High oil prices drive sovereign wealth funds

Assets of most GCC sovereign wealth funds easily outweigh annual government spending. Published in MEED, 10 September 2013

There is a greater concentration of sovereign wealth funds (SWFs) in the Middle East and North Africa (Mena) region than any other part of the world, and with oil prices high, SWFs are growing strongly.

Of the 69 SWFs around the world, 19 of them are in the Mena region, with seven in the UAE alone. In size, they range from the behemoths of the GCC such as the Abu Dhabi Investment Authority (ADIA) and the Kuwait Investment Authority (KIA), which each manage several hundred billion dollars of assets, to far smaller pools of capital managed by Palestinian and Mauritanian bodies, which look after just a few hundred million dollars.

Regardless of their size, though, they tend to have been set the same tasks by their governments. The rationale for such funds is either to help develop and diversify the local economies or ensure there is something left for future generations once existing oil and gas reserves have been used up. But working out how well they might be performing those tasks is not easy.

Low transparency

Transparency has never been a strong suit for such funds and the Middle East has by far the worst record in this area. According to US-based research firm SWF Institute, the average transparency score for funds in the Mena region is just 4.6 out of a possible 10. Asian and sub-Saharan African funds score about 6 and those in the rest of the world more still.

Some insight can be gleaned from the financial reports a few of the small and mid-sized funds in the Middle East do release, which give details of their portfolio size and their investment strategies and performance. What those reports show was a fairly mixed picture in 2012.

Two UAE funds, Mubadala Development Company and International Petroleum Investment Company (Ipic), saw their operations grow. In the case of Mubadala, revenues increased by 12 per cent compared with the previous year to AED31.3bn ($8.5bn) in 2012 and total assets rose by 15 per cent to AED202.8bn. It also managed to turn a loss of AED3.2bn in 2011 into a profit of AED455m in 2012, due to better gross margins and lower impairments.

It was a similar story at Ipic, where revenues rose by 51 per cent to $51.9bn, and profits were up from $44.7m in 2011 to $1.8bn. The value of its assets, however, was flat at $65bn.

On the other hand, two smaller funds did less well. Bahrain’s Mumtalakat Holding Company, which prefers to invest in its troubled domestic economy, saw the value of its assets decline by 3 per cent to BD4.1bn ($10.9bn). Revenues also shrank by 10 per cent to BD1.2bn, but it did manage to reduce its losses from BD270.1m in 2011 to BD181.7m in 2012.

The even smaller Palestine Investment Fund (PIF) also faces a challenging domestic environment to invest in. The fund saw its asset portfolio fall in value from $822.7m at the end of 2011 to $782.8m by December 2012, a drop of 5 per cent. Operating income was also down by 17 per cent to $151.7m. Despite this, the PIF managed a small increase in profits to $36.5m, compared with $35.7m a year earlier.

The broader picture is harder to gauge, given the opaque approach taken by the rest of the region’s funds. There was a brief period in 2008 when international concern about the secrecy of SWF investments in global markets prompted the funds to consider greater transparency. A working group was set up in May 2008, and in October that year it finalised a set of generally accepted principles and practices known as the Santiago Principles. However, adherence to these guidelines has been patchy. At a meeting in Kuwait in April 2009, the funds agreed to create a more permanent structure, the International Forum of Sovereign Wealth Funds, but even then, practices have not changed much.

Despite the difficulty in estimating the size of the funds, US ratings agency Moody’s Investors Service claims the assets of the GCC SWFs have grown in line with the strong oil prices of recent years.

In a report released in early August, the agency estimated that last year alone, the aggregate current account surplus across the GCC was close to $350bn. Bolstered by this, the SWFs of the six GCC countries controlled a total of $1.6 trillion in assets at the end of 2012, equivalent to 107 per cent of the region’s gross domestic product (GDP), compared with $980bn in assets or 105 per cent of GDP in 2007, according to the agency.

Size disparity

By common consent, the greatest reserves are the foreign currency holdings of the Saudi Arabian Monetary Agency (Sama), the kingdom’s central bank. It is thought to have about $640bn-680bn in holdings. But there is a large disparity in the estimated size of some of the other large funds, including the ADIA and the Qatar Investment Authority (QIA).

The US’ Fitch Ratings estimates that the ADIA controls £300bn ($469.3bn) in assets, but Moody’s puts the number at $397bn and the SWF Institute says the fund has $627bn. The estimated size of the QIA’s holdings is also disputed, with estimates ranging from $115bn by the SWF Institute to $175bn by Moody’s.

There is a greater degree of consensus regarding the holdings of the KIA, with observers placing it within a range of $322bn-395bn. The authority’s managing director, Bader al-Saad, gave an insight into the size and growth of a part of its holdings during a speech in London in June to mark the 60th anniversary of its international arm, the Kuwait Investment Office (KIO).

“The KIO now manages more than $120bn globally, compared with only $27bn 10 years ago,” he said. “[It had] only a few hundred thousands of pounds when we set up in 1953. The KIO will be looking to manage more funds in more asset classes and in more regions worldwide in the near future.”

The KIA was given a boost in September last year with a decision by its government to increase the budget allocation to the Reserve Fund for Future Generations, its internationally-focused fund. Instead of the usual 10 per cent of general revenues given to the fund, the government decided to give 25 per cent for the 2012/13 fiscal year. Any further surplus is stored in the General Reserve Fund, which is also managed by the KIA and focuses on domestic assets.

Infrastructure spending

Not all Mena countries have been willing to pour so much extra money into their funds. Instead, many of them have diverted their rising oil revenues into a mix of infrastructure and current expenditure. This rise in spending is partly due to a desire to bring infrastructure up to international levels, but also to offset the chances of domestic political opposition emerging to challenge the ruling elites

Even so, Moody’s points out that in all the GCC countries except Bahrain, SWF assets now exceed central government liabilities and, in most cases, easily outweigh annual spending.

The agency says Kuwait has the largest cushion, with SWF assets almost six times the level of annual government expenditure. The UAE and Saudi Arabia are also in a strong position, while Qatar has more modest resources to draw on and Bahrain and Oman are in relatively fragile fiscal positions. Mumtalakat has assets of some $10.9bn, while Oman’s State General Reserve Fund is thought to control $8bn-14bn in assets.

Across the rest of the Mena region, other countries with large oil endowments are also in comfortable positions, including Algeria and Iraq, which have substantial amounts of foreign reserves and, in the case of Algeria, a well-funded SWF. Lebanon is also relatively well-placed, according to the Washington-headquartered IMF’s reports on foreign currency reserves.

Oil dependence

Whether countries have the benefit of large SWFs or substantial holdings of foreign reserves or neither, all governments face tough choices if and when revenues drop significantly. For the Gulf states and some other governments, this is a function of the oil markets more than anything else. But if oil prices do fall sharply, those governments may prefer to raise debt rather than try and sell the assets held by their funds.

As Moody’s points out, liquidating assets during times of stress can be difficult and if equity prices decline in line with a fall in oil prices, as sometimes happens, these states may find they have less to play with than they thought.