Abraaj fall from grace prompts investors to sharpen due diligence

Investing in emerging market private equity is about to become that bit tougher.

Abraaj, once the largest private equity firm specialising in regions such as Africa and the Middle East, has been accused by investors including the Bill & Melinda Gates Foundation and the World Bank of mishandling millions of dollars of their investments.

Since concerns were first raised in autumn 2017, investor trust has further eroded and the firm’s indebtedness has been exposed.

The Dubai-based fund is under investigation by regulators in the city state. Abraaj’s founder, Arif Naqvi, has reportedly been speaking with creditors in an effort to avert the company being liquidated.

Its demise has sent shockwaves through the fund management industry. Institutional investors in emerging markets — from pension funds to endowments and sovereign wealth funds — are now tightening their due diligence.

Abraaj funds had some of the most conservative investors in them…. They are going to be even more conservative now

The fall of the private equity firm, which had $14bn of assets under management and was behind some of the biggest takeovers in the Middle East, has added a layer of complexity to dealmaking in what were already difficult jurisdictions in which to do business, say industry insiders.

Investors entering the sector will have to carry out more stringent checks and balances, says a former adviser to Abraaj in Dubai, speaking on condition of anonymity.

“Abraaj funds had some of the most conservative investors in them. They have layer upon layer of due diligence. And even then they failed to spot any issues,” says the adviser. “They are going to be even more conservative now.”

Investors cannot be passive in private equity funds, says Ludovic Phalippou, a finance professor at the University of Oxford’s Saïd Business School, adding that Abraaj’s unravelling came about in part thanks to investors being better informed. “The next step will be to have mechanisms in place so that these sorts of things do not happen in the first place,” Mr Phalippou says.

A public relations expert working for a large money manager in emerging markets, believes investors have come to an “informal consensus that they don’t want their names to be associated with Abraaj because it was so toxic for emerging markets” — a view reflected in people’s reluctance to be named in this article.

One observer compares the softening of investors’ due diligence to that seen in the case of Bernard Madoff, the US financier behind a $65bn Ponzi scheme that came to light in 2008. “Like Abraaj, Madoff was about: ‘Well, everybody is in it and I [don’t want to miss out], so let me just write a cheque and not ask too many questions’,” says the private equity investor in emerging markets, who asked to remain anonymous.

Abraaj has always denied any wrongdoing.

Attracting private equity investment to emerging economies has traditionally been challenging. By some measures, returns are more compelling in developed economies than in so-called frontier ones.

The British Venture Capital Association, a private equity industry body, calculates that funds managed or advised from the UK produce an average annual internal rate of return — a closely watched measure of profitability — of 13.7 per cent, after charges. This compares with a cumulative IRR of 4.4 per cent from African investments over a five-year period to the end of last year, according to the Africa Private Equity and Venture Capital Fund Index.

Big names have retreated from some corners of emerging markets. KKR, for example, disbanded its Africa team because of a lack of sizeable deals last year.

Many investors have been put off emerging markets by recent currency volatility and political upheaval in some jurisdictions.

Yet some warn that being too downbeat on the sector risks missing out on opportunities. Private equity firms point to the high valuations of companies in the US and Europe as a reason to explore emerging markets now.

However the quality of managers in the sector is “variable”, according to Rupesh Madlani, chief executive of GSCM, an investment firm focused on emerging markets. “But there are enormous opportunities to deliver returns because in developed countries the process can be more competitive than in emerging markets, which allows investors to get better prices,” he says.

After Abraaj, though, investors are likely to proceed in dealmaking with far greater caution. “Investors wanted to believe in a story where one firm was big enough to take care of all of emerging markets and didn’t take care of proper due diligence,” says a manager at a rival private equity group based in Turkey, who declined to be named.

“It was lazy investors who created this monster.”