Baghdad or Baltimore: Which is More Dangerous?

“Baltimore is more dangerous than Baghdad when you look at chances of being killed by another person,” said a principal at an Iraq-dedicated hedge fund with about $85 million invested in Iraq.

Despite the obvious risks like security and ISIS, Iraq is a highly attractive frontier market opportunity to the principal at the hedge fund, which only invests in Iraqi-listed equities and is the largest non-Iraqi investor on the local stock exchange.

“The attraction of the investment right now is that the risks are generally well known, well understood and priced in. What’s not priced in are any positive surprises or developments,” said the investor.

 “When I used to go to Iraq, I’d use a professional security team. Now I just go around with our local analysts with a driver in a Hyundai. I’ve never had a bad experience, knock on wood,” he said. “So that’s a perceived risk that’s not really affecting the investment environment that much.”

The investor recently spoke with OnFrontiers by phone. Read highlights from the interview below.

So what is the biggest risk in Iraq?

Oil. It drives everything in the system from liquidity to money supply to the strength of the currency. So with the downturn in the oil price we are seeing this risk manifest itself, and that’s what matters most for Iraq.

On the flip side, that’s what I mean when I say the risks are well understood. Everyone is focused on the oil price crash, but no one has priced in the potential for a rebound.

If you look at sentiment in the oil market, it’s fascinating how at the bottom it’s always universally bearish. We have a couple examples in history – and we are at that moment now, where we have every reason to be worried about the oil price and that’s usually when you see a market turn higher.

As for politics, Iraq has always been noisy, and we expect that to continue, as we are seeing now in Baghdad. The most important thing politically is that the key players continue to play by the same rules and act within the system – and so far they are doing that in the current volatility we’re seeing in Baghdad.

As equity investors, corporate governance is also clearly a risk.

 How do you manage risks like corruption?

The key to managing corruption and bad corporate governance most effectively is to make sure there is a high margin of safety factored into the investment.

You have to assume that local management will engage in bad behavior or be exposed to government officials who do, so the entry price on an investment has to be low enough so that you are compensated even if you are victimized.

In Iraq – the valuations in the public market for stocks are arguably the cheapest in the world. It’s about four and a half times earnings right now based on our estimates. So there is a margin of safety.

 What can you do to try to improve governance?

We are on the boards of several Iraqi blue chips, so we try to engage and bring constructive criticism at the board level to try to improve governance.

But at the end of the day, they are local, they are Iraqi and we are not. So there is a limit to how much influence we can have.

How do you do on-the-ground due diligence there?

I go there once a quarter. I meet with the management of the companies we own. You develop a relationship with them so they feel like they can be honest with you.

For example, when I first met the CEO of our biggest investment – a leading consumer goods company – in 2012, he was very suspicious. Here is an American, and this guy is an Iraqi nationalist. It is fair to say he had no particularly fond feelings for Americans. He was very skeptical.

But now he sees us every quarter and he sees that we are long-term investors who respect him and who share the same goals for his company.

The most valuable insights come from the locals whose trust you’ve earned over time.

What is the regulation of the stock market like in Iraq?

To my mind, that is one of the most overlooked positive legacies from the American involvement in Iraq.

The infrastructure they have for the exchange is among the most advanced for any emerging market in the world. The exchange is all computerized and runs on NASDAQ technology. Most of the regulatory framework and disclosure rules are modeled on the most effective practices of the SEC.

So the disclosures, the listing requirements and the transparency that’s required – it’s on par with what we have in the West. The question is what’s going on behind the scenes with some companies… Cynically, what you are seeing is what we call: “profits after stealing.” That is why it is so important to invest alongside management teams you trust.

I see the head of the exchange every time I’m in Baghdad. He’s on a mission to make the Iraq Stock Exchange one of the best in the Middle East. So let’s hope he does it.

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