Without a doubt the largest sector is real estate (RE). However there is little in terms of RE product offerings by asset managers. Even when it does happen, it is informal, such as the ‘musharakat’ deals in Saudi.
A clear opportunity exists in the equity funding gap faced by developers during the construction phase of their projects. One solution used pre the 2008 global financial crisis was to bridge the gap using funds from the ultimate buyers in what was termed off-plan purchases.
This is no longer viable as the financial collapse exposed the large risk difference between buying off-plan and buying a completed property. On the other hand, professional investors might find such a source of risk very appealing, especially if there is a buyer for the property who is legally bound to purchase at a known price upon completion.
Another asset class that looks promising is growth PE. PE has received a bad name as late stage investors, dependent on the timing of market cycles for an IPO, got caught out. A focus on free cash flow (FCF) would have better served investors, as with FCF if one does not exit, they can at least pay out a dividend.
FCF is only one component, one of its values is decreasing dependence on investment exit timing. Another component is the value of the company, which can be decomposed into a price/earnings (P/E) multiple multiplied by earnings. P/E multiples can be manipulated by public relations and brand improvement, but it is mostly a function of the market. PE firms focussed on P/E multiple expansion are adding no value, or in investment terms they are all beta and no alpha.
This leaves earnings as the main value component that PE managers can influence. Earnings are driven by strategy, management and execution. In the GCC, there is room to improve on all three.
The management gap is the easiest to explain. Normally an economy cannot outgrow its talent pool. In the GCC, due to massive commodity production, this anomaly is exactly what happened. Importing talent creates the paradox of GCC economies becoming even more efficient and productive, thus growing even faster.
This persistent economy — talent gap creates a sustainable opportunity for PE managers to create value. This is not about identifying firms with bad talent, but identifying economic sectors where there is a shortage of talent, acquiring a successful firm in that sector and then driving its growth into uncontested market share. IPOs do not come into it.
Execution, or lack thereof, provides an opportunity not just at the executive level but at the shareholder and board level as well. Executive management in the GCC has evolved far faster than shareholders and board members. The reason is not clear, although the main culprits are probably a lack of understanding of the value a shareholder can add as well as a persistent belief that board appointments are a reward rather than a responsibility.
Strategy is a deeper topic that has been covered in several previous posts. The start is understanding the value of using long term strategy, followed by understanding the main pitfalls faced in developing a strategy and finally how to develop an adaptive strategy.
This column has repeatedly emphasised why and how shareholders and boards add value and this will not be repeated here. The natural consequences of such a statement, however, need to be understood: Execution cannot be improved without control or at the least leadership. There is no room in private equity for passive investors, at least not if they wish to be successful.
The problem with asset management in the GCC is not the sector but the strategy, management and execution.