By V L Srinivasan, Qatar Today Magazine
WHAT SHOULD BE THE ROLE OF SOVEREIGN WEALTH FUNDS IN THE GCC REGION WHEN OIL PRICES ARE FALLING? ARE THEY TAKING PART IN THE ECONOMIC DIVERSIFICATION PROGRAMMES OF THE SIX MEMBER STATES? QATAR TODAY FINDS OUT.
Most of the oil economies in the Middle East suffered revenue losses on account of fluctuation in global oil prices in the past as they continue to do so now. As part of their long-term investment strategies, many countries in the region, including those in the GCC like Qatar, have set up Sovereign Wealth Funds (SWFs) to negate any impact caused by turbulence in global markets and their efforts paid off when the income generated by these funds provided a cushion to absorb the shocks. Following the windfall from hydrocarbon revenues over the years, these countries have diversified their asset portfolios by investing the surplus reserves through SWFs (said to be more than 10% of the budgets of countries such as Qatar, Kuwait and the UAE), in buying and investing in assets of banks, financial institutions, hedge funds, private equity and other sectors like real estate, agriculture and even retail markets, which resulted in accumulation of more revenues. In fact, the GCC countries have been transformed into financial centres in the last few decades, and put in place some sophisticated financial investment strategies to sustain economic development. The GCC SWFs have accumulated over $2.5 trillion (QR9.1 trillion) at the beginning of 2015, more than a third of SWFs in the world, which has come in handy to absorb the loss of revenues due to oil prices plunging by over 60% since June 2014. In the past, these SWFs were looking at low risk and low yielding assets but things have changed over the years. They have now shifted to riskier asset classes and have been allocating money to hedge funds and other alternative investments such as private equities to create new sources of income for their countries. However, a decisive move towards the high end of the risk spectrum requires a thorough risk management system, awareness of risk tolerance, internal competencies and sophisticated vision. In particular, higher returns can be achieved in areas that require highly skilled human capital especially in turn-around operations, mergers and acquisitions that foster synergies or in venture capital.
Asset allocation is on the agenda As far as Qatar is concerned, the stateowned Qatar Investment Authority (QIA), which is said to have over QR910 billion ($250 billion), is reportedly keen to introduce asset allocation targets for the first time. It is reportedly planning a wideranging overhaul of its portfolio, according to Reuters. Qatar has invested around QR236 billion ($65 billion) in several ventures in Europe like The Shard, Heathrow Airport, Chelsea Barracks and Harrods departmental store in London, besides Siemens and Volkswagen in Germany and Le Brant and Le Tanneur leather industries in France. It has also purchased shares valued at QR9.83 billion ($2.7 billion) in Agriculture Bank of China and plans to invest about QR54.6 billion ($15 billion) in Asia in the next five years.
Helping diversify economies
With oil prices showing no signs of recovery at least for a year and half, it has become imperative on the part of the GCC governments to diversify their economies and the SWFs have been playing a critical role in the process. “Most of these funds were established to invest abroad to avoid inflation and diversify the national economy away from hydrocarbons, and many of them have done a good job,” says David Evans, Senior Writer and Editor of Institutional Investor’s Sovereign Wealth Centre . According to him, some funds may have been invested at home to help build up nonenergy sectors. “In Oman, for example, the state-owned State General Reserve and the Oman Oil Company recently signed an agreement that will see them work together on initiatives to diversify the Omani economy away from its reliance on hydrocarbons. To do this they will finance small and medium-sized companies that are active in other industry sectors,” Evans says.
Diverse asset classes
The SWFs have a long-term investment horizon when compared with other investors and have diversified across asset classes. Short-term volatility, for example, may present a buying opportunity for some of these funds as there is the potential for a considerable saving. Head of Asset Management with QInvest, Dr Ataf Ahmed says that the GCC SWFs are already playing a key role in the economic diversification programmes as their investment focus is typically outside their host country and has led to extensive diversification within GCC economies. “However, we have witnessed some changes. For example, there is a trend which has seen some SWFs moving from indirect to direct investments. There is also a trend of larger mandates being managed in-house and SWFs taking direct stakes in more developments,” Dr Ahmed says. Oman Investment Fund’s Chief Economist Dr Fabio Scacciavillani too says that the oil price drop has induced most SWFs to emphasise capital preservation over a more aggressive asset allocation and, specifically, the current volatile market conditions warrant a retrenchment from bullish strategies towards defensive plays because the macroeconomic outlook is fraught with substantial downwards risks. “Asset valuations are overstretched and crucially dependent on the massive liquidity injections provided by all major central banks. Furthermore, high debt and leverage remain a sinister threat to the global financial architecture, still fragile even after eight years of global financial crisis,” Scacciavillani points out. He also feels that the SWFs could play a pivotal role in the transformation of the region into a hub for innovation and hi-tech deployment. “I strongly believe that they could very effectively pursue a cash-forknow-how strategy: specifically they could inject equity capital in the most innovative global companies in exchange for locating their international activities and research centres in the region,” he says. Citing an example, Scacciavillani says that Singapore successfully implemented a similar strategy since the 1980s and is now one of the most advanced economies in the world. The GCC, and Qatar in particular, have the potential to become a “Singapore on steroids,” he adds.
Global in nature
Ernst & Young Executive Director of MENA’s Wealth & Asset Management, George Triplow points out that GCC SWFs are institutional in size and quality and have had significant capital to deploy. “Portfolios are global in nature, well diversified and cover all the major asset classes and recent trends have included greater investments in alternative type asset classes, private equity and infrastructure,” Triplow says. Even the asset mix has changed over recent years with GCC funds increasingly looking to diversify away from domestic investments. “SWFs have become more embracing of passive type investments, especially to gain geographical and sector exposure. There has been significant ongoing investment in real estate, private equity and infrastructure projects,” Triplow says.
