Year: 2010

F




or decades, western companies and wealthy investors have been rubbing their hands at the prospect of Asia’s largest countries announcing large-scale sell-offs of state-owned enterprises. Unfortunately for them, countries like India and its neighbours in the Far East have been less receptive to the idea, either rebuffing the notion altogether or inadvertently scaring investors away by imposing such draconian terms on how the sale should be managed and the company run with the blessing of employees, management and the government – all of which could be shareholders.

But there are now signs that governments in Asia have got round to the idea that they may need to cede more management control when they sell off part of the business. After winning a strong re-election mandate last year, India’s Congress party-led government has said that it will press ahead with stake sales in state firms as it no longer has to depend on Communist support to survive in parliament. The government has promised to keep at least 51 percent stakes in all public sector companies, but the concept of any privatisation is fiercely opposed by leftist parties and unions.

In August India announced that it is considering selling stakes in two state firms, Shipping Corp of India and trading operator MMTC, as it readies for its biggest ever divestment – the sale of a holding in Coal India that could raise $3.8bn. The issue is expected to be launched on October 18.

The government has a goal of raising 400 billion rupees ($8.7bn) from selling stakes in state-run firms in the fiscal year to March 2011 as it seeks to raise funds for infrastructure and poverty alleviation. The sale of the stake in Kolkata-based Coal India, which accounts for 80 percent of India’s coal output, would be the country’s largest ever new share sale, analysts say, outstripping utility Reliance Power’s $2.9bn share sale in January 2008.

Buoyed by success of share sales in two state-run firms earlier this year, the government has also cleared sales of stakes in Steel Authority of India Ltd., Power Grid Corp of India Ltd. and Hindustan Copper Ltd. No dates for the sales have been set. Since April, the government has raised $260m by selling shares in hydro producer Satluj Jal Vidyut Nigam and $210m through a share sale in Engineers India.

Unsurprisingly, India’s massive coastline and its geographic position as a gateway to Africa and the Middle East to the west, and China and the Far East to the east, makes it an ideal location for shipping operators and logistics firms to set up. With 13 major ports, around 200 non-major ports and a coastline of 7,500km, global consultancy firm Ernst & Young and industry chamber Ficci believe that India offers huge opportunities for the maritime industry.

“Indian ports are now witnessing unprecedented interest both from strategic buyers, including international liners, terminal operators and captive players, as well as financial suitors, including banks and infrastructure funds,” say E&Y and Ficci in a report issued in August. It adds that to leverage this opportunity and to ensure optimum utilisation of the coastline, the Government of India is encouraging more private-sector participation in ports’ development.

“By establishing a direct link between performance and profitability, privatisation motivates private entrepreneurs to improve their return on investment and provides them with an incentive to continuously improve their efficiency,” E&Y’s infrastructure practice partner Sushi Shyamal says.

Other countries in the region are also contemplating selling-off their state assets, although probably not at the rate that investors would like. If and when Indonesia’s state-owned enterprises are finally privatised, analysts say that it will usher in a new era for the often poorly run firms. For years now, the government has been planning to list many of these companies on the stock market to raise fresh funds. But privatisation will bring much more than just additional money – it will inject new ideas and professional management practices into companies that have been underperforming for years.

There are more than 140 state-owned enterprises in the country, the vast majority of them loss-making and badly managed. But Indonesia’s State Enterprises Ministry says that as many as 10 of its companies will be ready to go public by next year, as the ministry expects the country’s economy to continue improving and experience a surge in capital inflows.

State Enterprises Minister Mustafa Abubakar has said that with the stock market roaring, this would be a good time to list the better managed and more profitable companies. Although he has not provided any names, he has said the targeted companies were in the insurance, agriculture, finance and construction sectors. Mustafa has also said the companies would prepare their IPOs starting early next year, and he expects that they could be ready by the end of the first half.

Analysts have highlighted a number of state-owned enterprises that could easily be privatised successfully. One such company is construction firm Waskita Karya, which plans to sell 35 percent of its equity to raise IDR 600bn ($66.6m). The government held a roadshow in September for the country’s largest steel maker Krakatau Steel’s initial public offering which was aimed at targeting international corporate investors in Asia, Europe and the US.

The Indonesia Stock Exchange said that Krakatau Steel had filed a document saying it would float 20 percent of its shares through an IPO which is scheduled to be launched on 11 November 2010. The company might offer another 10 percent in shares in a second listing. Other state companies that are looking to be privatised next year are another state construction builder Hutama Karya, state insurance company Jasindo, state cement company Semen Baturaja, and state finance firm Permodalan Nasional Madani.

Another Asian country that has had a poor reputation with regards to selling off state enterprises is Vietnam. But in January this year the country appeared ready to restart its privatisation drive after the government signalled it was preparing to sell two of the largest state-owned enterprises. Nguyen Tan Dung, the Vietnamese prime minister, earmarked Petrolimex, the largest fuel importer and distributor, and Vietnam Steel Corp, the steelmaker, as the next candidates, but did not give a timetable. Details of the sell-off are still being prepared. Analysts have said that it is impossible to give an accurate valuation for either company because they do not publish accounts. Petrolimex – which controls 60 percent of the fuel distribution market in Vietnam and has 6,000 petrol stations – turned over an estimated $1.3bn in 2008 and could be worth between $1bn and $1.5bn.

