Investment Banking Essay, Research Paper

Introduction to the topic:

The topic we are approaching is Fund Management Companies; the job of those companies is to manage the funds or in simpler terms the money of the individuals or the corporations. They take the money and invest it through one of many different methods like buying shares in a promising company, for example. This is very simply what fund management companies do.

What we did is that we chose a practical example for a fund management company operating in Egypt to see what they are really doing. We chose EFG-HERMES to be our example.

Throughout the paper we will discuss the company and its different investments concentrating on fund management job.

Executive Summary

In this paper we are discussing fund management companies using EFG-Hermes as an example. The paper can be summarized in the following points :

? Introduction about EFG-Hermes in Egypt.

? The mission and the objective of EFG-Hermes Asset Management aims to be the leading investment manager for private and institutional portfolios in Egypt, the Middle East, and North Africa.

? The five divisions of EFG-Hermes are Investment banking which prepares companies for being listed; Securities brokerage which is for trading stocks; Private equity which is a service in which it invests its own money in emerging and not listed companies; fund management which is managing money of a group of people (like for a bank); and finally portfolio management which is managing funds for individuals or organizations.

? The investment strategy of the company is to provide investment management excellence to its clients which entails the identification of each client’s return/risk and the desire of a suitable portfolio to match this profile, and the policies for investments serves this strategy also.

Introduction

EFG

The Egyptian Financial Group (EFG) was established in 1980 as the first investment banking firm in Egypt. For more than 15 years it offered its clients a variety of services and was involved in a large number of privatization studies for the Egyptian government. EFG moved into brokerage in 1993 and Asset management in 1994. EFG established the first equity index in Egypt.

Hermes

In 1994, Hermes was established as another leading financial services company based on the international experience gained by its founders in the U.S.A . and on a young energetic team. Hermes showed great success in securities brokerage and fund management.

The Merger

When the local market had reached a point where large financial institutions were needed with real financial muscles and a wide network of local and international clients, the two firms decided to merge.

In 1996, EFG-Hermes was born out of the highly publicized merger between the Egyptian Financial Group (EFG) and Hermes Financial.

EFG – Hermes Now

The company’s present structure reflects the consolidation of several ventures. Created with the merger in June 1996 of the Egyptian Financial Group (EFG) and the Hermes Financial Group, EFG-Hermes conducts business through 10 operating subsidiaries, located in Egypt and offshore.

The process of centralizing and institutionalizing the combined company’s procedures continued through 1998, with emphasis on streamlining the operations of subsidiaries and minimizing risk. Changes aimed at eliminating bottlenecks included new account-opening forms and a different formula for commissions.

EFG-Hermes’ activities are regulated by the Egyptian Capital Market Authority, and the firm also has a secondary regulatory reporting line with the London Stock Exchange, following its listing on 28 July 1998.

EFG-Hermes is organized into five principal divisions (which will be discussed in detail further in the paper) :

1) Investment Banking

2) Securities Brokerage

3) Private Equity

4) Fund Management

5) Portfolio Management

Mission & Objective

EFG-Hermes Asset Management aims to be the leading investment manager for private and institutional portfolios in Egypt, The Middle East and North Africa.

The company can aspire to this goal through achieving premium investment performance in the innovative products and solutions that it bring to an increasingly competitive market. EFG-Hermes believes a thorough, research-driven approach to its investment decision-making is necessary to the successful growth of its business.

The Group’s internal systems are always tailored to manage the growing diversity of products and resources, ensuring that it maintains the highest professional standards in all its activities.

EFG-Hermes Asset Management has the skills and flexibility to cater for a wide range of clients with different needs. It guarantees that the interests of their clients are protected and monitored through rigorous compliance procedures.

Managing Growth

EFG-Hermes Asset Management’s strategy is to manage growth while maintaining the highest quality service to existing clients. It will grow assets under management in a disciplined and controlled fashion, without prejudicing the interests of existing clients.

Mandates that EFG-Hermes is seeking to develop include private pension funds, specialist sector-based funds and regional funds. As the domestic Egyptian and regional markets develop, EFG-Hermes believes there is considerable potential for increasing the number of institutional portfolios as well as broadening its range of Individual client mandates in Portfolio Management.

In its capacity as leading participants in capital market development across the region, EFG-Hermes will continue to pursue its role of developing public awareness in the benefits of capital markets, their products and their role in capital formation and economic development.

