Abraaj’s unraveling tells us due diligence must change

As you read this, liquidators from PwC and Deloitte are poring over the remnants of the Middle East’s biggest private equity firm.

Not many real estate professionals may be aware of Abraaj Group, fewer still its tribulations. However, the story of what was once a powerful force in emerging markets private equity has a bearing on anyone investing in private markets through traditional fund models.

While the wider damage the Abraaj case causes to Middle Eastern private equity is grounds for debate, relevant to all private fund managers is the need to revisit manager due diligence methods.

Abraaj had little real estate exposure, but the lessons apply across any asset class subject to investment via limited partnerships or other third-party vehicles. Since its founding in 2002, Abraaj has enjoyed the support of many investors heavily engaged with private real estate funds: the now canceled Abraaj Private Equity Fund VI, mentioned above, attracted commitments from US pensions Washington State Investment Board, Teacher Retirement System of Texas, Teachers’ Retirement System of Louisiana and the Employees’ Retirement System of the State of Hawaii – all of which have significant real estate fund positions.

Regardless of how thorough their governance scrutiny was before, further transparency over manager overheads must be inevitable. While managers are often open about fund fees and costs, non-listed private managers are not obliged to share their P&Ls, even if some do.

But how many are even asked for these numbers? Two prominent consultancies told PERE in the last week how they have dedicated operational due diligence units, with assessing manager overheads a big part of what they do. Nevertheless, we understand that another consultancy funnelled more than $1 billion of advisory and discretionary capital into Abraaj’s cancelled global mega fund – it would be hard to imagine that consultancy is not also reevaluating its diligence processes. It may well be subject to greater scrutiny from its clients, too.

According to one of the two consultancies with due diligence units, less than half of real estate managers currently share their balance sheets; for that half, the consultant constructs what it imagines to be the firm’s financial situation via interviews and publicly available data. That must be considered alarming; private real estate’s supposed sophistication will be hampered if such opacity continues.

Managers may well be uncomfortable explaining where their fee income is deployed. Some may even try branding the Abraaj case as a reflection of engaging with emerging market strategies – which would probably be unfair. But managers giving investors and their consultants clear guidance on what it costs to run their operations is a minimum requirement and the Abraaj case should serve as a prompt to visit, or revisit, a proper evaluation of those costs.

To contact the author, email jonathan.b@peimedia.com