In August the Prime Minister also approved the equitisation plan of the Vietnam Electrical Equipment Joint Stock Company. The company will sell part of the state’s stake in the corporation, and at the same time issue more shares to increase chartered capital. The Ministry of Finance will sell a 11.21 percent stake via auction at the Hanoi Stock Exchange, while the state retains a controlling 85 percent stake. The remaining three percent stake will be sold to a trade union.

Analysts say the move, known as “equitisation” in Vietnam rather than the more politically charged “privatisation”, marks a return of confidence on the back of strong economic data and recovering markets. So far, the long-pledged privatisation drive has stuttered. A free trade agreement with the US in 2000, and the 2007 accession to the World Trade Organisation indicate the government’s commitment to economic transformation, but the country remains a one-party communist state. State-owned enterprises continue to dominate the economy, and equitised enterprises account for only about 15 percent of total state-owned enterprise capitalisation.

Hanoi is scheduled to sell more minority stakes in high-profile enterprises. The country aims to privatise 1,000 state-owned enterprises by 2015. Yet the communist authorities’ apparent emphasis on maximising profits from these sales rather than ensuring long-term benefits to the companies and the wider economy has hindered deals and deterred investors. In particular, prospective foreign buyers have balked at a peculiar legal requirement. These buyers, who are supposed to be selected and announced before the domestic IPO, are legally bound to pay the average bid price achieved at the auction if that is higher than theirs. The average bid price is calculated following a Dutch auction for shares offered to domestic retail and institutional investors.

Furthermore, IPOs take place before the enterprises have been legally converted into shareholding companies, leaving uncertainties about which assets (and liabilities) will be transferred to the new corporation. Often the new companies are not established until months after the IPO with the enterprises holding investors’ money in the interim. Investors say the process is out of touch with the realities of business The flaws in the process became evident with the botched partial privatisation in 2007 of Bao Viet Insurance, the country’s largest insurer. While 11 leading names in global financial services – including Swiss Re, Nippon Life and HSBC – carried out due diligence on Bao Viet, all resisted the legal requirement that they commit to paying the average price to be reached at auction.

Similarly, when Vietnam’s state-owned Vietcombank put out a call in 2007 for potential strategic investors, big financial groups such as Goldman Sachs and GE Money of the US and Japan’s Mizuho and Nomura all queued up for the chance to buy into one of the largest commercial banks in one of Asia’s fastest-growing economies. Vietcombank hoped a tie-up with a respected international partner would help it command a high price in an initial public offering as well as improve operational efficiency amid competition from foreign banks entering the market. Yet neither the global players nor the Vietnamese bank achieved their ambitions. After looking at both the bank and the rules governing Vietnam’s state enterprise sell-offs, all potential foreign bidders walked away. Eventually, Vietcombank proceeded with a domestic flotation that raised $625m.

Since the equitisation process started in 1992, Vietnam had restructured 5,556 state-run enterprises (SOE) and eight corporations by the end of 2008, including 3,854 companies that were equitised, 155 firms that have been sold, 30 which have been leased and 531 that have been merged. In 2009, Vietnam restructured 105 state-owned enterprises, including sales of shares in 60 companies, meeting 8.4 percent of the national plan during 2009-2010. The sluggish process during 2009 was attributed to the economic crisis and improper policies related to privatisation and share sales.

But foreign ownership has not reached the levels that either foreign investors expected or the Vietnamese government hoped for. As at the end of 2008 foreign investors held only six percent stakes in 3,854 Vietnamese enterprises which were equitised. The state owned a combined 57 percent stake in these companies, while the staff and other investors held 14 percent and 23 percent, respectively.

However, the Vietnamese government has acknowledged that selling shares in state-owned enterprises to foreign investors has helped to improve their management capacity and raise a great amount of funds for the state budget. The government has also indicated that it wants to lure more foreign capital into the country by saying that it plans to change the regulation surrounding share sales so that strategic overseas investors would be allowed to buy stakes in state-owned enterprises before an IPO takes place.

Such promises seem to be helping to raise Vietnam’s investment profile and the overall outlook is positive. In its World Investment Prospects Survey 2009-2011, the United Nations Conference for Trade and Development found Vietnam to be the world’s 11th most attractive destination for FDI (after ranking 6th in 2007-09).

Deal makers have traditionally steered clear of investing heavily in emerging markets. A combination of poor management, state-ownership, opaque business practices and financial accounting, as well as burdensome regulation, have ensured that the closest some of the world’s biggest private equity players have come to looking at developing nations is on a kid’s globe. But attitudes are changing – as are the financial fortunes of some of the world’s biggest developing economies.

