Money talks for Gulf SWFs

The Gulf’s oil-rich sovereign wealth funds are seeking to increase their allocations to assets including private equity, infrastructure and real estate, while scouting out new opportunities in emerging markets
By Daniel Shane
Sat 25 Jan 2014 10:43 AM

Sovereign wealth funds in the oil-rich Gulf will seek to raise allocations for private equity, infrastructure and real estate this year, while funnelling cash into local infrastructure, as part of a broader strategy to diversify their portfolios and spur the regional economy.

While none of these funds disclose the extent of their assets, they are widely perceived as ranking among the world’s richest institutional investors, not to mention the most secretive. According to estimates from the Sovereign Wealth Fund Institute, Saudi Arabia’s SAMA Foreign Holdings’ assets total $675.9bn, Abu Dhabi Investment Authority’s (ADIA) $627bn, Kuwait Investment Authority’s (KIA) $386bn and Qatar Investment Authority’s (QIA) $170bn.

Each of these derives its funding from its respective government’s hydrocarbons receipts and has a mandate to diversify its national economy, but they differ markedly in asset allocation and overall strategy.

ADIA, currently the only Gulf SWF to publicly disclose its asset allocations, presently allocates the bulk of its portfolio to developed market equities and government bonds, but is increasingly diversifying into areas including private equity, infrastructure and real estate.

According to its latest Middle East Asset Management Study, published last year, investment manager Invesco highlighted increased appetite for private equity-style deals as a key trend among the Gulf’s SWFs. In terms of those funds that primarily invest internationally, such as ADIA, KIA and QIA’s Qatar Holding, the average allocation for this asset class has risen from 5 percent in 2011 to 13 percent last year.

“They’re using private equity because they think that’s an opportunity where they can perhaps be more active and gain more value from the money they’re putting to work,” says Nick Tolchard, head of Middle East at Invesco. He says that this is part of a broader move by SWFs in the Gulf to reduce fees, increase exposure and pursue investment strategies outside of the remit of the large private equity houses.

Tolchard adds that sovereign wealth funds in the region are also seeking to tie-up with SWFs in regions like Asia for co-investment private equity deals.

There is evidence that sovereign funds in the Gulf have been bulking up their internal expertise in terms of private equity and infrastructure deals. Under Ahmed Al Sayed, appointed CEO last summer, QIA has since announced senior hires in emerging markets, real estate and infrastructure. ADIA has also recently hired new heads in its infrastructure division.

“There’s an area which most funds seem to think they can improve, and that’s to bring in more skills. But there’s only a certain amount of technical expertise to go around,” Tolchard says.

Gary Smith, head of sovereign wealth funds at Baring Asset Management, agrees that diversification has become the primary focus for the region’s sovereign wealth funds. The performance of Western equity markets last year, which saw the Dow Jones Industrial Average close the year up 26.5 percent and the S&P 500 up 29.6 percent, means that those funds with larger allocations to developed equities may have more risk appetite around the fringes of their portfolios.

“For most funds this means both a continued move away from government bonds to other asset classes,” explains Smith.

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“Given that 2013 was the first year for a generation that a five-year US T-bill investment gave negative returns, this will have been viewed in retrospect as a wise shift, and may suggest that there will be more of the same in 2014.”

Positive performances by equity markets have meant that, by and large, the region’s sovereign funds will have higher allocations this year, says Vikas Papriwal, head of sovereign wealth funds and private equity at professional services firm KPMG Gulf. He notes that over the past year volumes of direct transactions have leapt by more than 50 percent.

“If you see some of the rates of returns exchanges have been giving, especially in the developed markets, [such as] what’s happening in the US and European exchanges, categorically equities have been on the rebound and sovereign wealth funds by and large have a holding in these markets,” Papriwal explains.

Emerging markets will be another key theme for the Gulf’s sovereign funds over the coming year, notably India and China. Last year, China’s foreign exchange regulator increased the amount which the Kuwait Investment Authority can invest directly into Chinese securities to more than $1bn. Qatar is one of the few other sovereign funds to have a similarly large allotment, although it is not known how much either has pumped into Chinese stock markets.

