Gulf sovereign wealth funds look east

Asiamoney, February 2008

Last month [JAN 29] Kuala Lumpur’s biggest shopping mall, a 1.4 million square foot monster called the Pavilion, held its formal opening ceremony. Among the represented parties was what might seem an unusual figure in southeast Asian real estate: Qatar’s sovereign wealth fund, the Qatar Investment Authority. The QIA, though you’ll rarely read about it, owns 49% of the venture that built the mall.

You’d be forgiven for thinking the Middle East’s sovereign wealth funds have been looking west, not east. Over the last few months, all the headlines have been about them taking stakes in Western banks: the Abu Dhabi Investment Authority (ADIA) into Citi, the Kuwait Investment Authority (KIA) into Merrill Lynch. But these opportunistic deals, taking advantage of low valuations caused by sub-prime losses and the credit crunch, disguise the true picture: that these organisations and others like them are increasingly focusing on Asia.

 “Right now, the headlines coming out of Middle East sovereign wealth funds are about their  buying well-branded financial institutions in the US and Europe,” says Douglas Hansen-Luke, CEO for the Middle East at Robeco in Bahrain, and until recently the CEO of asset management at Saudi Hollandi, the Riyadh-based bank part owned by ABN Amro. “But if you actually talk to them, whilst they’re very pleased with the opportunities for these large one-off deals, they see themselves as being under-represented and missing out on significant opportunities in the Far East.”

They have an awful lot of capital to deploy. Pinning down accurate numbers on Middle Eastern sovereign wealth funds is notoriously difficult – ADIA has never published a single number on its assets under management since the authority’s foundation in 1976, and its peers in Kuwait, Saudi and Qatar have taken a similarly distant approach to publicity. But estimates are staggeringly high. Deutsche Bank puts ADIA’s total assets at US$900 billion, roughly the size of the Indian economy; Morgan Stanley last year reckoned US$875 billion while Standard Chartered estimates a relatively cautious $625 billion (it’s come to something when $625 billion looks like a low-end guess for a single fund’s assets). ADIA is the outlier, but its counterparts are far from puny: estimates for the KIA tend to be between $200 and $300 billion, for the Qatar Investment Authority between $40 and $70 billion, and for the various Saudi entities that invest on behalf of the state (there is no single Saudi sovereign wealth fund) around $300 billion. In short, the United Arab Emirates, Saudi Arabia, Qatar and Kuwait have as much as $1.5 trillion to put to work between them. And all of them, with the possible exception of some more cautious Saudi institutions, are understood to have made a priority of increasing their allocation of this vast wealth to Asia.

It’s not as if they’re not already here. Although sovereign funds have only recently captured world attention, many of them go back decades; Kuwait’s KIA was set up in 1953. And while there may have been a time when relationships were enough to get foreign fund managers through the door, Middle Eastern sovereign funds today are highly sophisticated institutions. Asia is nothing new to them and they have been significant players in Asian listed equities for many years, although private equity is a newer adventure.

But the feeling is that more and more of their riches are heading east instead of west. It’s not just a question of their own views, but those of their advisors too. “They are being advised by the bigger investment banks and sell side brokers that Asia is the right place to go,” says Hansen-Luke. Indeed, since the brightest institutional money seems to be heading to Asia, it should be no surprise that sovereign wealth money is coming here too. “What we see at the moment in Europe and America is closely related to market conditions, giving sovereign wealth funds great opportunity to acquire significant stakes at reasonable valuations,” says Steffen Kern at Deutsche Bank in Frankfurt, who put out a widely-read report on sovereign wealth funds in September. “But from a longer term perspective, sovereign wealth funds will see greater diversification across asset classes and regions. Asia is clearly showing stock market growth above international averages, and therefore I would expect Asia would be a prime focus for investments from sovereign wealth funds in the Middle East.”

The Kuwait Investment Agency is an example. Following a revamp of the group’s asset allocation recommended by an international asset consultant in 2004 (see box), KIA’s managing director said he planned to increase its allocation to Asia to 20% – well above the allocation typically found in, say, a global equities mutual fund tracking the MSCI world index. “KIA has been at the forefront of Asian investment and they have made their intentions pretty well known,” says MR Raghu, senior vice president at Kuwait Financial Centre, a funds management group in Kuwait City. “What is making the news is their support to Citi, but on the side I think they have been quietly going about increasing their exposure to Asia in a very significant manner.”