According to the Emerging Markets Private Equity Association (EMPEA), a global body that promotes private equity investment in developing countries, a robust recovery is underway in emerging market’s private equity as investment pace is picking up significantly post-crisis, and appears on track to beat 2009 totals. In the first half of this year, investment totals stood at $13bn versus $8bn at this time last year, an increase of 55 percent. The total value of private equity investments made in the first two quarters of 2010 was $4.5bn more than that invested through the same period last year, led by an investment surge in Latin America and continued strong activity levels in China and India.

“Investment conditions in emerging markets private equity are revitalising,” says Sarah Alexander, EMPEA’s president and CEO. “There are more and better quality deals in the pipelines. The continued easing of price expectations among sellers means managers have been more successful in closing transactions. Emerging market fund managers are increasingly bullish in light of stabilising markets and lower valuations,” she adds.

EMPEA has also found that fundraising levels are showing signs of rebounding, with $11bn raised in the first half of 2010 versus $9bn raised in the same period last year. EMPEA says that Asian funds continue to account for more than half of the total (55 percent), with China continuing as the leading destination for new capital. China-dedicated funds accounted for two-thirds of the 46 Asian funds that raised capital through mid-year, 60 percent of total capital raised for Asia, and one-third of the total capital raised for emerging markets during that period.

EMPEA’s analysis has found that 90 percent of the rise in both transaction volume and in total investment can be attributed to increased investment activity in China, India and Latin America. It also found that there were 44 percent more deals completed, with 402 deals done this year to date versus 280 deals this time last year. Furthermore, its research points out that there has been an increase in large transactions, pushing average deal sizes up 27 percent (from $40m to $51m), driven by 28 deals topping $100m versus only 17 of similar size in the first half of 2009.

Deal volume in Latin America continues to be small, but private equity firms are seeing promise in the region’s untapped potential. So far much of the attention has been on Brazil, which accounted for 62 percent of total deal volume in Latin America in 2009, according to the Latin American Venture Capital Association.

In September emerging markets buyout firm Actis carried out its first investment in Brazil, having been active in Latin American for more than 30 years. The firm, the former direct investment arm of UK government-backed investor CDC Group, has bought supermarket chain operator Companhia Sulamericana de Distribuicao. The $58m acquisition marks Actis’s first Brazilian deal. Actis wants to expand the group and take advantage of Brazil’s steadily increasing consumer wealth. Paul Fletcher, a senior partner at Actis, said: “This is a highly auspicious time for Brazil with rising income and increasing access to credit; over 20 million Brazilians have entered the middle class over the last five years.”

“Relatively welcome”
The deal is the latest example of private equity companies taking an interest in the country. In July, David Rubenstein, co-founder of US buyout firm Carlyle Group, touted Brazil as one of the most attractive countries for private equity investment. Speaking in an interview with Dow Jones Newswires, he said: “China, India, Brazil, South Korea, Taiwan, Saudi Arabia, South Africa, among other countries, are places where your growth rates are going to be 5-10 percent, where private equity is relatively welcomed, and where there’s a culture that foreign capital is being sought. The comment followed Carlyle’s first Brazilian deal, an acquisition of tour operator CVC Brasil Operadora e Agência de Viagens.

Since then, the group has bought Brazilian health services provider Grupo Qualicorp, as well as a 51 percent stake in Brazil’s Scalina, the owner of a pantyhose maker, with the funds for the $159.7m deal coming from South America Buyout, a Carlyle fund, and a fund Carlyle has in partnership with state-run Banco do Brasil. The aim is also to increase the company’s participation in international markets.

Other private equity firms have been quick to seize investment opportunities in Brazil. In May, UK buyout firm Apax Partners also made its first Latin American investment, with an acquisition of a listed Brazilian information technology and outsourcing services company from a local venture capital firm. The deal was worth €383m, according to data provider Dealogic. In July, Swiss private equity manager Partners Group was preparing to open a Brazilian office while rival Capital Dynamics said it had already opened an office in Rio de Janeiro.

No middle ground
Elsewhere, the Middle East is showing signs of recovery with attractive investment opportunities which will help the private equity industry to grow significantly over the next three to five years, even though its investor base may remain mostly niche, according to research carried out by consultancy Booz & Company and leading French business school Insead. Called Private Equity in the Middle East: A Rising Contender in Emerging Markets, the research has found that as governments, particularly in the Gulf Co-operation Countries (GCC), seek to diversify their economies and shift some of the burden of funding to the private sector, opportunities for private equity will grow. The report adds that the number of funds operating in the market has continued to grow and by May this year there were 150 funds identified in the region.

However, the research adds that the market remains highly concentrated with three fund managers controlling about 79 percent or $4.8bn of the total value of closed funds. Nonetheless, around 120 firms have survived the recent economic turbulence in the region and these will most likely opt for increased specialisation, greater emphasis on earlier stage investing and small and medium enterprises (SMEs), improved economics for investors and more operationally focused sector-specific teams.

Given the operational expertise required to succeed in a more challenging environment, and more clear streams of growth in the region, a growing number of firms are focusing on very specific sectors, mainly infrastructure, consumption, healthcare and agriculture, says the report. But it also adds that the number of exits recorded by private equity in the Middle East is still small. This is due to a combination of the recent financial crisis, the relative young age of the Middle Eastern private equity industry, and the limited data availability on private placements.