The Five Divisions of EFG-Hermes :

1) Investment Banking :

An investment banker is one which acts as an underwriter or agent for corporations and municipalities issuing securities, but does not accept deposits or make loans. Most also maintain broker/dealer operations, maintain markets for previously issued securities, and offer advisory services to investors. As EFG-Hermes increased its commitment to domestic and regional private sector development, Investment Banking focused on traditional industries and on the rapidly emerging telecom and information technology sectors.

The firm, closely involved with established Egyptian companies looking for a place on the regional map, served as global coordinator on a LE97.6 million IPO for Al Ezz Porcelain, Egypt’s leading porcelain-tile producer. In the food industry sector, we acted as global coordinator for the LE142 million public offering of Savola Sime Egypt. This transaction set new precedents: the first Egyptian IPO for an Arab Gulf subsidiary and the first Egyptian stock sold directly in the USA under Regulation 144A.

EFG-Hermes also played a major role in advisories, advising Amoun Pharmaceutical Industries in its sale for LE400 million to pharmaceutical giant Glaxo Wellcome-the largest transnational M&A transaction involving an Egyptian private sector company to date. Another client, Oriental Weavers, a global player in rug manufacturing, became a case study in successful restructuring.

Despite a downturn in tourism and hospitality following the November 1997 Luxor incident, EFG-Hermes entered this sector, looking forward to the inevitable recovery. In March, the group became sole placement manager for the LE61.2 million sale of shares in Orascom Projects and Touristic Development, and in July, managed to raise LE137.5 million for Orascom Hotels Holding.

By August, 1996, the firm was involved in sell side as well as buy side advisory mandates on behalf of a number of local and international clients. The firm’s backlog deals (August, 1996) stands at its highest point and continues to grow in terms of public offerings, it exceeds LE 250 million, all of which represents private sector clients. Moreover, in terms of strategic sales it was involved in several sell side advisory mandates with an aggregate value of over LE 1.1 billion. The firm’s backlog of fixed income products of LE 500 million represents three forthcoming debt issues.

Telecommunications and information technology (IT) represent areas of rapid growth in developing markets. As sole financial advisor to Vodafone and AirTouch in the creation of Misrfone, Egypt’s second GSM network, EFG-Hermes handled the LE1.8 billion licensing agreement and oversaw the country’s largest-ever loan syndication transaction, worth LE2.4 billion. In addition, having identified a need for IT specifically suited to the Arab market, we initiated the pooling of three of Egypt’s

largest IT firms under a new entity, Tritech (later Raya), a major force in software development, systems integration and hardware distribution.

EFG-Hermes concluded its first Jordanian deal in July 1998, as sole placement agent for the sale of shares worth US$26 million in Pella, owner of Jordanian GSM network Fastlink. Soon after, against stiff international competition, the firm was chosen as sole financial advisor in the Jordan Cement privatization issue. According to London’s “Financial Times”, the resulting US$100 million purchase by Lafarge

was “a triumph for Egypt’s efforts to export its privatization expertise.”

Looking also at Africa, we advised a leading Yemeni group on its US$35.7 million acquisition of a controlling stake in National Tobacco Enterprises, Ethiopia’s monopoly producer. That agreement was signed in January 1999. As economies continue to expand, EFG-Hermes should be well positioned to capitalize on regional development

2) Securities Brokerage

EFG-Hermes’ two distribution arms–Financial Brokerage Group (FBG) and Hermes Securities Brokerage (HSB)–are clear leaders in the Egyptian capital market. Facing competition from over 110 local and international firms, the combined firms have consistently maintained the highest market share. Indeed, in 1998, EFG-Hermes Securities executed over 14% of all transactions on the Cairo Stock Exchange (CSE), outgrowing its nearest competitor by over 70%.

The firm keeps a dedicated trading desk for fixed income products. Given the currently lop-sided nature of the Egyptian securities market–with few bond issues outside the government–fixed income securities represent an area of huge potential growth.

HSB caters to high net-worth individuals and private clients, locally and regionally, through an expanding network of sales outlets in Cairo and other major Egyptian cities.

FBG focuses on providing sales services exclusively to financial institutions, both international and local. In terms of both operations and capital, FBG is able to meet the requirements of all major international institutions, and its sales team and back office are among the most efficient and reliable in Egypt. Consequently, Reuters News Service’s annual “Global Emerging Markets Report” named EFG-Hermes the best firm covering Egypt for 1998.

The Securities Brokerage division includes a research department that is internationally recognized as the best in Egypt. A team of 15 analysts produces a varied array of products, such as country reports covering Egypt and (starting in 1998) Jordan, industry sectoral reports, and regularly updated coverage of over 50 actively traded companies on the CSE. Aiming to address regional

needs, the research department greatly increased its output of Arabic-language publications in 1998.

