For Grant Felgenhauer, a money manager whose hedge fund owns $110 million of Iraqi equities, the 15 explosions that reverberated across the country in a single day earlier this month weren’t a reason to stop buying.
“The Iraq that is unfolding in Baghdad is not the Iraq you read about in the headlines,” Felgenhauer, a portfolio manager at Euphrates Iraq Fund Ltd., said in a Jan. 16 phone interview from the nation’s capital. “The opportunities offered by Iraqi equities overshadow anything else we see in the world today.”
The Yale University graduate, who formerly traded Russian stocks at Bill Browder’s Hermitage Capital Management in Moscow, returned 28 percent last year with bets on Iraqi shares such as Bank of Baghdad, compared with a 9.5 percent decline for Iraq’s ISX General Index. That helped make New York-based Euphrates the fourth-best performing emerging-market fund managing more than $50 million in 2013, outpacing gains at rivals such as BlackRock Inc., according to data compiled by Bloomberg.
Iraq is drawing investors from specialized hedge funds to global banks including Citigroup Inc. and Standard Chartered Plc as the oil-rich nation rebuilds 11 years after the U.S.-led invasion that toppled Saddam Hussein. The economy will expand 6.3 percent this year, up from 3.7 percent in 2013, the International Monetary Fund said in October. By 2018, GDP may gain 9.6 percent, while the Iraqi government estimates crude production will rise to 9 million barrels a day by 2020, compared with about 3.4 million a day last month.
“No other country has this growth trajectory,” Felgenhauer, 39, said during one of his quarterly visits to Baghdad. “The scale of the increase in oil production expected from Iraq has only happened twice in history: once in Saudi Arabia in the 1960s and in Russia in the 1990s. Both episodes transformed the local banks and equity markets.”
Bank stocks account for about half the Euphrates Iraq Fund, with Bank of Baghdad its biggest financial holding. Felgenhauer says the industry’s growth prospects in Iraq contrast with banks in many other parts of the world because fewer than one in five people in Iraq hold an account and demand for credit is high. Banks have pricing power and are in a position to lend to only the best counterparties because of rising demand, he said.
Net income at the five largest privately owned banks more than tripled from 2010 to 2012 and more than doubled earnings per share, according to Singapore-based Sansar Capital Management LLC, which has $35 million in Iraqi equities and returned about 27 percent last year. It named the lenders as Bank of Baghdad, Kurdistan International Bank, North Bank, Iraqi Middle East Investment Bank and Dar Es Salaam Investment Bank.
“With private credit still well below 10 percent of GDP, banks here are making money despite the unrest,” Felgenhauer said. “It’s a unique story when global banks generally are in a challenging spot. Managers in these banks know how to make money even in one of the world’s most difficult markets.”
Iraqi stocks trade at around six times earnings, compared with about nine times for emerging-market stocks, according to data compiled by Bloomberg. Bank of Baghdad gained 21 percent over the past 12 months and closed at 2.09 Iraqi dinars in Baghdad on Jan. 27, while the ISX General Index last year declined about 9.5 percent to 113.5 points after reaching a high of 124.7 in February.
The Iraq bourse drew investors last February when mobile operator Asiacell Communications PJSC listed after a $1.3 billion share sale, in the Middle East’s biggest initial public offering since 2008. The country’s two other mobile operators, Zain Iraq and Korek Telecom, also plan to list on the bourse.
Kyle Stelma, who runs Dubai-based Dunia Frontier Consultants, is also bullish, pointing to the 50 percent annual loan growth at the country’s top 14 banks between 2009 and 2012. Deposits grew 30 percent on average each year, he said in a phone interview from the emirate on Jan. 20.
“A basket of top quality banks can provide favorable risk/reward characteristics, despite the acknowledged uncertainties in Iraq,” he wrote earlier this month in a report to investors.
Stelma said his team spent about three months in Iraq conducting interviews with banks and meeting investors for information, while Sansar collected data on bank revenue and loan growth after also conducting surveys with the central bank, lenders and investors. Publicly available information at the central bank and other Iraqi institutions is limited.