But other experts are less enthusiastic about the attractiveness of the region for buyout firms. Bankers say that private equity is falling behind other rival asset classes in the Middle East in the competition to attract Islamic money. Head of Middle East structuring at Deutsche Bank Hussein A Hassan says many Islamic banks will not commit capital due to the long-term and illiquid nature of many of the region’s private equity funds and their levels of debt liability.

“Islamic banks cannot invest in private equity funds in a meaningful way even though private equity is as close as one can get to pure or real Islamic finance,” says Hassan.

The total value of private equity funds raised fell to $1.06bn last year, down from $5.4bn in 2008, while the number of fund closings dropped to six in 2009, from 17 a year earlier, a report by the Gulf Venture Capital Association (GVCA) says. Less than five percent of this money, it is thought, was committed by Islamic investors. Bankers say that Islamic focused private equity has failed to take off largely due to Shariah regulations that prohibit too much debt and investments in companies that trade in non-compliant goods and services.

Yet while investor appetite in the Middle East may be cooling, there are signs that investor interest may be picking up in what have until now been regarded as the most unlikely places. EMPEA has found that “notable up-ticks” in Sub-Saharan Africa have accounted for a significant portion of the overall increase in capital raised in emerging markets. “African funds raised through June already exceeded the full year 2009 total, and some sizeable funds being raised point to a return to pre-crisis levels,” says EMPEA’s Alexander.

In September, anti-poverty campaigner Bob Geldof announced he is to become the frontman for a new $750m (£487m) private equity fund that will invest in Africa. The influential rock star has teamed up with Mark Florman, a former executive at Doughty Hanson, and Gordon Moore, formerly of Cinven. The former private equity duo will run the fund – named 8 Miles, the distance between the southern tip of Europe and northern Africa – with the aim of making it one of the biggest private equity investors in Africa.

Geldof says that he has been planning to launch the fund for several years but his efforts were delayed by the onset of the financial crisis. He is expected to use his knowledge of African development to source deals for the fund, even though the venture will be entirely commercial rather than charitable. The team have already secured backing from the African Development Bank and the International Finance Corporation. Several other investors are set to sign up.

Geldof’s foray into private equity follows in the footsteps of U2’s Bono who co-founded Elevation Partners in 2005.

More widely, confidence may be being restored in Africa by the ongoing work of the World Bank on the continent. Its private-sector lending arm is leading large government-owned wealth and state pension groups into frontier markets in Africa and elsewhere where few big investors have sought to venture. The hope is that by investing money on behalf of these deep-pocketed funds in regions they would normally shun as too volatile, they will learn to appreciate the long-term profit potential.

Over the past few months, the International Finance Corp’s Asset Management Company (AMC) has made investments using capital from the Korea Investment Corporation, Azerbaijan’s state oil fund, Dutch pension fund manager PGGM, and an unnamed fund investor in Saudi Arabia. The first investments by AMC’s Africa, Latin America and Caribbean “ALAC” fund have gone into HeidelbergCement, the world’s fourth largest cement maker, which has expansion plans in west and central Africa, and Ecobank Transnational, a leading pan-African bank group seeking to boost lending.

While the investors do not have a say in where the money is invested, the initial choices appear to be conservative, focusing on segments likely to be in hot demand. “The investments we have made so far show there is a strong pipeline out there,” says Gavin Wilson, AMC chief executive.

World Bank President Robert Zoellick first pitched the idea of using money from powerful sovereign wealth funds of Asia and the Middle East in 2008, challenging them to invest one percent of their assets in Africa. The funds have amassed nearly $3trn in assets, and a one percent investment of their assets could add up to $30bn a year in private investment for Africa. “We are seen as a safe pair of hands by those who have previously not done much investing in emerging markets,” says Wilson. “They recognise we’re not going to take foolish risks, or try to invest the funds too quickly and move on to the next thing.”

Noting this milestone in its August paper: ‘The Commodity Investor – The $300bn question’ – Barclays Capital also confirmed the growth of index swaps as the main driver for this sub-sector, following a large outflow of funds from physically backed gold products. It added that over the past 10 years, commodity AUMs had risen by $290bn, with investment inflows amounting to $245bn, at an annual average rate of about $24bn.

Since ETFs (Exchange-Traded Funds) made their debut in the US 17 years ago the industry has developed to the point where these vehicles are now viewed as everyday investment tools for portfolio planning purposes. In the interim, choice has widened – led by ETCs (Exchange Traded Commodities) − with products becoming ever more sophisticated.

Fund issuer, Black Rock, in its ‘ETF Landscape Industry Review: End of Q2 2010’ reported that as of end-April 2010 the ETF industry globally comprised 2,252 products with 4,637 listings, assets of $1,025.9bn from 130 providers on 42 exchanges.

YTD assets were showing a one percent decline, as opposed to a 10.9 percent fall in the MSCI World Index in dollar terms.

