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29 March 2024

Gulf sovereign wealth funds see further fall

(SALEK KHAMIS)

Published
By Nadim Kawach

The global financial distress has inflicted heavy losses on state funds from the Gulf oil heavyweights and their assets will likely erode further in 2009 because of low oil prices, according to a US study.

Even if oil prices averaged around $75 (Dh275.49) in the next few years, the asset portfolio of the sovereign wealth funds (SWFs) in the region could still suffer as high public spending means little surplus will be left for those funds, said the study by the New York-based Council on Foreign Relations (CFR).

In a working paper by two of its experts, CFR said the assets of those funds, especially the Abu Dhabi Investment Authority (Adia), had largely been overstated, estimating Adia's funds at below $300 billion.

In case oil prices surge back to $100 a barrel, Gulf SWFs will be able to rebuild their resources, which could swell to around $2.2 trillion by 2012, far below than earlier forecasts by some experts that the assets could surge to nearly $10-12trn if oil prices remain strong, the study said.

While acknowledging that Adia is the largest SWF in the world, the study said its size had largely been overstated, sometimes by as much as 100 per cent.

It said Adia was also hard hit by the recent fall in global equities, as many of the same factors that worked in its favour from 2004 to 2007– a high allocation to equities, emerging market, and private equity – worked against it in 2008. Other SWFs, including the Kuwait Investment Authority (KIA) and the Qatar Investment Authority (QIA) – are in a similar position.

The Saudi Arabian Monetary Agency (Sama) by contrast benefitted from its fairly conservative portfolio, the study said, adding that it is now likely to hold the largest sovereign portfolio in the Gulf.

LOSSES

It estimated the external assets of Adia and the Abu Dhabi Investment Council (Adic) at less than $400bn, adding that they could be as low as $300bn – well below Sama's over $500bn in assets.

The study said the surge in oil prices to record high levels in 2008 pumped at least $300bn into Adia and other Gulf SWFs and central banks, compared with nearly $230bn in 2007, when oil prices averaged $70.

"However, the 2008 inflow was more than offset by the mark-to-market losses on the equity portfolios of the large sovereign funds. All these funds now look likely to shrink in 2009, as the price of oil has fallen to the point where many Gulf economies will need to draw on their foreign assets to sustain their current level of imports," the study said.

"Estimates of the Gulf's current and future external wealth consequently need to be scaled back to reflect the large losses of many Gulf funds and the much more subdued pace of future asset accumulation that seems likely over the next couple of years."

Its figures showed that 2006 and 2007 were the golden years for the GCC's sovereign funds because of high oil prices and strong global equity markets.

It estimated that Adia's funds under management rose from $285bn in 2005 to $400bn at the end of 2006 and $475bn at the end of 2007. KIA's assets peaked at $275bn and QIA reached nearly $65bn – for a total of around $800bn.

"This made the large Gulf funds among the biggest sovereign investors in a host of risky assets – as no other large pool of public money had a comparable appetite for risk."

TOTAL ASSETS

The report showed the total assets of the Gulf's sovereign funds and central banks likely peaked at over $1.4trn in the second quarter of 2008, including the foreign assets of Saudi pension funds managed by Sama.

They subsequently have fallen to around $1.2trn with the fall in the market value of the assets managed by the large sovereign funds accounting for the entire decline, according to CFR. It noted that Sama took losses on its equity portfolio but that those losses were modest and more than offset by the enormous inflow associated with high oil prices in the third quarter of 2008.

The study found that the rapid growth of Sama's foreign deposits in the third quarter of 2008 suggests that Sama reduced its equity purchases and thus its exposure to the fourth-quarter slump in global equities could be smaller than had been expected at around $60bn.

OIL PRICES SCENARIOS

The study presented four oil price scenarios for the prospects of Gulf SWFs in the next few years, including $25, $50, $75 and $100 a barrel. "The authors (of the study) do not assume that the Gulf's asset allocation will change in the future. As the authors assume only modest returns consistent across funds, the main driver of asset growth is the size of the region's oil windfall – which depends on the oil price and spending levels. All scenarios assume modest, but positive, returns on the Gulf's equity and alternative asset portfolios and stable exchange rates," it said.

"Even if oil stabilises at $75 a barrel over the next five years, the pace of foreign asset accumulation in the Gulf will slow substantially. Based on current trends, the increase in imports associated with higher spending would push the break-even oil price up to $75 a barrel by 2010 or 2011."

But the study noted that lower oil prices could rein in some of the region's development plans – and that the oil price needed to cover the region's imports will only rise to about $70 a barrel over the next five years.

"Under these assumptions, the major Gulf funds would receive $130bn in 2009, $120bn in 2010, and $90bn in 2012. The authors assume that the reserves held by GCC central banks will be constant."

