David Stevenson: Opportunities in Dubai

Monday 30 November, 2009:

A few weeks back you may remember that I talked about the Stratton Street ECG Wealthy Nations bond fund which I believed warranted further attention. This invested in a wide range of sovereign and corporate debt issued by countries regarded as ’wealthy’ under Stratton Street’s screening methodology - and those countries included Middle Eastern hot shots such as Qatar, Abu Dhabi, UAE and of course, Dubai.

Now you won’t need me to remind you of the events of the last few days, but you might be interested in the views of the fund managers from Thursday evening.

I think the crucial paragraph is the last one. Increasingly I’m tending to bold contrarian positions especially when a flight from risk ends up devaluing assets in related peer groups not suffering quite the same structural problems. Dubai may or may not be in deep, deep trouble but the sudden collapse in prices for say Qatar debt I think may present a compelling opportunity. Read on.

”Dubai was once again the focus for investors. Although little new news has been forthcoming since yesterday’s press release, equity and credit markets have reacted nervously today. Today was a US Thanksgiving Day holiday which may have e per cent with the FTSE down 3.18 per cent and the DAX down 3.25 per cent.

The epicentre for recent events is the uncertainty caused by yesterday’s press release by the Government of Dubai. The press release implies a potential deferral of the maturity date of Nakheel bonds (due for redemption on 14th December) until 30th May 2010, and more general restructuring of it’s parent company Dubai World. Dubai World is 100% owned by the Government of Dubai and, in turn, Nakheel is 100 per cent owned by Dubai World. Although neither entity is fully guaranteed by the Dubai government, the ownership structure has led many investors, including ourselves, to believe that the government will extend support to such government-related issuers (GRI’s). The wording of the press release has created uncertainty, particularly the words “Dubai World intends to ask all providers of financing to Dubai World and Nakheel to standstill until at least 30 May 2010.”

Several weeks ago it was reported that one possible option for Nakheel would be for domestic investors to be offered the option of deferring repayment, whilst international investors would be paid in full. Although the most recent press release clearly stated that Dubai World would ‘ask’ investors to defer redemption (presumably on favourable terms), the market has interpreted this to mean that investors will be forced to defer repayment.

For bond investors the distinction is subtle, but extremely important. A voluntary deferral of repayment (at an attractive rate of interest) may be acceptable and therefore would not be viewed as a default on Nakheel bonds. However a forced extension of the maturity date would constitute a default. Our long held view has been, and remains the case currently, that any deferral would be voluntary. Today’s FT seems to support this view; ”A spokeswoman for the [Dubai] department of finance said the government intended to ask all bondholders to extend until May. But the government said no decision had yet been made on how to deal with investors insisting on repayment in December.”

Please be aware that Wealthy Nations Bond Fund does not own any Nakheel bonds, nor does it have any direct exposure to Dubai World bonds which are at the centre of the current concerns. However we do own other Dubai-related credits whose prices have been marked down in sympathy. The current price of 99.85 for the GBP C class represents a decline of approximately 1.5 per cent compared to the previous day’s price. Owing to the US Thanksgiving Day holiday, pricing is more difficult than normal but we would estimate a further 1 per cent decline for the fund tomorrow (ie close today).”

We have used today’s weakness in prices to add to positions, specifically in Qatar 2040’s where we added an additional 1 per cent exposure (which will be reflected in tomorrow’s update). We are still inclined to add to exposure when opportunities present themselves as we believe that investment grade bonds remain very mispriced when compared to cash, government bonds or sub-investment grade debt.”

David Stevenson is also one of the Four Wise Monkeys at the online TV investment programme www.4wm.co.uk

adventurous@ft.com