Breaking the numbers down, the US industry comprised 846 ETFs, assets of $693.2bn, from 30 providers on two exchanges.

In Europe, there were 961 ETFs with 2,979 listings, assets of $218bn, from 35 providers on 18 exchanges, while in Asia the corresponding numbers were: 254 ETFs, 360 listings, assets of $74.1bn from 66 providers on 15 exchanges.
Bringing up the rear were Canada (145 ETFs, 170 listings, assets of $30.4bn, from four providers on one exchange) and Latin America (21 ETFs, 257 listings, assets of $8.4bn from three providers on three exchanges).

Whether commodity-based funds of this type are referred to as ETCs or Commodity ETFs, the underlying principle is basically the same, though subject to the laws of the jurisdiction in which they operate, of course.

The key point for ETCs is broad exposure to the commodities markets and, by extension, at a significantly reduced risk to the investor than would ordinarily be the case via more specifically targeted futures and options trading contracts.

ETCs in their simplest form are pooled investments tracking an underlying commodity or basket of commodities. Self evidently, single commodity ETCs will follow the spot price of say gold, while index-tracking ETCs will follow a group of commodities.

They also have the benefit of being open-ended – hence units can be created or redeemed on a continuous basis by market makers, matching the liquidity of the underlying markets. Therefore, supply is theoretically unlimited and price changes will reflect developments in the price of the underlying commodity being tracked.

Life is never that simple of course and for the investor there are myriad ETCs available.

The first and most obvious ones are equity ETCs giving investors exposure to mining companies involved in commodities production.

Alternatively, ETCs based on futures contracts do what they say on the tin – the underlying principle being that contracts are settled or swapped for cash before their expiry date.

Physical ETFs, on the other hand, hold the actual physical commodity with individual investors owning a fractional amount of the commodity concerned. The company rather than the investor takes on the physical delivery of the said commodity.

Finally, there are swaps-based vehicles − a swap in its basic form being an agreement between two parties to swap future cash flows.

Swaps-based ETCs having been gaining in popularity as managers have sought to keep their total expense ratios (TER) down, given that a full replication ETC buying every constituent of a given index is going to incur additional costs for the manager. Swaps-based ETCs also allow for one set of holdings to be used as a substitute for the benchmark the ETC is following.

The downside is that the counterparty could theoretically default on its obligation. Liquidity and transparency can also become issues.

If default is a very real issue for swaps-based ETCs their futures-based counterparts face the possible negative impact of contango.

In a futures context a market is said to be in contango if the price of a commodity for future delivery is higher than the spot price, or where a far future delivery price is higher than a nearer future delivery. While this may be a normal situation for equity markets a fund operating in a market in contango may face the prospect of being forced into buying more expensive futures contracts as nearer contracts expire, in order to avoid having to take delivery of a particular commodity. As a consequence, investors end up paying the penalty in the form of lower returns as profits are impacted. The opposite effect of contango is known as backwardation.

Of course, companies use their own strategies to lessen the impact of contango, not least Invesco PowerShares Capital Management through its stable of US-listed PowerShares DB funds based on Deutsche Bank Indices.

Noting there is a great deal of learning taking place in the ETC space, Bryon Lake, senior product manager at Invesco PowerShares, says PowerShares has a strong focus on educating advisers through its PowerShares Universities (PSUs).

He adds that a great deal of time has been spent discussing the potential benefits of the PowerShares DB lineup such as the Optimum Yield roll process.

“Since the underlying holdings in most ETC products are futures contracts, the way in which those contracts are rolled is of great significance.

“Futures returns are driven by three things, spot return, collateral return, and roll return. There isn’t much you can do about spot, unlike some actively managed commodity offerings, the Index does not collateralise with any security other than 90-day or less Treasury bills. This avoids adding bond risk or duration risk to the commodity fund.

“The Optimum Yield process, which is implemented in all of the PowerShares DB funds, seeks to maximise the positive impact of backwardation and minimise the negative impact of contango in the futures market,” he notes.

“We believe the employment of this strategy unlike some of the more rigid front month rolling strategies may level the playing field for investors wishing to implement strategies that have been utilised by professional investors,” he adds.

The firm’s PowerShares DB Precious Metals Fund (DBP) – tracking the Deutsche Bank Liquid Commodity Index – Optimum Yield Precious Metals (Index) and managed by DB Commodity Services – is based on gold and silver futures contracts.

Through end-June 2010 the fund’s NAV was showing a 33.1 percent return over 12 months, 11.81 percent over two years 19.85 percent over three and 18.60 percent since inception. Corresponding figures for the DB Precious Metals Index were 34.41 percent, 12.61, 20.72 and 19.52 respectively. The Index had a 79.8 percent weighting in gold, 20.20 percent in silver.

PowerShares DB Commodity Index Tracking Fund (DBC) on the other hand, has a wider brief – the fund being based on the Deutsche Bank Liquid Commodity Index — Optimum Yield Diversified Excess Return (Index), and composed of futures contracts on 14 of the most heavily-traded and important physical commodities in the world.

