Sophisticated investors in the Middle East are reluctant to allocate to hedge funds. Marketing funds in the Gulf Co-operation Council remains difficult as numbers of net worth individuals decline.

Marketing hedge funds into the Middle East became much harder following the financial crisis and the poor performance hedge funds showed in 2008. Investors in the region were not impressed with the gates, suspended redemptions and general illiquidity of many funds.

This has put them off re-investing back into hedge funds. At the same time many have seen their own net worth decline and events in the region, such as the Dubai debt crisis, have made cautious investors even more so.

Middle Eastern high net worth individuals (HNWIs), the main target for many hedge funds, have seen a significant decline in their numbers. For example, the HNWI wealth distribution over 2006-09 declined by 5.15% in the Middle East, according to the 2010 Merrill Lynch/Capgemini World Wealth Report.

Despite this gloomy picture some predict increased allocations to hedge funds in the future. In “The Hedge Fund of Tomorrow: Building an Enduring Firm” (April 2009), Casey Quirk and BNY Mellon predict the region’s sovereign wealth funds, cautious but steady allocators to hedge funds over the past five years, will pause in 2009 and into 2010, but forecast investment to pick up soon after that with Middle East share of hedge fund -ets to rise 30% to $194 billion by 2013.

A more recent survey by UAE-based Capintro Partners found over a third (36.4%) of respondents said they would increase allocations to hedge funds in 2010 with less than 10% saying they intended to ­decrease allocations.

Marketing hedge funds to the Gulf Co-operation Council (GCC) countries needs to be tailor-made and to take into account different sensibilities as well as financial regulations regarding hedge fund distribution and marketing. The GCC is diverse and incorporates the UAE, Saudi Arabia, Qatar, Oman, Bahrain and Kuwait.

“People make the mistake of trying to treat the Gulf as a single market. Every market in the region is different in some way,” says Brian Luck, managing partner of the Dubai office of The Capital Partnership, which provides -et management services for ins-utional investors and wealthy families.

The regulatory environments in the various GCC countries are far from uniform. For example, it is easier for hedge funds to market into Dubai than in Saudi Arabia.

“In Saudi Arabia everything is more difficult,” confirms Zubair Mir, a partner in the Dubai office of law firm Herbert Smith. Even getting into the country to meet investors can be a chal-ge. According to Mir obtaining a Saudi visa is bureaucratic and far from simple when compared with Dubai.

CEO and fund manager at Gulfmena Alternative Investments H-aim Arabi agrees Saudi Arabia is a hard place to market hedge funds and is complicated by strict regulations that severely limit private placement. The Dubai-based fund’s clients include regional and international investors as well as HNWIs.

Other GCC nations are only just developing an appe-e for hedge funds. Qatar, for example, is an upcoming prospect according to Luck. “Qatar is a younger market with growing wealth, so there will be a lot of change there,” he says.

Bahrain has flexible rules on marketing hedge funds to sophisticated investors, says Madhur Bhandari, deputy head of securities at HSBC in Bahrain.

Bhandari says the Bahraini regulator, the financial ins-utions supervision directorate at the Central Bank of Bahrain, is flexible and comfortable about the marketing of hedge funds. Once a hedge fund obtains exempt status, it can be marketed to wealthy investors with few restrictions.

Distributing a hedge fund in Dubai is straightforward. Luck describes the local regulator, the Dubai Financial Services Authority (DFSA), as world cl-. “The DFSA does a great job. They have taken on board best practice from around the world. That makes it easy to market in Dubai. The DFSA is also very accessible and they are interested in talking to people in the region,” says Luck.

Hedge funds are required to abide by Dubai’s 2006 Collective Investment Rules, known as the CIF regime, and must also adhere to the DFSA’s code of practice which aims to minimise risk and encourages best practice. Under the CIF hedge funds must give investors details about their strategy and management, similar requirements in most countries that permit the marketing of hedge funds.

Offs- funds based in the Dubai International Finance Centre (DIFC) must follow the centre’s own regulations in order to market funds. Under DIFC rules if an authorised company is operating from a jurisdiction outside the country, that jurisdiction must have “internationally compliant regulatory and legal standards” and should be compliant with the International Organisation of Securities Commission’s ­(Iosco) principles.

Most hedge funds generally raise -ets through private placement. However, there are some restrictions on marketing funds through private placements in other GCC states, particularly Dubai and Bahrain.

If they are not permanently based in the region, hedge funds will typically seek to distribute through a local bank to HNWIs, says Mir. Banks will “bear responsibility for the funds’ clients” when acting as placement agents, he adds.

Luck says there are few agents in the Middle East so the majority of fund managers deal directly with the investors. This means managers must do their homework and be knowledgeable about investor preferences in the region.

Being based on the ground is something Luck believes is an absolute prerequisite for being successful in the GCC. “People need to be based here and show that they are committed. If you do that, you are going to do well. If a hedge fund has people based in the region, it makes a big difference as it is easier to speak to people,” he explains.

This is a view shared by Mir. “Investors want to see their managers on the ground,” he says.

Good communication is essential says Luck, especially when dealing with sophisticated investors such as sovereign wealth funds (SWFs), HNWIs and ultra-high net worth individuals (UHNWIs).

“It is about evolving relations and having people on the ground talking to investors,” notes Luck. “It is essential that you understand the culture and that you have people in the region who genuinely want to be there.”

This is important particularly in well-established markets like Kuwait where there are numerous ins-utional, HNWIs and UHNWIs. Luck says the key to being successful in marketing to Kuwaiti investors is working with local ins-utions and banks with good knowledge of the jurisdiction.

Gulfmena’s Arabi says his fund usually organises one to one meetings with investors or holds seminars and conferences to explain how his fund invests and how it achieves returns.

The poor performance hedge funds endured in 2008 together with gating and suspensions coupled with the Bernard Madoff scandal has fuelled su-ion of funds in the GCC, according to Arabi. This means funds need to provide more information about their risk management to potential investors.

Arabi says there is little interest for hedge funds at the moment. “Funds have to address concerns and show that they are properly regulated. People want to know that funds are not pulling a Madoff or that they are going to find themselves locked in,” says Arabi.

Herbert Smith’s Mir agrees investors want more information regarding risk management and transparency. “Investors have heightened awareness and they now want greater information in regards to who manages the fund and what their track record is.”

“There is a great demand for low-risk products and the reality is that you need to understand investor needs,” concludes Luck.

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