Only the very largest deals are ever publicly confirmed by the KIA, and among Asian assets, the only one to have fitted the bill in recent times has been its cornerstone role in the IPO of the Industrial and Commercial Bank of China (ICBC) in 2006. Then, Bader Al-Sa’ad, the KIA’s managing director, spoke of “Kuwait’s deepening economic ties with China…This participation also marks the beginning of KIA’s long term strategic investment plan in China, which the KIA hopes to extent to many other sectors.”

At the time, Al-Sa’ad also said he hoped the deal would “showcase the long term strategic value of KIA as a core investor.” And this is an important point. Because sovereign wealth funds are patient, long-term investors – they are supposedly building wealth to support the future of their country – they are perfectly placed for private equity participation, which is less likely ever to be seen in the outside world. “They prefer private equity to direct equity,” says Raghu. “They like private equity as a vehicle. They don’t have any liquidity needs and they’re prepared to wait a long time to get that extra alpha from their investment. There’s a big difference between Fidelity saying they want to be 20% emerging markets and the KIA saying they want to be 20% emerging markets. Fidelity will impact the stock markets the next day; KIA might mean waiting on the sidelines for big private equity opportunities to come along.”

Sovereign wealth funds are generally very unwilling to speak, but Navid Chamdia, who heads real estate at the Qatar Investment Authority, gave an interview to Asiamoney. He speaks of an extraordinarily high allocation to Asia. “We want to ensure Asia should be about 40% of our portfolio,” he says. Today, QIA is a long way short – he doesn’t say how much – but it is changing. “Historically we used to invest primarily in Europe and to some extent in the US,” he says. “However over the last 18 months we have primarily been focusing on Asia. One, we have been positive on the economic growth that is forecast for Asia; and two, it’s diversification.” The QIA’s chief executive, Sheikh Tamim Bin Hamad Al Thani, who is the son of Qatar’s emir, has spoken of the 40% figure as being a five year target.

The QIA also took a stake in ICBC, and is a shareholder in India’s HDFC Bank. It has entered into several real estate ventures aside from the KL Pavilion: it is developing high end property in Singapore, is investing in India, and according to Chamdia is interested in financials, utilities and more real estate. “Our model is we develop a relationship either with people who are financially smart or people who are operationally smart, and either create joint ventures or take strategic stakes in them,” he says. “Through them, we seek opportunities in the region. We will see a big pipeline of co-investment opportunities with them.”

“In all these [Asian] countries there is a fundamental unmet demand for real estate, infrastructure and sophisticated financial institutions,” Chamdia adds. “In terms of the opportunities to get into a JV or company early on and see it grow, the potential upside is significantly higher in Asia than it would be in a developed market like the US or London.”

ADIA is where the really big money is, and it is perhaps the most secretive of the lot. Take a look at its web site, www.adia.ae: a single page containing address, phone and fax number. Nothing to click through to; nothing to tell you what it is, who works there, what it does or why. However, it is known as a savvy institution that has been very early into new asset classes, including the emerging markets. It is also known as a group that has the courage of its convictions and will take significant overweight positions when it believes in them; it is understood Asia is one of those overweight positions.

For all Middle Eastern institutions, there is a local affinity with the Asian region, starting with the fact that South Asia in particular is very close. “India has traditionally had strong trading links with the Gulf states,” says Hansen-Luke. “You have an awful lot of Indians and other people from the subcontinent here – and not just migrant workers but businesses people with substantial interests here, and so people in the Middle East have witnessed first hand the growth of the Indian economy.”

Chamdia confirms this connection. “In Qatar, we are closer to the emerging markets and have very good political relationships with places like India and China, because of the fact that we are one of the largest gas exporters,” he says. “On the back of these relationships, in many ways we can mitigate the emerging market risk a non-government investor would face in these countries.” The political concerns that some sovereign funds face in the US and Europe from governments nervous about their intentions tend not to be an issue in Asia, although Chamdia says “we’ve been very welcomed in Europe and the US whenever we have done any transactions over there.”

That said, an argument often made at the retail and mass affluent level – that Asia has a similar risk/reward profile to the Middle East and so is therefore a more natural home for capital from the Gulf than Europe or the US is – probably does not apply at the sovereign wealth level, where the imperative is to preserve wealth for the next generation.