Most sovereign wealth funds in the Gulf, perhaps excluding QIA which pursues a fairly opportunistic strategy, are generally conservative and some say they cannot see these funds allocating sizeable direct investments into riskier emerging markets.

“Gulf funds want exposure to emerging market growth, but the risk, volatility and relative illiquidity of many emerging markets make it difficult for them to get alpha-generating exposure,” says Victoria Barbary, director of the Institutional Investor’s Sovereign Wealth Centre, a provider of intelligence on sovereign funds. “So they tend to adopt strategies to invest in developed market companies that have growth potential in emerging markets.”

There is recent evidence of such investments. In December 2013, ADIA bought up a $250m stake in the Indian arm of US property management firm Hines in a move that will give the fund exposure to India’s real estate market. This came on the back of about $500m in placements into private equity funds with exposure to India.

KPMG’s Papriwal agrees that emerging markets, as well as real estate and alternatives, will be a large focus for sovereign funds this year, they are still unlikely to reduce their holdings in more conventional assets. “What we’re noticing is that they are focusing on these more and more, and recruiting heavily in these segments (real estate, infrastructure and alternatives), but because these funds are generally growing, allocations to T-bills and equities are still sizeable,” he points out.

While it is true that the Gulf’s sovereign funds are seeking to increase their international exposure, they are also likely to allocate more towards achieving economic goals at home. This will most pertinently be seen in investments in Qatar, which is expected to spend upwards of $200bn on new infrastructure ahead of it hosting the World Cup in 2022, and in the UAE, where Dubai will host the 2020 World’s Fair.

“There’s definitely a focus on regional development and infrastructure,” says KPMG’s Papriwal. One of the long-term goals for the UAE economy, Papriwal says, is to provide more employment opportunities and housing for citizens. In Qatar, billions of dollars will be spent on developing a new rail system and logistics infrastructure. As a result, governments are likely to allocate more towards those sovereign funds that predominantly invest locally, such as Mubadala Development in the UAE.

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Invesco’s Tolchard agrees: “You’re going to see capital put into projects that fit the local economic plans. It may be the case that some of the sovereign funds receive less funding because of these projects,” he says.

Stellar performances by Western equities markets and a steadily high price of oil have encouraged the region’s sovereign funds to diversify and turn their attention to higher-returning assets.

The elephant in the room for all of these funds though is the possibility of the US going energy independent as early as 2035, as forecast by some analyses, and the subsequent impact on oil receipts for Arabian Gulf governments. Some say that this has put pressure on the region’s sovereign funds to secure stronger returns in the meantime.

“If the price of oil kicks down a little bit because the US has less reliance on it, then the surpluses will be squeezed a little bit as well,” says Invesco’s Tolchard. “So there will be more of a focus of getting good returns, whether that’s through international alternatives or local development.”

Investing at home

Perhaps the only thing in common between the Gulf’s SWFs is their shroud of secrecy and the fact that they mostly derive their funding from hydrocarbons receipts.

Bahrain’s Mumtalakat Holding is arguably the exception to this, however. Small by Gulf standards, with an estimated $7bn in assets, none of its funding is derived from the country’s oil revenues and it is also more transparent than most.

It is mandated by the Bahraini government to diversify the island’s economy by targeting investments in equities including healthcare, technology, financial services and real estate. According to the fund’s head, it largely operates on an opportunistic basis.

“We’re not constrained by predetermined amounts of investments in any given year or targeted to any specific geographic area or business sector,” Mahmood Al Kooheji, CEO of Mumtalakat tells Arabian Business. “Our investment scope includes both local and international opportunities.”

The fund’s portfolio is largely geared towards the local economy. Its stakes include Alba, one of the world’s largest aluminium smelters, and majority ownership of struggling local airline Gulf Air, which it has spent the last year restructuring ahead of a possible IPO. Internationally, its investments include car maker McLaren Automotive.

Al Kooheij says Mumtalakat considers itself an activist investor and prefers assets where it can influence strategy at boardroom level.

”We’re an active investor and will focus on opportunities where we can add value,” he says. “Typically in international transactions we seek to align ourselves with strong partners that provide complementary skills, resources and perspective. We want to establish a significant minority stake in any direct investment, so we ensure board representation and appropriate levels of influence. ”

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