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When Big Money Comes Calling
Gulf-based SWFs are reorienting their investment strategies and emerging markets such as India could emerge beneficiaries
Special Issue: The Gulf Special The Gulf Special

The global sovereign wealth funds (SWFs) currently control an aggregate of approximately $5 trillion in assets under management (AUM). Of this amount, the Gulf-based SWFs — most notably the Abu Dhabi Investment Authority, the world’s third-largest SWF behind the Norway Government Pension Fund and China Investment Corporation — account for approximately 40% of global AUM.

According to market estimates, close to 80% of SWF assets owned by the Gulf Cooperation Council (GCC) states are accounted for by three major players — the Abu Dhabi Investment Authority, foreign holdings at the Saudi Arabia Monetary Authority and the Kuwait Investment Authority.

While AUMs have continued to increase year on year, there is no doubt that, like the rest of the international investor community, the GCC states felt the impact by the global financial crisis. This saw GCC SWFs take steps to curb their investment activity and, in many cases, reset their investment strategies altogether.

However, while the wider international investor community was experiencing a type of investment paralysis during this time, the impact on SWFs in the oil-rich countries was mitigated by the high price of oil — often trading well in excess of $100 per barrel since 2011. So, as liquidity tightened in the West (made worse by the Euro zone sovereign debt crisis), GCC SWFs were not only able to continue to explore investment opportunities but also build up significant cash reserves. 

To put this into perspective, we can look at the various countries’ break-even oil price (the price oil needs to remain above in order for that country to balance their fiscal budgets). Saudi Arabia’s breakeven oil price is approximately $97 a barrel and the UAE’s is much lower at approximately $77 a barrel. So you can see how, during the times when oil prices were higher than $100 a barrel, these significant cash reserves were able to accumulate.

As I mentioned above, the past five years have seen GCC SWFs rethink their approach to investments. While the underlying objective is to diversify and maintain balanced investment portfolios, the approach in which SWFs are taking to investing and where they are investing has certainly evolved. 

Direct Investment

While the majority of GCC SWFs continue to deploy their funds in bonds and global equities, a relatively low interest-rate environment, continually evolving investment strategies and a growing appetite for alternative asset classes are resulting in a shift away from what has typically been a passive investment philosophy.

Private equity funds with a focused approach may be preferred to those that have a wide investment mandate
We have seen an accelerating trend towards direct investment and towards strategies that offer the funds a greater level of control over investment strategy. In this respect, we are defining direct investment in a broad sense to include direct investment and co-investment alongside other investors — such as a property company — and investments made via structures over which the investor has a degree of discretion such as certain ‘managed account’ arrangements with private equity fund managers.

In support of this strategy, we have seen many funds significantly increase their internal headcount and strengthen their in-house capabilities. We are seeing a number of funds hiring investment and investment management professionals to increase their capacity to evaluate direct investment and co-investment opportunities. This is typically in asset classes that lend themselves to direct investments such as real estate and private equity.

Successful Partnerships

It has become increasingly clear that in situations where SWFs invest alongside fund managers, they need to have complete confidence in the ability of fund managers to produce results — both financial and structural. SWFs have, therefore, become more selective in deciding who their investment partners are.

SWFs are giving increased consideration to a fund manager’s ability to demonstrate a proven track record of success over an extended period of time. This is not only limited to financial returns but also to a fund manager’s ability to demonstrate good portfolio management.

In cases where SWFs are investing directly into a private equity fund as a limited partner, it is apparent that they require more certainty and control over the investment strategy of these funds. In many cases, this means certainty in relation to geographic and sector focus. Private equity funds with a focused approach may be preferred to those that have a wide investment mandate.

An Increased Regional Focus

Whether due to international forces, such as the Euro zone debt crisis, or as a result of local factors, such as the Arab Spring, it is becoming evident that GCC SWFs are redirecting a greater portion of their funds from international investments back into the region. A big part of this is driven by large-scale infrastructure plans.

