Wealth funds homing in on emerging economies

Global recovery and rise in oil prices prompt sovereign wealth funds to focus more on attractively valued emerging markets. (SUPPLIED)

With emerging markets outpacing developed economies and recovering from global recession faster than developing economies, many sovereign wealth funds are focusing their attention and thus their investment strategies towards these countries.

"In our experience, sovereign wealth funds are increasingly focusing on emerging market equities at the expense of large-cap stocks in the United Kingdom, the United States and Europe. In part this is because emerging markets look more attractively valued," Rob Lay, Head of Mena, Europe and Alternatives at Baring Asset Management, told Emirates Business.

"However, it is also the recognition of outstanding long-term growth prospects of emerging economies. China, Eastern Europe and Russia are areas of growing interest. China's economy has particularly strong long-term prospects. Equity markets across the Mena are also appealing. As well as being resource-rich, regional economies are diversifying rapidly. Finally, emerging market debt is an area of interest for sovereign wealth funds," he adds.

Experts also believe as global economy recovery and the price of oil goes up, many wealth funds should again increase their investments after a rather lull period last year. "While sovereign wealth funds don't disclose their individual investment strategies, we certainly expect to see greater levels of investment this year than last, particularly overseas, and the proportion of investment in developing markets is also likely to increase," says Francis Small, Head of Private Capital & Sovereign Wealth at Ernst & Young Global.

"Last year, reported investment by sovereign wealth funds fell to levels last seen in 2004, but we expect this to increase in 2010. With the oil price around $70/bbl, a number of regional economies are likely to show a surplus and therefore have potential to increase the size of their wealth fund. An Ernst & Young report released late last year estimated that the total funds under SWF management could double to $8 trillion (Dh29.3trn) by 2015."

According to E&Y, there are already growing signs of increased investments by the SWFs, which should set the trend for the year. "Already there are signs of increasing investment activity in real estate, infrastructure, energy and mining & minerals. It was recently reported that the Abu Dhabi Investment Authority bought a stake in Gatwick Airport and the Libyan Investment Authority invested $300 million in Russian aluminium giant, Rusal. Wealth funds are also increasing their investment in developing markets in Asia and Latin America, particularly Brazil," says Small.

Even though investments by SWFs increase, strategies differ from one entity to another. "The funds continue to look at different ways to invest," says the E&Y expert.

"Last year, the Kuwait Investment Authority was reported to have invested $750m in Blackrock and recently the Chinese wealth fund, CIC, invested $950m in a fund managed by the global private equity house, Apax Partners.

Singapore GIC recently joined forces with Deutsche Bank to provide debt finance to the European Real Estate market, while the Bahrain fund, Mumtalakat, is reported to be looking to diversify away from private equity investments and into stocks and bonds."

Coming to the SWFs in the region, Small says: "Middle East wealth funds are all different. They have different objectives, different levels of autonomy and are at different stages of development. Some are mature, well-established investment houses while others are young and developing rapidly. In part, their strategies reflect the economic position and prospects of their country. As the economic outlook shifts, the role of the wealth fund can also change."

Despite being flush with money, SWFs are increasingly looking at the commercial viability of projects that they are investing in, something which analysts believe started before the downturn.

"Even before the global financial crisis, SWFs started to apply commercially based investment principles more rigorously. This means that even economic development projects are clearly expected to prove commercial viability. During the financial crisis, the weight of some asset classes have been mechanically reduced in the asset allocation (equities, real estate) due to the sharp decrease of their value. It has been only partially compensated since, and the exposure to bonds and other fixed income securities has slightly increased," states Cyril Garbois, Principal, AT Kearney Middle East.

SWF can broadly be categorised into two buckets in terms of investment strategy and asset allocation, he says, while explaining each of them. "Those who do not invest locally and who do not seek the control of the companies they invest in – their perspective is only long term, and the financial crisis has not changed significantly their investment strategy.

"Those who still have a significant share of their assets invested in their home market – they have started to increase their geographic and asset diversification, but they still pursue as an objective to strengthen the domestic economy. During the crisis, some of them have directly invested in companies in troubles." Like in the case of any other financial institution, the downturn has taught SWFs to pay more attention to risk management, believes Garbois.

 

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