The most recent information for Bank of Baghdad shows a 36 percent jump in revenue in 2011 from a year earlier, according to financial statements on its website. Revenue at North Bank increased 43 percent over the same period and 45 percent at the Iraqi Middle East Investment Bank.
Financial statements for 2012 weren’t available and financial information for Dar Es Salaam Investment Bank and Kurdistan International Bank weren’t on the company websites. Calls to the banks seeking further information on earnings weren’t immediately returned.
Citigroup and Standard Chartered each have full or representative offices in Baghdad, and also plan a presence in the cities of Erbil and Basra. The government is working with Standard Chartered and Goldman Sachs Group Inc. to obtain a sovereign credit rating, Sami al-Araji, chairman of Iraq’s National Investment Commission, said in a Dubai interview on Jan. 28. The country would probably have a similar rating to Gabon and Nigeria, Bank of America said in a Jan. 24 report.
JPMorgan Chase & Co. is also helping the Trade Bank of Iraq finance imports of goods and services, while Turkiye Is Bankasi plans four offices in Iraq.
Not everyone agrees now is the time to invest in Iraq. Rami Sidani, who runs the $343 million Schroders International Selection Fund, the best-performing stock fund in emerging and frontier markets, says the country must give international investors better legal protection before he’ll commit funds.
Some foreign investors have avoided Iraqi stocks because of the lack of custodian services in the country, preferring to avoid the risk of dealing with local brokerages.
“The separation of custody and brokerage is the most important step toward encouraging foreign inflows into this young market,” Sidani said in e-mailed comments to Bloomberg. “We’re hoping that this will happen soon.”
Taha Ahmed Al-Rubaye, chief executive officer of the Iraq Stock Exchange, is seeking to attract more investors like Euphrates, saying foreigners account for just 20 percent of the investors active on the $9.9 billion bourse.
“I’m happy to see non-Iraqi investors like him,” Al-Rubaye said in a Jan. 26 interview in Dubai, referring to Felgenhauer. “They see the picture of Iraq from the outside and together we can come up with solutions for issues.”
A Spokane, Washington native, Felgenhauer joined Hermitage in Moscow in 2004 after traveling and living in the former Soviet Union since high school and studying Russian at Yale. He moved to London to start a global emerging-market fund for Hermitage in 2007, after Browder was barred from the country by the Russian government and forced to relocate to the U.K.
Geoffrey Batt started Euphrates in 2010 with Firebird Management LLC founder Daniel Cloud, using $5 million of their own cash. Assets had swelled to about $19 million by the time Felgenhauer joined in April 2012 after investing his own cash the previous year. Euphrates returned 4.9 percent in 2011 and declined 2.8 percent in 2012 before last year’s rebound.
Felgenhauer’s visits to Baghdad are spent shuttling between hotels, the offices of portfolio companies, brokers, the Iraq stock exchange and restaurants. He avoids conspicuous security convoys in favor of a local driver unless traveling in Baghdad’s Green Zone, the heavily fortified central diplomatic area of the city, and says he confronts check points almost every mile.
He’s drawing on street smarts honed during the turbulent post-communism period in Moscow to stay safe in Iraq after car-bombings and other violent acts intensified. Almost 9,500 civilians were killed last year, more than double the number a year earlier, according to the website Iraq Body Count.
While keeping a daily tally of the number of explosions in Iraq, he says these incidents aren’t affecting investments and moving freely around the city is possible with sensible precautions.
“You can function in Baghdad just fine and not come across this stuff,” he said. “If you think about the risk objectively and you’re reasonably careful you can go about your business. We’re being well compensated for the headline risks of terrorism and noisy politics with the valuations we are paying.”
Euphrates’s other competitors are the Iraq Opportunity Fund, managed by Abu Dhabi’s Invest AD, and Bermuda-based FMG Iraq Fund. They’ve returned 7.2 percent and 13 percent respectively over the past year, according to data compiled by Bloomberg.
“Investors should look at the Iraq stock exchange because the headlines are going to scare away the vast majority of people,” Dunia Frontier’s Stelma said. “When the headlines do eventually go away, it’s going to be too late.”