During 1998, both brokerage arms were strengthened by large investments in state-of-the-art information technology. Along with efficiency in decision making, reliable communication with clients, precise reporting and secure execution and settlement, the ongoing upgrading of capabilities has allowed EFG-Hermes Securities to consistently provide its clients with the best brokerage service in Egypt.

The brokerage division’s extensive distribution network has also proven to be a great asset in other areas of the company’s business. In textbook fashion, brokerage distribution links has enhanced the placement capabilities of the investment banking division, while the brokerage division’s placement prowess has infused investment banking clients with confidence in the firm’s ability to close deals. As EFG-Hermes continues to expand its range of fixed income products, the brokerage distribution base can be expected to grow further.

3)Private Equity

Private Equity is a service provided by EFG-Hermes in which it invests its own money in companies that are still emerging and not listed. In recent years, the Egyptian economy has developed sufficiently to provide increasing opportunities for long-term investment in the growing private sector. EFG-Hermes has promoted the directing of resources towards medium- to long-term investments in successful, well-managed privately held Egyptian companies.

The company has played an instrumental role in the establishment–based on money from institutional and private investors in Egypt and the Middle East–of two private equity investment vehicles:

? Arab Investment Company (ABIC)

? Horus Private Equity Fund (HORUS)

ABIC is an Egyptian shareholding company founded by the Arab Bank and EFG-Hermes. ABIC’s share capital is LE250 million, fully paid, and it has 120 shareholders representing most Arab countries.

In 1998, ABIC pursued a very active investment program, conducting 13 investments with a total value of LE239 million. Estimated returns, based on conservative valuations, gave investors an IRR of over 30%. ABIC’s holdings represent substantial minority stakes, ensuring board representation and an active role in the development of its investments.

HORUS is an offshore limited partnership with committed capital of US$54 million (US$35 million paid). EFG-Hermes is one of the general partners of HORUS, and also serves as the fund’s advisor, providing information on investment opportunities and advice on Egypt’s economic and financial climate. The company also gives general support to HORUS’s local office.

Most of HORUS’s investments were made in pre-IPO situations, but where an IPO was imminent. Accordingly, viable exit scenarios for the investments have been visualized. By the end of 1998, HORUS had made 11 investments with a total value of US$25 million. IRR on these investments is estimated at over 30%.

Private investment funds are sure to be a critical factor in the region’s economic development in the next century, and through involvement in ABIC and HORUS, EFG-Hermes Private Equity has already established a firm foothold in the field at a critical initial stage.

4) Fund Management

Fund management is an essential service provided by EFG-Hermes. Being a fund manager means that EFG-Hermes manages the money of other organizations. In funds, the money that EFG-Hermes manages does not belong to one individual, but instead to a group of people. An example would be managing the money of a bank (the bank does not own the money, but it just collected money from people). So EFG-Hermes takes this fund and invests it mainly by purchasing stocks of listed companies.

Procedure :

First promoter (the bank for example) sits with the fund manager (EFG-Hermes) to write a prospectus. This prospectus is like an agreement on some broad regulations EFG-Hermes must follow in investing the fund. The prospectus follows the guidelines of law. It is then submitted to the CMA (Capital Market Authority) for approval. Then it is published in two major newspapers. After that, the subscription period begins.

Approaches :

There are two approaches for making investment plans; top down and bottom up. By using the top down the firm would first look at well performing countries. Then after choosing the country look at the different fields in this country, then look at a certain company. The bottom up approach works the other way around; the firm would first choose the company that it will invest in, then look at the entire field, then entire country.

Types of Funds:

EFG-Hermes invests in different types of funds. The major types of funds are :

1) Open ended vs Closed Ended : All the funds are open ended except the Delta Mutual Fund which is closed ended. The closed ended one has no redemptions nor subscriptions.

2) Islamic Fund : These are funds in which no investments are made in any alcoholic products, cigarettes, hotels, or any ‘borrowing’ transactions. The two Islamic funds are Al Rajhy and Faisal.

3) Local vs Offshore : The local funds are those invested in companies listed in Egypt, while the offshore is for countries listed outside Egypt.

4) Growth vs Income : The growth funds are the investments in companies which don’t distribute dividends and keep the money as Retained Earnings, while the income funds are those in companies that distribute dividends. Most funds are income funds, while the Cairo fund is growth.

5) High risk vs low risk : These are investments in companies with either high or low risk. High risk companies generally offer high return, while low risk offer low return.