The big beast in the precious metals jungle though is US-listed SPDR Gold Shares marketed by State Street Global Markets.

Noting it’s the second largest ETF in the world ($52bn in assets as of end-August), behind SPDR S&P 500, Tom Anderson, Head of the Strategy and Research Group for the Intermediary Business Group for State Street Global Advisors, says that as investors’ views of gold shift from a safe haven asset to a core allocation, demand for gold will remain strong.

At the end of the second quarter, total identifiable gold demand reached a quarterly record high of 1,050.3 tonnes, according to Anderson – a result of a rise in identifiable investment and industrial demand and a slight decline in jewelry demand.

“Identifiable investment demand was the strongest performing segment, with a 118 percent increase over Q2 2009.

Gold ETF demand played a significant role in this substantial rise, growing to 291.3 tonnes, an increase of 414 percent over Q2 2009. Investors bought 273.8 net tonnes of gold via exchange traded funds, bringing total gold to a new high of 2,041.8 tonnes, worth $81.6bn at the end of the second quarter,” he says.

Designed to track the price of gold with the yellow metal physically held in an allocated account, the fund – YTD to August 31 – was showing a 13.75 percent increase against 13.4 percent uplift for the spot price of gold.

Corresponding figures over 12 months were 30.74 percent and 30.4 percent. Since inception (November 2004) the fund was showing a gain of 18.92 percent against a 19.61 percent rise for spot gold.

In the UK and Europe meanwhile the ETF industry can trace its origins back to April 2000 when Merrill Lynch listed two vehicles tracking the Eurostoxx 50 and Stoxx 50 indices on the Frankfurt Stock Exchange. iShares listed its first ETF in the UK shortly afterwards, with a FTSE 100 linked fund. However, the first ETC wasn’t launched until 2005, after The Committee of European Securities Regulators (Cesr) clarified the definition as to what benchmarks product providers could use under the Ucits III Directive – allowing for the creation of commodity indices.

Ucits III (Undertakings for Collective Investment in Transferable Securities) is the latest version of Europe-wide regulations governing the creation and distribution of pooled investment funds, including mutual funds and exchange-traded funds.

A stamp of EU-wide regulatory approval, a UCITS fund listed on one European exchange may be “passported” to and distributed in all other Member States. Almost all European ETFs are now structured to comply with Ucits III.

Equally important, the implementation of Ucits III from 2002 created the necessary conditions allowing for issuers to create ETFs using swaps and other derivatives.

Philip Knueppel Vice President db ETC Product Management notes the ETC market is heavily dominated by the UK, with gold accounting for roughly 80 percent of AUM. He adds that ETCs have approximately 50 percent of the overall ETF market.

Kneuppel notes that under Ucits III it is only possible to issue ETFs on well diversified indices, so at least seven non-correlated underlyings are needed, which is far too many if you look into the commodity world.

“For ETCs you want to trade sectors like industrial metals or energy or even single commodities like gold or oil. So, an ETF is simply not possible in this market and ETCs are the best alternative,” he says db x-trackers, Deutsche Bank’s Exchange Traded Funds (ETFs) index tracking solution platform (launched in January 2007), is currently the fastest growing ETF provider in Europe, with over £20bn of AUM according to the latest available figures.

The Luxembourg-domiciled firm’s ETFs are listed on six different exchanges across Europe and Asia (Borsa Italiana, Frankfurt Xetra, Paris Euronext, London Stock Exchange, Zurich SIX Swiss Exchange and Singapore Exchange SGX) and are supported by multiple market makers.

On the LSE, over 60 ETFs are covered offering equity, fixed income, credit, money markets and commodities.
With gold recently hitting an all-time high and silver climbing to 30-month high investors could be forgiven for thinking that ETCs represent nothing more than a precious metals investment play.

But as last summer’s heat and drought in the wheat producing areas of Russia – prompting a temporary ban on exports – showed, agriculture, along with the usual suspects such as oil, are set to become even more important.

Indeed, Bryon Lake of Invesco PowerShares says that globally there are a number of macro factors that are impacting commodities. Agriculture has been getting a great deal of attention lately due to the impact on supply from wild fires and poorer harvests.

“The feedback we are seeing from clients is that broad based commodity ETFs such as PowerShares DB Agriculture Fund (DBA) and PowerShares DB Commodity Index Tracking Fund (DBC) offer direct access to some of the permanent shifts that are taking place globally in the commodity space,” he says.

Lake notes, for example, significant shifts in the eating patterns of the emerging markets’ middle classes.
For example Brazil, from 1996 to 2008, witnessed double digit growth in GDP, which in turn had a knock-on effect for meat and dairy product demand.

Indeed, in 2008, red meat and poultry meat consumption was 31 kg above its 1993 level at 89 kilograms per person. Yet meat production takes four times as many resources as producing plant-based foods, which will lead to increasing demand for other staple crops such as corn, soy and grains, says Lake.

Additionally, continued population growth in emerging markets creates further demand for agriculture producers.
“Finally, we are also watching interesting shifts in the base metals complex as producers like Chile watch their production go down and consumers like China are seeing double digit demand for metals like copper.