The GCC region plans to spend approximately $140 billion on infrastructure projects between now and 2020, the majority of which relates to rail and road projects. This is in addition to planned mega projects in the region such as the $86 billion King Abdullah Economic City in Saudi Arabia, Qatar’s $70 billion 2022 FIFA World Cup-related infrastructure and the UAE’s EXPO 2020.

As the shift towards local investments appears to be gathering momentum, the question remains whether this nascent position is a transitory trend or a strategic direction for the medium term. The question as to whether the GCC economies are able to absorb large sovereign fund investments while providing SWFs with a suitable risk/return profile is an entirely separate matter.

Higher Public Spending

In stark contrast to other parts of the world where governments are promoting austerity and introducing significant cuts to public spending, years of accumulated funds from historically high oil prices have enabled the GCC governments to continue increasing public expenditure.

A number of the GCC governments, including those of Bahrain, Qatar and Saudi Arabia have introduced considerable public stimulus programmes during the past 18 months.

With a seemingly renewed focus on unemployment, education and healthcare, regional governments are making considerable efforts to invest and promote development within their own countries.

The Rise Of The Emerging Markets

A trend we have seen in the last 12 months or so has been the increase in SWF investment appetite for emerging markets. While Africa is often spoken about, this approach can only benefit the likes of India, which is not only strategically placed in its proximity to the GCC but also possesses strong demographics, a large and growing population and high growth potential.

Given the nature of risks that businesses in emerging markets are subject to, investments require close Monitoring
However, GCC SWFs do remain relatively cautious in their approach to emerging markets. Those in emerging markets looking to partner alongside these funds should keep the following in mind:

Long-term local relationships: When investing in emerging markets such as India, there appears to be no substitute for having skilled and experienced people on the ground. Building relationships and forging alliances with domestic partners and regulators is a long-term process and is viewed by GCC SWFs as key for a successful execution.

Information limitations: Information asymmetry and lack of a proven track record in these geographies makes investor decisions more challenging. As with many emerging economies, quality data is hard to come by and therefore, those who are able to present it in a sophisticated manner may find themselves in the best position to capture this investment opportunity.

Close and regular monitoring of investments: Given the nature of the market and unique risks that businesses in emerging markets are subject to, investments require close and regular monitoring before, during and after an acquisition. Related to the point made above, having close and regular involvement with teams on the ground is crucial.

India — An Opportunity?

We would expect GCC SWFs to look at investment opportunities in India as part of their broader plan to explore emerging markets and generate higher returns from a more diversified portfolio of assets. Relative to the size of the Indian economy, global SWF investment to date is perhaps lower than what it ought to be.

With India’s $1.9 trillion economy predicted to grow at over 5% during 2015, the general consensus appears to be that India’s government is clearly taking significant steps to demonstrate that it is willing to make changes in order to attract investments from around the region, including the GCC.

Many believe India’s recently announced budget should have a notable impact on the country’s infrastructure sector, which according to market estimates, may require as much as $1 trillion in the next four years. The Indian infrastructure sector may well become a key area of focus for GCC SWFs.

Looking Forward

While GCC SWFs have become a key source of liquidity globally, many are predicting a slowdown due to the recent decline in oil prices. In the short term, we have not seen much of an impact in terms of investment appetite as most oil-dependent countries have successfully built up large cash reserves. However, if the prices remain depressed for a period of time, I would certainly expect a more cautious approach to investment as these cash reserves reduce.

One thing that the recent volatility in the oil price has confirmed is the need to continue to diversify. Like many emerging economies with strong fundamentals, India is well positioned to attract international attention. However, with opportunities come challenges.

GCC SWF’s have a long-term investment horizon. Therefore, those looking to attract SWF investment must demonstrate a commitment to creating and growing these long-term relationships. There must also be a willingness to accept active participation and even direct investment and these funds look to take a much more active role.

This web-exclusive Column does not appear in print magazine.

Brad Whittfield, Associate Director, KPMG (UAE)

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