The mutual funds division in EFG-Hermes operates through four subsidiaries: Egyptian Fund Management Group (EFMG); Hermes Fund Management (HFM); Hermes Financial Management (Egypt); and EFG-Hermes (UK) Limited. The four entities combined manage a family of eleven mutual funds. These include six local mutual funds as well as five offshore funds, three of which are listed on the Irish Stock Exchange. Five of the local funds are open-ended and the sixth is a closed-ended vehicle listed on the Cairo Stock Exchange.

The fund management division has recently established EFG-Hermes UK, which will facilitate the management of country, and regional offshore Middle Eastern Funds.

The Mutual Fund group’s goal in managing equity, fixed income and balanced accounts is to produce superior returns while minimizing volatility. In the firm’s opinion, asset allocation is the most important factor in determining portfolio returns and risk levels.

Each fund’s stated investment objective and policy determines portfolio asset allocations, which the Investment Committee adjusts depending on the overall economic outlook and equity valuation.

EFG-Hermes uses a “bottom up” approach for equity management, concentrating on both fundamental and technical analyses. The firm believes that predicting future securities values depends mainly on forecasting future earnings and the market valuation of these earnings. In this context, it seeks to identify growth opportunities or deeply discounted value plays.

A “top down” strategy is used for fixed income securities, focusing on interest rate forecasts followed by duration issuer quality and security liquidity.

The following table shows an example of the performance of funds managed by EFG-Hermes performance update. It compares years 1996, 1997, 1998 as well as mid year, quarter, and last month.

The table shows that all funds have been going down in 1997 then increased in 1998. This was because in 1997 the entire Egyptian market was going down starting February. In 1998, the entire market went up. The situation of the market could be detected from the Capital Market index at the bottom of the table. One of the factors that helped the funds of EFG-Hermes is that it began to purchase stocks in Mobinil in 1998. The following table shows the top 10 performance stocks in which EFG-Hermes invested in.

Each of the funds has a prospectus (as previously explained). After the table are 2 examples of the prospectuses of two funds (Al Rajhy and Banque Du Cair)

Portfolio Management

The difference between a fund a portfolio is that for the fund, the money

managed is not owned by one individual, but instead by a group of people. As for the portfolio, it is the money of one organization or person.

A conventional portfolio is formed out of a mixture of three asset classes; Stocks, Bonds and Cash (T-Bills/ Bank Deposits).Diversification among asset classes reduces the volatility of portfolio return and hence the overall risk. It is a well-known fact that good performance is mainly attributed to wise asset allocation among asset classes; i.e. low equity exposure at market peak and high equity exposure at trough. The second contributor to good performance is picking the right securities within each asset class; a process referred to as “stock picking”.

At EPMG, there is a track record of wise and fairly aggressive changes in asset allocation to benefit from market cycles.

As for stock picking, EFG-Hermes follows a bottom-up approach in making investment decisions. Its potential universe of stocks includes only solid companies with healthy financial position and sustainable profits. The firm thus pay a lot of attention to Fundamental Analysis. But timing is what counts in investments so the firm uses a few Technical models as well to determine the target buy/sell levels.

At EPMG, the firm has a product for clients with different risk tolerance levels. The Indexed Portfolio is for clients who follow the market closely, believe in asset allocation and who would like to form a portfolio which replicates the performance of the market as represented by an index. This is the only Indexed Portfolio designed for the Egyptian market so don’t bother looking elsewhere.

For a less aggressive client with a normal risk tolerance level, EFG-Hermes offers its Balanced Portfolio which depends on its capability in making aggressive asset allocation and stock picking as well. The aim for Balanced Portfolios is to achieve a descent return over a 3-4 year investment horizon while safe guarding the principal in any environment.

For the very cautious client who does not mind giving away potential high returns for a safer investment, EFG-Hermes offers the Capital Guaranteed Portfolio in which a First Class Bank (The Arab Bank PLC.) guarantees 100% of the principal while leaving the upside potential partially opened.

EFG-Hermes deals with International Custodian Banks which means that its clients are not exposed to credit risk. The firm provides its clients with monthly detailed Valuation Reports, News letter which keeps them up to date with the current environment and its View on the Market.

EFG-Hermes’ portfolio management company, Egyptian Portfolio Management Group (EPMG), offers tailored services to institutional and high networth individual investors. The firm’s partner in EPMG is the ARAB BANK plc, the fourth largest Arab Bank with total assets exceeding $ 20 billion as of end 1996.