The sums are such that a reallocation of this wealth towards Asia is enough to have a material impact on market valuations – yet another element underpinning Asia’s attractive dynamics, which in turn becomes another reason for sovereign funds to invest in it, creating a virtuous circle. “If you look at GDP growth forecasts, even for next year, China is around 8%, India 8%, Vietnam, Singapore, Malaysia…” says Chamdia. “Their growth forecasts completely outstrip anything you would see in the developed world.”

BOX: THE SOVEREIGNS COMPARED

Each sovereign fund has a different character and approach. The thing they all share is secrecy, which has got so many western governments hot under the collar about their record on transparency. That record is easily summarised: there is no transparency. And nobody in the Gulf sees why there should be any.

One former ADIA employee recalls how he used to run a book of business focusing on the equities of a single country. He didn’t know how that fit into the overall portfolio; what ADIA’s total assets under management were; or even what the people sitting next to him were managing, or at least not with any great accuracy. And this was someone who worked in-house: for the people handling outsourced mandates, believed to account for 70 to 80% of ADIA’s funds, they are even more in the dark, instead given highly specialist mandates and benchmarks.

It would be naive in the extreme to think of these groups as unsophisticated bodies who give out their business based on personal or family relationships. ADIA and KIA in particular are seen as sophisticated institutions. A 2006 interview between two ADIA executive directors and Euromoney – one of the only occasions the institution has ever spoken publicly – painted a picture of great technical ability. An overall global book is broken down into numerous sub-classes (in debt, for example, they include global government bonds, global investment grade credit, emerging markets, global inflation-index bonds and others) and each has its own fund managers, in-house analysts, benchmarks and guidelines, with each class covered by  a number of different investment strategies. There is a team of senior and experienced people doing nothing but selecting underlying managers.

ADIA employs an international staff rather than just nationals, as is the case at some other sovereign funds. “It’s known as being much more aggressive, particularly in private equity, and has more closely associated itself with the long-run growth model of US endowment funds like a Harvard rather than short-term capital preservation and liquidity management, which is the focus of central banks,” says Hansen-Luke. It is believed to have been an early investor into emerging markets, and to hold an aggressive allocation towards them today, including Asia.

The Kuwait Investment Authority has been around since the 1950s but the fund of greatest interest – the Future Generation Fund, which receives 10% of all state revenues, including the oil wealth – was formed in 1976, the same year as ADIA. The KIA has long had a reputation for great professionalism, building a strong in-house training program and hiring the best minds in the country. But it was until recently considered highly conservative.

That changed in August 2004 when the KIA appointed an international consultant to review its strategic allocation. The consultant (who has never been named) recommended a more diversified portfolio, investing in uncorrelated assets, with a lower weighting towards public listed equities and bonds and an increased allocation to alternatives, private equity and real estate. Specifically, it recommended emerging markets.

An organisation on the scale of the KIA, beholden to one of the region’s more vigorous parliaments, takes time to change, but a year later its board of directors approved the new allocation along with a new target rate of return and risk profile geared towards doubling the assets under management within 10 years. Within this allocation came not only an interest in emerging market equities, but debt too. In April 2006 a new organisational framework was approved to implement the recommendations (included a dedicated portfolio investment department for Asia), and it’s really only now that the portfolio is shifting to reflect the new approach. KIA does not disclose holdings but its anchor positions in some major stocks, notably BP and DaimlerChrysler, have become well-known.

Saudi Arabia is different again, lacking a single dedicated body to act as its sovereign wealth fund. The Saudi Arabian Monetary Authority, which is the country’s central bank, takes on part of that role, as does the General Organisation for Social Insurance (GOSI) and some other state institutions. Price Alwaleed bin Talal, a member of the Saudi royal family who runs Kingdom Holdings and who has twice been responsible for taking major stakes in Citigroup, invests as an entrepreneur rather than in the name of the Saudi Arabian state. The formal Saudi institutions are considered the most conservative financial enterprises in the Gulf.

Then there’s the new kid: the Qatar Investment Authority. A more recent presence, launched only in 2005 (reflecting the more recent arrival of wealth to Qatar predicated mainly on the discovery of huge natural gas reserves beneath the tiny country), the QIA has quickly made a name for itself with some high-profile acquisitions of well-branded businesses, particularly in the UK. For example, it owns 23.5% of the London Stock Exchange (as well as just under 10% in OMC, which owns Nordic and Baltic exchanges); all of Four Seasons Healthcare in the UK; and 25% of the supermarket chain J Sainsbury, which it nearly acquired in its entirety before the credit crunch prompted it to pull out.