Zaab Sethna interviewed on investing in Iraq

February 26, 2019

Profile: Northern Gulf Partners
26 February 2019   
by Ludovica Brignola      

Launched in March 2009, Iraqi Investment Partners I, a hedge fund advised by Northern Gulf Partners, is betting on the future of a country that was cast into the abyss by war: Iraq.

Its founders, Zaab Sethna and Bartle Bull, think that the signals coming from the much-maligned nation are pointing to growth and economic momentum, and that Iraq offers a significant opportunity for alpha generation in the coming years.

After the invasion of Iraq in 2003, Sethna was working in the Iraqi government where he had roles in the ministry of finance, the oil ministry and the prime minister’s office. His colleague and co-founder Bull also had experience working in emerging markets, having spent time at frontier market funds and in the Middle East as political and economic analyst.

“We both had a good grounding in Iraq, that’s how we decided to come together and realised there were opportunities in the country, as well as capital outside: there was space for us to be the bridge between that external capital and the opportunities within Iraq”.

The strategy is long only and discretionary, and the investment universe is predominantly blue-chips on the ISX – the Iraqi stock exchange. The fund doesn’t preclude itself from investing on other exchanges, but it does so trying to exploit opportunities in the energy sector by investing in oil companies that are listed abroad but work in and derive their revenues from Iraq.

Northern Gulf's Zaab SethnaThe fund charges a 2 and 10 fee structure rather than the more common 2 and 20 employed by the market. “Shorting in Iraq is impossible, so there are less ways for us to produce alpha. Our returns above the market usually come from deep research, local knowledge, and local contacts” Sethna explained.

According to Sethna, the instability and the violence that the country endured, from the US-led invasion in 2003 to the establishment and subsequent defeat of the Islamic State of Iraq and the Levant in in 2017, is coming to an end.

“In January the United Nations stopped issuing statistics on Iraqi political violence, because they say now that it’s too low to measure. Violent incidents have declined by 99%; you can now essentially say that violence has ended,” he said.

Opportunities in the country are far-reaching: the nation is slowly transitioning out of a centrally-planned economy torn by war to an increasingly open free-market system in a post-war environment. But the potential of the country lies in one specific area.

“Growth is driven by Iraq’s hydrocarbons – oil and gas. Iraq is essentially a poor country but it has an opportunity to lift itself very quickly into the ranks of middle-income countries, and eventually it has the possibility to become a rich country. That’s all driven by oil and gas” said Sethna. “Iraq is sitting on one of the world’s largest oil reserves. It’s currently the world’s fourth largest producer - and the second largest producer in OPEC, just after Saudi Arabia - so that’s what’s driving it. From an investment standpoint we see two particular scenes: one is the large expenditure that will go into oilfield development and basic infrastructural development as a spinoff from that, such as roads, ports and airports. The other broad investment theme is the large jump we observed in consumer spending power in the last decade; we foresee this will continue in the next decade.”

GDP per capita has almost quadrupled in Iraq in the last 12 years and socio-economic trends which follow increases in disposable income, like spending on consumer products, financial services, education and healthcare all have investment opportunities that you can gain exposure to through the Iraqi public equities market. Examples of this can be seen in the holdings of Iraq Investment Partners I; mobile phone carrier Asiacell gained 47% last year, and local Pepsi-bottler Baghdad Soft Drinks Co was up 37%.

Despite the opportunities within the investment landscape, Iraq is still a region viewed with scepticism by investors.

“There is regional risk, and Iraq is in the middle east, which, as everyone knows, is an area of heightened geopolitical risk.But this nation itself is now emerging from that period, and there is no question that it will ever be under sanctions” Sethna stressed.

Furthermore, the threat posed by ISIS – or Daesh – is, according to Sethna, slowly fading.

“In Iraq, ISIS exists as a terrorist group but it’s no longer in the cities; they are now doing pin prick attacks in rural areas out in the desert or in the mountains. You hear about an attack every now and then against a military convoy, but they don’t pose any kind of threat to the state. Take Iraq’s oil facilities which are predominantly in the south of Iraq: there has never been a single terrorist attack against any oil facility, or against any foreign companies or foreign investor in Iraq”.

Political risk aside, a major impediment to investing in the Iraq Stock Exchange is the lack of third-party custodians.

“This holds back institutional investors from the Iraq market. Our custodian is an Iraqi organisation called the Iraq Depositary Centre (IDC) which is owned by the ISX which in turn is owned by the brokers who are members of the ISX. It’s not enough of an arm’s length relationship for many of the large institutional investors. To mitigate those fears, we constantly stay in touch with the IDC to make sure that their records tally with our records. When we go and visit them, we stand behind them and watch them as they examine our account so we can see that the custodian records reconcile with our own records for our holdings”.

Northern Gulf’s risk management process follows international standards with regards to middle and back office, audit, banking and legal counsel, and it’s particularly focused on due-diligence on the brokers.

“We visited all the available licenced brokers, met them, asked to examine their books whenever that was possible, and then we did sample trades, until we had short-list of the brokers that we believed were the best in class in Iraq. We continue that process on an annual basis, and we look at any potential new relationships that we think may be useful to us”.

Good demographics and a strong education system also inspire confidence in the opportunity for alpha returns, according to Sethna.

“Iraq has a population of 38 million, with a high proportion of those being under 25. Iraqis are in general well-educated and the country needs everything: the demand is huge in all sectors, from hotels and hospitality, to real estate. For example, Baghdad is a city of 10 million people and for now there’s only one shopping mall”.

Looking ahead, Sethna foresees a big rise in domestic liquidity driven by rising stability and enhanced oil production. Foreign investment is noticeably picking up. “In terms of our fund we have had more interest in the last few months than we had in 2 or 3 years before that. We would not be surprised at seeing new funds entering the market”.

Once the cradle of civilisation, Iraq endured one of the longest conflicts of the twenty-first century. But the withdrawal of armed forces, the return of stability and the rise of a middle-class determined to rebuild an entire country from the rubble of war could signify a new Golden Era for modern Mesopotamia and a corresponding outsized opportunity for alpha generation for investors.