Abraaj Group was the poster child of Emerging Markets private equity investment. Founded by Arif Naqvi in 2002, the firm grew to $14 billion and counted among its investors such prominent entities as Teachers Retirement System of Texas, Bill & Melinda Gates Foundation, Washington State Investment Board, World Bank, and dozens of other highly sophisticated investors. At the height of its success in 2015, the firm raised almost $1.5 billion to invest in Africa, in just under 12 months.
Then things spiraled out of control quickly.
Several limited partners began asking questions about the use of funds. A 2017 independent audit showed that the management company was siphoning investors’ money to fund its own operations. A spectacular collapse followed. The founder, Arif Naqvi was arrested on fraud charges, along with other two top executives. What took 16 years to build unraveled in less than 4 months.
Many investors who made an investment in Abraaj followed advice of a single large consultant, Hamilton Lane, who encouraged investors to commit as much as $900 million to Abraaj in 2017, just a few months before things began unraveling.
Yet, others avoided investment. TorreyCove Capital, another consulting firm, wrote: “we met with Abraaj several times over the course of months and had concerns… we were fortunate enough to be able to speak with former employees who described problematic management practices”, according to a Pension & Investments article.
To paraphrase Tolstoy, every debacle in the world of private funds is different in its own way. What unites most of them is that sophisticated investors who suffered the loss always realize in hindsight how easily the problem could have been avoided had the right questions been asked early enough.
The fundamental problem lies in how due diligence is performed. Many institutional investors pay hundreds of thousands (or millions) of dollars to consulting firms to generate due diligence reports on all their current and prospective investments. Many others, including smaller investors, perform some level of due diligence themselves, or worse yet, not at all.
In every case where due diligence is performed, each investor obtains it from a single source – either an external consultant or an internal team. In case of Abraaj, the most prominent external source of due diligence missed important warning signals, resulting in many clients making a bad decision.
A large component of the risk of investing in private funds comes from non-investment activities. It is known as operational risk. Because it’s so difficult to quantify, it is used as a binary filter. If a problem is noticed, the operational risk filters out the investment, otherwise it is allowed. As with all binary decisions, it is critically important to minimize the likelihood that something is missed. As readers of our previous blog posts know, we are fervent believers that a consensus opinion of experts can help increase the effectiveness of the operational risk filter.
Imagine the world where due diligence performed by many experts is recorded on a private blockchain and shared in a secure, trusted manner. How many problems would be avoided if the dissenting voices were heard along with the majority opinion? This, by the way, is the reason why public companies are eager to obtain analyst coverage from multiple sources: broader coverage = better decisions = wider investor participation.
In the world we envision, access to multiple expert opinions about private funds would make the entire ecosystem more transparent, less prone to manipulation, and improve transactional flow, something that all participants are ultimately hoping for.
DDX Technologies is developing a comprehensive protocol for exchange of due diligence on a distributed ledger. To learn about our project or apply to join the group of large financial institutions helping us with the development of the blockchain due diligence protocol, visit our website, https://ddx.exchange