“We believe, PowerShares DB Base Metals (DBB), which offers exposure to aluminum, zinc and copper (grade A), looks like a good opportunity to invest in the continued emergence of countries, like Brazil, India, and China.”

Looking ahead, Black Rock has found almost 55 percent of institutions currently employing ETFs expect their usage of the product to increase in the next three years − including nearly 20 percent that expect the amount of assets dedicated to ETFs to grow by 5–10 percent in that period. However, around 20 percent of plan sponsors expect to reduce their use of ETFs.

The issuer also found that 30 percent of institutions not using ETFs say they lack familiarity with the product. Self evidently, many investment consultants are either not recommending ETFs to clients or even initiating discussions with them, according to Black Rock.

On a global level many regulators are now looking at rules regarding short selling, the use of commodity futures, the use of derivatives and the transparency of fees. Given many of the documents examining these issues, such as the European Union directive on markets in Financial Instruments (MifID II) and the Retail Distribution Review in the UK, are either in consultation phase or have yet to be implemented, a high degree of uncertainty remains for the industry.

In the market itself meanwhile, it has yet to be determined whether the increasing tendency for investors to buy swaps-based ETCs is part of a definitive trend. What is clear however is that commodities will continue to be a valid investment play given the global macroeconomic uncertainties in the West as the banking system – two years on following the collapse of Lehman Brothers – continues to rebuild itself.

The disposal is expected to be one of the biggest privatisations ever embarked upon in Africa, with asset sales likely to be in excess of $10bn. If it succeeds in boosting power generation where previous efforts have failed, Nigeria’s non-oil economy can be expected to grow exponentially over the next decade, bringing immense rewards for the power companies who succeed in helping Africa’s crippled giant to switch the lights on.

Despite decades of broken promises by successive military and civilian governments to reform power generation, expectations for the power sector asset disposal are high. Paradoxically, Nigeria is sub-Saharan Africa’s biggest oil and gas exporter, yet it has one of the lowest per capita supplies of electricity in the world.

The scale of the Nigerian power sector calamity is difficult to exaggerate. On a good day, Nigeria can generate around 3,000 mega watts of electricity – about one tenth of what South Africa generates with a third of Nigeria’s population. Even tiny Ghana, with one sixth of the population, generates more electricity than its giant neighbour.

But there aren’t that many good days. Power generation frequently falls below 1,000 mega watts, leaving the country with as little as a couple of hours of electricity a day. Blackouts and brownouts can last for days, even weeks, while some regions may have no power for months at a time – if at all. Estimates on the balance of supply and demand vary considerably, but it is generally acknowledged that demand is running about 25 times in excess of supply.

Consequently, the Nigerian economy – like those in many other African countries, has been forced to run on diesel generators. Nigeria currently accounts for 40 percent of all the generators imported into Africa. The Central Bank of Nigeria estimates that 60 million Nigerians are reliant on diesel generators for their main source of electricity, and they spend about $14bn a year on the imported fuel needed to run them.

An unhealthy reliance
Everything in Nigeria, from street corner mobile phone chargers to five star luxury hotels, rely on noisy, foul-smelling, diesel generators to run their businesses and bring light to their homes. For everyone else who can’t afford to buy and run a generator – the other 90 million Nigerians, kerosene lamps and candles are all that is available. Little wonder that jokes about the power sector are the main focus of Nigerian national humour.

The origins of Nigeria’s power sector failure date from the successive military regimes that ran and plundered the country prior to the return to civilian rule in 1999. Long-term planning, without which big ticket assets like power stations, cannot be designed, constructed, operated and maintained, was not a strong feature of military rule.

As a result, no new power stations were built in Nigeria for more than two decades. Most of the country’s existing power generation assets are now thirty or forty years old, and most of those break down constantly because of aging equipment, poor maintenance, a lack of spare parts, and an acute shortage of the skills needed to run them.

Former President Olusegun Obasanjo, who led the transition to democratic rule, attempted to reform Nigeria’s decrepit power sector with the 2005 Electricity Power Reform Act. It replaced the discredited state-owned generator, the National Electric Power Authority (NEPA) – known to Nigerians as “Never Expect Power Always” – with the new Power Holding Company of Nigeria (PHCN), which – because of its failure to bring about any improvement in electricity generation, soon became known to Nigerians as “Please Hold Candle Near”.

The 2005 Act broke up NEPA into its component parts, 11 regional distribution companies, six generating companies and one transmission company, in anticipation of their eventual privatisation. But then the reform impulse stalled. Instead, Obasanjo embarked in 2006 on a crash programme to build seven new, federally financed, gas-fired power stations, which were supposed to add 3,000 mega watts to the national grid within two years.

To date, nearly five years later, and after spending an estimated $15bn, not one of the new gas-fired power plants has come on line. After ten years of civilian rule, Nigeria is now generating less electricity than it was the generals were running the show, and Nigerians have had enough.

Obasanjo seemed to think that Nigeria’s power generation problem could be solved by just throwing large amounts of money at it. Unfortunately for Nigeria, it had the hard cash on hand to throw around. A poorer country would not have had that luxury, and would probably have achieved much more with considerably less.