Assuming an oil price of $50, the study said most countries in the region would end up drawing on their funds to support current levels of spending. At $25 a barrel, the erosion of assets is more significant despite an assumption that spending will sharply decline in 2010 and 2011 as Gulf governments adjust to a much lower oil price.

"If oil is $100 a barrel, by contrast, far larger sums are available to invest abroad as well as at home," CFR said. "If oil averages $50 a barrel for the next five years, many countries may actually start drawing on their savings in 2009." But the study added that such a move would not necessarily lead to a rapid depletion of the funds on the grounds that the interest and dividend income of the funds – together with capital gains – could produce annual growth of around $70bn a year.

$100 A BARREL

"In contrast, if oil averages $100 or more over the next five years, the GCC's assets will resume their rapid expansion and expand to $2.2trn by 2012. Even so the region would fall well short of generating the massive sovereign funds implied by those who project that the assets under management by sovereign funds would rise to $10trn to $12trn in 2012," it said.

"No matter what the oil price, the authors assume that overtime spending would approach revenues, although the authors assume a large, if narrowing surplus for many years if the oil price averages $100 a barrel."


Key players in the region

Published estimates that Abu Dhabi Investment Authority (Adia) – by all accounts the largest sovereign fund—managed almost $900 billion (Dh3.3 trillion) before the recent market slump almost certainly overstate Adia's true size. The authors' model suggests Adia's assets were closer to $500bn at the end of 2007 – an assumption supported by statements from Abu Dhabi officials and the IMF.

The authors' estimate assumes that Adia had assets of around $150bn in 2001, that Adia received the bulk of Abu Dhabi's oil surplus and that Adia had index-based returns on a portfolio with a heavy allocation toward equities and emerging markets.

Given that Adia reportedly had high returns on its portfolio in 2005–2007, the authors' estimate could understate its returns and assets under management, just as it might overstate more recent losses. Adia's large allocation to equities, especially those in Europe and emerging markets, contributed to its high returns in 2005–2007. Returns on its equity investment were thus the largest source of Adia's asset growth from 2003 to mid 2007. However, since mid 2008 losses on its equity and alternative assets offset the oil windfall. The authors estimate that the assets under management of Adia and Adic fell by about $140 billion in 2008.

KUWAIT INVESTMENT AUTHORITY

Kuwait Investment Authority (KIA) manages the funds of Kuwait's Fund for Future Generations (FFG) and its general reserve fund, which together exceeded $260bn in March 2008. With KIA's heavy exposure to equities, the Authority, like Adia, also suffered significant losses.

The FFG, which invests primarily abroad in equities and alternative assets, managed about $213bn. The reserve fund, which includes some domestic property and equity investments, managed about $40bn. Kuwait's FFG legally receives at least 10 per cent of Kuwait's revenues from oil. In practice, it likely has received far more in recent years, as Kuwait's oil revenues have exceeded its domestic needs and the reserve fund was still repaying the debt to the FFG incurred during and after the Gulf War.

QATAR INVESTMENT AUTHORITY

Founded in 2004, the authority is the newest and smallest of the major GCC sovereign funds. Qatar exports less oil than the UAE or Kuwait, but increasingly is poised to supplement its oil export revenue with revenue from its large natural gas fields.

Qatar has tried to scale up its assets quickly and seems to have been willing to take some of the highest risk bets. It has a high rate of return target of around 15 per cent and has not shied away from either the use of leverage or making large, concentrated bets.

For example, it continued to invest in European banks (Credit Suisse and Barclays) after most other sovereign funds withdrew. QIA has had a dollar share of around 40 per cent since at least 2005 with European assets likely making up most of its portfolio.

SAUUDI ARABIAN MONETARY AGENCY

SAMA is widely considered to be the most conservatively managed large Gulf fund, with a portfolio closer to a classic central bank reserve portfolio than to a typical sovereign wealth fund. It is probably better understood as a stabilisation fund than a wealth fund. In addition to managing the government's reserves and its non-reserve foreign assets, Sama manages the foreign assets of the Saudi government pension funds – a total of over $500bn at the end of 2008.

It is also the most transparent of the large funds, reporting – with a monthly lag – its total no reserve foreign assets (and the total foreign assets of the government pension funds) which totalled over $400bn and almost $70bn respectively at the end of November 2008.

Sama also held around $32bn in foreign exchange reserves. Sama discloses the size of its security portfolio (as well as the size of its deposits in the international banking system) – but not the currency composition of its portfolio or the bond/equity split of its security portfolio. The authors consequently know that Sama increased the share of its assets in deposits over the course of the third quarter of 2008.

The authors have assumed that 80 per cent of Sama's assets are in dollars and that 80 per cent of its securities portfolio has been invested in government bonds, with the remainder in equities.