Oil decline is redefining role of sovereign wealth funds

Aren't sovereign wealth funds (SWFs) fascinating? These mega-investors have assets bigger than the gross domestic product (GDP) of many nations and can affect markets around the world with a single “buy” order, yet in many cases they are run as an arm of the state bureaucracy that owns them. 

They are the ultimate investing machines, but they have not — on the whole — managed to develop their own investment style to suit their enormous resources.

They have tended to veer between two distinct strategies: Cautiously putting their money into rock solid but unimaginative global investments like tracking instruments and government bonds; or splashing billions on baubles — football clubs, glamorous retail outlets, luxury hotels — that mainly seem to reflect the leisure-lifestyle choices of their owners.

Over the past 10 years, there has been a debate within many SWFs in the region as to what their role should be in the modern financial world.

Before the global financial crisis, they seemed to spend a lot of their time trying to convince Western governments, corporates and institutions that SWFs were normal investors, rather than the unaccountable private bank of a ruler. The Santiago Principles committed them to transparency and accountability.

As soon as the crisis hit, the West forgot its objections to SWF investment, and was just glad to shore up the balance sheet with cash it would have previously sniffed at suspiciously. Several big Western banks were glad to have SWFs underpinning their share price.

Strategic rethink

Soon afterward the Arab Spring also forced a shift in thinking. Dissatisfied youth around the Middle East were calling for transformational investment in their infrastructure and their futures, and there is some evidence the SWFs agreed as inward investment increased and many of the big glitzy foreign investments were dropped.

Then, the fall in the oil price that began in summer 2014 further increased the pressure for change. SWFs in other parts of the world — in China and Singapore, for example — amassed their assets through many years of trade surpluses.

In the Middle East and Norway, the wealth came from profits on oil trading and when those profits were halved in the space of a few months, it soon became apparent that something would have to be done to preserve wealth for future generations. A serious strategic rethink was needed.

We are seeing the results of that rethink most noticeably now in the SWFs of Saudi Arabia and the United Arab Emirates (UAE).

In Abu Dhabi, the merger between Mubadala Development and International Petroleum Investment Company (IPIC) will form a new $125 billion investment powerhouse in the Arabian Gulf. The hope is that greater financial firepower will produce better returns, but it is also an expressed aim of the merged entity — to be called Mubadala Investment Company — to accelerate the process of economic diversification in the Emirates.

Financial return will continue to be a key yardstick for investment, but there will be a bigger emphasis on job creation and technology transfer to the UAE as part of any big investment. It seems unlikely there will be any further deals with football clubs, restaurant chains or Malaysian investment companies in the new Mubadala set-up.

Saudi Arabia’s ‘sleeping giant’ fund

In Saudi Arabia, the future for SWFs will be even more dramatic. The Kingdom’s vast oil-generated wealth was hitherto held by the Saudi Arabian Monetary Authority (SAMA) in its foreign reserves portfolio.

Under the National Transformation Plan (NTP) and the Vision 2030 strategy, it has been decided to create a Mubadala-style investment corporation out of the Public Investment Fund (PIF). This organization, which has been around since the early 1970s and has built up a portfolio of investments in some Saudi blue-chips, is now described as the “sleeping giant” of the investment world.

The government has set a target of $2 trillion as the eventual value of PIF’s assets under management, more than twice the size of the world’s current largest SWF, Norway’s Government Pension Fund Global.

That will take some doing. But PIF’s portfolio could be given a big boost if land and other properties are gifted to it, as has been suggested. It is also planned that PIF will be the recipient of the multi-billion-dollar proceeds from the proposed flotation of Saudi Aramco, which would set it well on course to the $2 trillion target.

PIF has already shown it will be adventurous in its investment policy, having committed $3.5 billion to Uber and a staggering $45 billion to the new investment vehicle of SoftBank.

The same inexorable forces are at work in Qatar, Kuwait, Bahrain and Dubai, all of which have SWFs at the core of their economies. Paradoxically, the falling oil price has only made the role of the Gulf SWFs more important.