But Nigeria lacked the power plant project management expertise and the domestic gas collection stations and transmission lines required to ensure that the new power plants were built on time, and were able to operate once completed. Even today, it is estimated that there are more than 250 shipping containers full of the generating equipment needed to run the planned new power plants sitting in Nigerian ports waiting to be collected.

Desperate to solve the one problem that effects every single Nigerian business and domestic household, President Goodluck Jonathan – with the backing of a new generation of reform-minded technocrats, has dusted off the old privatisation plans, and announced his intention to fast track power sector reform. There have been plenty of groans from Nigerians and foreign investors alike of “here we go again”. But this time things could be different.

Nigeria intends to keep the transmission grid as a federal asset, but will out source its management to a private sector operator. Three companies, including Manitoba Hydro of Canada, the Power Grid Corp of India and the Electricity Supply Board of Ireland have been short listed to operate the national grid, and a decision on who will win the contract is expected before the end of the year.

Majority stakes in the eleven regional distribution companies (discos) and six generating companies (gencos) will be offered to core investors, who will be required to form joint ventures with the state authorities, who in turn will exit after a five year transitional period, thereby leaving the new private sector operators in sole control of all Nigerian discos and gencos.

Interest grows
Expressions of interest in running the proposed joint ventures have poured in from all over the world, with China, Brazil, Germany, Canada, Turkey, India and Saudi Arabia leading the way. Each joint venture will be listed on the Nigerian Stock Exchange, and will be required to invest several multiples of the asset cost price in new generating and distribution assets in an effort to boost performance.

The proposed power sector privatisation was hailed by Bismarck Rewane, the head of Financial Derivatives, a leading Lagos-based consultancy, as one of the key pillars of Jonathan’s reform agenda. “If he can come through with power reform, and if it is sustained, it could be a political game changer,” Rewane said. If successful, power sector privatisation could transform Nigeria out of all recognition in three to five years, he added.

The Federal Government of Nigeria estimates that something in the region of $6bn a year for each of the next five years will need to be invested in the new gencos and discos in order to bring electricity supply into line with demand. Clearly, only investors with deep pockets need apply. But given that suppressed demand is currently running about 25 times in excess of supply, along with the fact that Nigeria’s population is expected to grow from around 150 million at present to 280 million by 2050, the medium to long-term demand for electricity can be expected to grow exponentially.

With a presidential election likely to be a little more than four months away, Jonathan failed to address himself to the issue of tariffs – upon which the fate of the entire privatisation exercise rests – for obvious reasons. Telling the electorate that it can have electricity but it will have to pay for it is a sensitive issue, and one that will have to be carefully managed.

Nigerians at present pay around seven naira ($0.047) per kilowatt hour. Neighbouring Ghana, for example, pays the equivalent of 22 naira per kilowatt hour. Even Liberia and Sierra Leone charge more for electricity than Nigeria. So prices are going to have to go up – and go up considerably.

Lamido Sanusi, the Governor of the Central Bank of Nigeria, and Professor Barth Nnaji, the Presidential Advisor on Power, have both suggested that tariffs will have to be tripled to around 22 naira per kilowatt hour to attract sufficient private sector interest. Jonathan has so far shied away from putting a figure on the required increase.

But Nigerians who are able to afford diesel generators are already paying 60 to 70 naira per kilowatt hour – ten times above grid prices – to run them. Even a tripling of grid prices would be cheaper by two-thirds than running private generators. Low income consumers will be catered for with a so-called lifeline tariff – a heavily discounted rate for a specified amount of electricity a month – to ensure that the poor do not suffer from the transition from a state-sector operated to a private sector operated power sector.

The inability to solve the power sector problem to date has been the single biggest drag on Nigeria’s economic development. Last year, while growth rates in much of the OECD were flat or negative, Nigeria notched up growth of 6.7 percent. Growth in 2010 todate has been around 7.4 percent, while growth in 2011 and 2012 is expected to reach double digits – and these impressive growth rates have been achieved – astonishingly – without mains electricity.
The Central Bank of Nigeria estimates that around 60 percent of the cost of producing manufactured goods in Nigeria is accounted for by energy – that is diesel – costs. What could Nigeria achieve if it was finally able to bridge the decades-old electricity generation deficit? The importers and distributors of diesel generators and diesel fuel would see their lucrative markets evaporate, and they are expected to use every dirty trick in the book to sabotage the power sector reform programme. But every other sector of the economy would receive an enormous boost.

Africa is littered with false dawns and broken promises, and Nigeria accounts for a great many of them. But with Jonathan at the helm, backed by a cadre of determined, reform-minded politicians, officials and technocrats, there are growing expectations that this time things could turn out differently. Admittedly, considerable political uncertainty remains on the short-term horizon. No one knows yet whether Jonathan will – or will be allowed – to stand as presidential candidate for the ruling People’s Democratic Party in the forthcoming poll. But he does appear to be the only candidate who can bring power to the people.