New Iran Funds Launched Within a Day of Nuclear Agreement

Euromoney, August 2015

Well, that didn’t take long. One day after the nuclear agreement between Iran and the P5 + 1 world powers was announced, a new investment fund was launched focusing on Iran. “This fund debut follows the landmark nuclear agreement reached by Iran and world powers yesterday in Vienna,” said the fund’s backer, Mandalay Capital Management, “in anticipation of the agreement being honoured by all parties, lifting of crippling sanctions, the end of Iran’s decades-long isolation and its eventual reintegration into the world economy.”

Those stirring words make a great deal of sense for any long-term fund manager. But the announcement represents a useful case study of the many complications involved in Iran’s return to the fold. None of this is going to be simple.

Let’s start with the dateline. “July 15 2015. Sliema, Malta/Tehran, Iran.” Sliema? Not London, or Luxembourg, or some other funds management centre? Mandalay is headquartered in Malta, and turns out to be part of Alisher Ali’s broader Silk Road Capital group, best known for its work in similarly frontier-spirited locations such as Mongolia, Burma and Mozambique. It is likely that many first movers will be from outside the mainstream financial centres – another is underway in Cyprus, we understand.

There are UK-based businesses looking closely at Iran – Charlemagne Capital, which runs a joint venture with Tehran’s Turquoise Partners, is the most well-known – but we are still some distance from the world’s biggest fund managers being ready (or legally able) to pile in to Tehran. Mandalay’s fund will use an investment team in Malta supported by a research team on the ground in Tehran.

Next, the fund will primarily invest in the Tehran Stock Exchange, but, while banking restrictions are still in place, will gain exposure in two other ways: through structuring offshore participation notes, and through buying equities in Turkey, Pakistan and Iran (since they’re Iran’s three largest neighbours) as well as other neighbouring countries in the Gulf, Caspian and Central Asia. In other words, at the start, it won’t directly own any Iranian shares.

This is an inevitability until the nuclear deal passes Congress and is ratified, and various other restrictions are removed. “What’s going to happen is what happened in Saudi for years,” says Ali Akbar Ahsan at Magellan Capital, an Iran specialist. “All you have is promissory notes: a fund manager in London holds £10 million on account for a fund manager in Iran who invests his own money in the stock exchange.” Saudi is now in the process of stepping away from a promissory note model to direct holdings by foreigners, but the process has taken years.

Some mooted products talk about sanction screening: avoiding companies which are connected to arms or nuclear power, or those linked to the Revolutionary Guard, or those who remain on the sanctions list. But that’s not straightforward either. The Iranian state, the army, and the Revolutionary Guard are enormously influential institutions on a commercial as much as a social level: they have their own investment companies, and some of Iran’s largest companies and investment vehicles have current or former generals in the background of their ownership structures. “Commercial entities of the military force known as Islamic Revolutionary Guard Corp are major actors [in the economy], with interests in a number of sectors such as construction, telecommunications and finance,” says Bank of America Merrill Lynch in a benchmark July 15 report, “The Iran Nexus”, a 117-page study representative of how seriously bulge bracket banks are taking research on the country’s opening.

Still, this bit’s unarguable. “Iran represents the biggest long-term investment opportunity in the global frontier universe by virtue of being the world’s largest untapped frontier market at the cusp of opening up,” says Alisher. Unlike most frontier markets, Iran already has a well-functioning stock exchange: its market cap is over $100 billion and it trades $100 million a day. Today, it trades at 5.7 times forward earnings and offers a double-digit dividend yield. “We expect the Tehran Stock Exchange to become one of the world’s best performing equity markets in 2016 and beyond.”

For that reason, managers like Mandalay are likely to be the vanguard of broader fund management engagement with the country as circumstances allow. It’s an open secret that a host of international frontier managers have been there for prospective looks around, even if the sanctions environment doesn’t yet permit them to go in; they want to know what’s there when the doors are properly open. If Mandalay has been quick to pull the trigger, plenty of others are primed. At Charlemagne Capital, director Varda Lotan tells Euromoney its planned Iran fund is “a work in progress, as we are ensuing the fund will be compliant with all relevant EU sanctions.”

Once it’s clear that it’s not only legal but sustainable to go in, a lot of money is likely to enter the country. “We expect $1 billion of inflows to equities within a year of sanctions ending,” says Charles Robertson, chief economist at Renaissance Capital. “With roughly $100 million daily turnover and no Iranian restrictions on foreign investment, we think portfolio flows could be significant as early as 2015. Others will buy into companies such as MTN or various Turkish stocks that have operational exposure.” Robertson sees several stages to Iran opening up: first, as is happening now, experienced emerging market and frontier investors arrive; then, in 2017 and 2018, “investors will likely learn the pitfalls of investing in a country with entrenched vested interests, from the clergy to the Revolutionary Guard, and surprising linkages between banks and companies that lead to some investments turning sour.” Third, around 2020, Iran responds to that investor attention, with at least some people in Iran attempting to become more activist shareholders and push through reforms.