Investment Objective

The Company’s investment objective is long term capital appreciation. The Company seeks to achieve this objective by investing in Egyptian equity and equity related securities. No assurance can be given that the Company’s investment objective will be achieved

Investment Strategy

The mission in EPMG is to provide investment management excellence to its clients which entails the identification of each client’s return / risk profile and the design of a suitable portfolio to match this profile. The firm’s objective is to achieve for its client a sustainable superior performance over a long period. Its investment strategy is based on a bottom up approach. Its approved list of stocks is chosen and periodically updated on the basis of fundamental strength of the underlying companies. This means that it does not consider daily changed in the stock market, rather on the performance of the company itself. However, the weight of every stock in the portfolio as well as the overall equity portion of the portfolio is continuously revised to reflect technical factors which relate to the supply-demand of the stock(s) in the market. To allow for liquidity, a model portfolio typically includes 15 companies with an above average size in terms of market capitalization.

Investment Policy

The Company invests primarily in securities of companies that are established or doing a substantial part of their business in Egypt or which are listed on the ESE. The Company seeks to acquire a prudently diversified investment portfolio in terms of exposure to any one issuer or group and in terms of exposure to any particular economic sector. The Egyptian equity securities in which the Company invests consist predominantly of common stock and preferred stock of Egyptian issuers, although the Company may also invest in convertible securities, options and warrants of Egyptian issuers if they are available. The Company does not invest in securities of start-up companies, other than in connection with privatizations.

The Company also invests in securities of companies that are being privatized by the Egyptian Government or divested by public sector enterprises. The Directors believe that these privatizations will have two significant results: a shift of management from government and public sector control to the private sector and the opening up to development of certain strategic economic sectors. Each privatization transaction is subject to its particular political and economic factors, which may vary the terms upon which investors, such as the Company, may participate.

Subject to the investment restrictions referred to below, the Company is allowed to invest in unlisted securities but will only do so if the Manager holds an expectation that the relevant securities will be listed within one year of the relevant investment.

The Company’s primary focus is on Egyptian issuers of above average size in terms of the market capitalization, although the Company reserves the right to invest its assets in the securities of issuers with smaller market capitalization’s (companies with an average market capitalization currently being, for these purposes, companies having a market capitalization of approximately US$275 million). Neither the Company nor the Manager are involved in the day-to-day management of portfolio companies and in no circumstances does the Company acquire legal or management control of any such companies. However, because of its shareholdings, the Company may have the power to influence management. It exercises this power only in extraordinary circumstances, including in connection with the implementation by the Company of an exit strategy in respect of any investment.

Pending investment or re-investment in Egyptian equity securities of the proceeds of the issue of Shares or the proceeds of any realization of investments or distributions to Shareholders, and to the extent otherwise considered appropriate by the Directors for meeting cash needs, the Company invests all or a portion of its assets not invested in Egyptian equity securities in cash deposits, money market investments and Egyptian or OECD government securities.

The Company’s assets are denominated principally in Egyptian Pounds and US Dollars.

Investment Rationale

The original rationale behind the establishment of the Company and the Initial Offer was the Directors belief that Egypt was economically diverse and offered attractive and varied investment opportunities and that economic reforms and the third phase agreement with the international Monetary Fund would improve growth prospects for the country. Many Egyptian companies were experiencing growth assisted by an Egyptian Government committed to market liberalization, a reduction in government bureaucracy, privatization and policies favoring exports. The Directors continue to hold these beliefs and consider that Government policy and economic and market growth since the Initial Offer is wholly consistent with such beliefs.

Portfolio Guidelines & Constraints

As earlier mentioned, the allocation of a client’s assets is based on his return / risk profile, and is guided by a few constraints. Following is a typical list of such constraints:

1. EPMG will not invest more than 20% of the Net Asset Value of the portfolio in securities which are not listed on the Egyptian stock exchanges or other regulated stock exchange.

2. EPMG will not invest more than 20% of the portfolio in any one stock.

3. EPMG will not invest more than 30% of the portfolio in any one economic sector.

4. Generally speaking, EPMG invests in Egyptian Securities. However, given window opportunities, EPMG will be allowed to invest up to 25% of the portfolio in US$ denominated Country / Regional / Global funds.

5. EPMG will not buy or sell commodities, futures or options contracts.

6. EPMG will not deal short or on margin except after getting the client’s written approval.

7. The portfolio will be kept with a Custodian Bank. EPMG will be allowed to deal with the portfolio on a Delivery versus payment (DVP) basis.

It is imperative to emphasize that every client drafts for EPMG his own guidelines. The client has the right in interfere in any decision made by the firm, but he doesn’t do so because that way he would be managing his own money, and there would be no need for a fund manager like EFG-Hermes.

Risk Factors

Investing in the Company involves certain considerations in