However, one expert differs on SWFs’ role in the economic diversification process and says that they should safeguard national wealth, store oil earnings abroad to avoid excessive exchange rate appreciation, provide a source of revenue for the future, and smooth out the government budget as oil prices rise and fall. “If the government wants to have a separate investment fund for investment in the domestic economy, that is fine but it is a different role,” says Robin Mills, Head of Consulting at Manaar Energy (Dubai).
With regard to a pattern of investments, Mills says: “Each SWF has its own strategy. Saudi Arabia is looking at more active investments rather than Saudi Arabiab Monetary Agency’s (SAMA) passive and low-risk holdings. But all SWFs are under pressure as low oil prices mean governments are making withdrawals, not paying into the funds.”
David Evans says that it is unlikely that the drop in oil prices will have much of an effect on these funds’ strategies unless prices stayed very low for several years. Most SWFs already have diversified portfolios and most are self-sufficient (they don’t rely on oil revenue for ongoing funding streams). “I don’t think they will take on more risk – if anything, they are likely to respond by doing the opposite, keeping more of their capital in liquid assets so that it is readily accessible in emergencies,” he says. One trend noticed among the more adventurous funds, though, is a willingness to move quickly to take advantage of the new dynamics of the energy sector. For example, QIA spent around QR8.37 billion ($2.3 billion) on shares in BG Group and Shell following the announcement of their merger earlier this year, Evans says.
Norway stands out as far as oil wealth management is concerned and many opine that the GCC SWFs either have gained or can benefit from its experiences. Dr Ahmed says that the GCC has already benefited from the establishment of a host of domestic SWFs by following the example set by Norway. “Numerous specific vehicles have been established, both internationally and domestically focused, to ensure the management and growth of surplus capital for future generations in the GCC,” he says. Evans says that the Middle East has some of the world’s biggest sovereign wealth funds and many of them are active and nimble investors with well-diversified portfolios. If they have anything to learn from Norway, it would be in the spheres of governance and transparency. “But the Middle Eastern funds are improving in this regard: The State General Reserve Fund of Oman and the Investment Corp. of Dubai, for instance, have started to disclose much more information about their investments over the past couple of years,” says Evans.
Triplow too feels that for the region’s SWFs, which operate within a unique macro and socioeconomic environment, policy-making decisions in other parts of the world are of interest and they can continually benefit from the experiences of other organisations.
However, Scacciavillani holds the view that the SWFs in the region will not benefit at all as the Norwegian Pension Fund has achieved paltry results over the years and sticks to rather ineffective strategies and is too big to be managed effectively. More generally, the Norwegian citizens would be better off if, instead of piling up humongous amounts of money to be invested in foreign countries, the government slashed corporate and income taxes (and bureaucracy). “It would foster the creation of companies, attract talent, and boost innovation, ultimately transforming Norway into a knowledge-based economy rather than a sclerotic rentiers’ society,” Scacciavillani adds. Robin Mills too says that Norway has strong rules for withdrawing funds from its SWF, does not pursue politicised investments and the fund management is independent. It has high levels of transparency which make host governments comfortable with their investments, he says.
Sectors and continents
All these years, a booming real estate market in cities like London proved to be a safe haven for the SWFs seeking to invest their reserves. Asia too is emerging as a hot destination for countries like Qatar to invest their funds. Evans says that the region’s SWFs have plowed money into European real estate and infrastructure over the past 12 months because they like the stable, long-term cash flows such assets offer. The China stock market slump is unlikely to unduly concern the Middle Eastern SWFs, which invested over generations, and short-term volatility probably won’t dissuade them from allocating capital in the region. Several unnamed Middle Eastern funds contributed to Global Logistics Properties’ new $7 billion (QR25.48 billion) Chinafocused infrastructure fund in June and the QIA has committed to invest in Asia over the next few years, he says.
This year, QIA closed a massive deal for Canary Wharf and the Abu Dhabi Investment Authority teamed up with other institutions to buy Germany’s motorway service station group Tank & Rast for QR12.74 billion ($3.5 billion). Fierce competition is pushing up prices, but we expect SWFs’ appetite for these hard assets to continue for now, Evans adds.
Scacciavillani says that, though emerging markets have lost their shine, there are some pockets of resilience, for example in the better managed Asian countries or in Eastern Europe. Some look with interest to India and await the implementation of a more ambitious reform agenda by Prime Minister Narendra Modi. However, at present India remains a challenging environment for outsiders, he says. “With regards to sectors, I think real estate in top locations remains an evergreen. Additionally, in Europe, there are wonderful opportunities in the private equity space, especially in those countries where, despite the ECB quantitative easing, companies are still experiencing a severe credit crunch,” he says.
Scacciavillani has analysed extremely enticing instances of leading multinationals or family-owned businesses which would benefit from a robust injection of equity capital and a more modern management approach. Finally, the US continues to drive innovation worldwide and a canny investor should be able to detect the great opportunities available in areas such as cyber security or cutting-edge healthcare. Africa has finally emerged from decades of crisis, but, like India, is a challenging environment where few dare to venture, Scacciavillani adds. Dr Ahmed also feels that it would not be possible to generalise as each SWF’s philosophy, investment objectives and geographic focus is designed to align with the needs of the specific country in which it is created.
Robin Mills says that most SWFs are not keen on heavy investments in oil, as their countries’ main income comes from oil. “The energy sector is attractive for investment now, however, given low valuations. Most of the SWFs (but not SAMA) have funds for higher-risk investments such as private equity. And they are all looking for yield given the very low rate of return currently on US Treasuries and cash,” he adds.