Euromoney: the shadowy world of Gulf sovereign wealth funds

Euromoney, November 2012

In March 2010, the Abu Dhabi Investment Authority – probably the world’s biggest sovereign fund – launched its first ever annual report.

It’s hard to overstate just how big a step this was. A couple of years earlier, visitors to ADIA’s website, reasonably hoping to learn more about one of the world’s largest and most influential institutional investors, had been greeted with a picture of ADIA’s gleaming headquarters on Abu Dhabi’s Corniche, a phone and fax number – and absolutely nothing else. They clicked in hope of other pages, more information, a hint of strategy and approach, but there were no more pages to click.

So ADIA’s annual report, though lacking the magic number of its total assets, was a big deal. And there was a feeling then that this was the start of a whole new period of openness among the Middle East’s powerful and growing sovereign wealth funds: that, galvanised by the Santiago Principles that urge sovereign funds towards greater disclosure, we would soon know how the Kuwait Investment Authority, the Qatar Investment Authority, maybe even the Saudi Arabian Monetary Agency, invest their cash.

Well, ADIA put its third annual report out in June, and it remains a loner in terms of transparency; nor has it gone any further in terms of what it discloses since the first report. Instead, there are more questions in the Middle East about the behaviour of these groups than ever. We know more about ADIA, but probably less about how its role interacts or overlaps with the many other sovereign entities that have grown out of Abu Dhabi. Across the region, the original mandate of sovereign funds – to diversify hydrocarbon wealth by investing internationally – has been muddied by a new pattern of investing in the region’s own markets, sometimes apparently just to prop them up. We still don’t really have the faintest sense whether the Qatar Investment Agency is working to any kind of roadmap, or if it continues to go for the trophies on a purely opportunistic basis. And what of Saudi, where grand new funds – Sanabil al-Saudia, a designated sovereign fund for Saudi Arabia, or the endowment fund for KAUST, a new university near Jeddah – have been proudly announced and then apparently vanished from view? Four years on from the proposal of the Santiago Principles – which have 25 signatories, including the KIA, QIA and ADIA – you could argue we know less than ever about the sovereign entities that run more than $1 trillion from the Gulf.

So what do we know? Generalisations are tricky. “Each of them are unique and have their own approach,” says Richard Street, head of investor client sales management for CTS in EMEA at Citi. “It’s difficult to look for a single theme when there is so much money at stake.

There are a handful of regional patterns, though, some obvious – like shifts into emerging markets and alternatives – and others newer. One is that cash is still very popular. “There is still a lot of money on the sidelines, going in to money market vehicles,” says Street. “There is a concentration issue – a very real one – where many managers on the money market side are having to turn away some of their most significant investors or direct them to a managed account structure.”

Another is the prevalence of a passive kernel to portfolios, with ADIA a prime example. “One theme in the region is a move to a core-satellite approach,” says Nick Tolchard, head of Invesco Middle East. “Target returns have reduced and we’re seeing a more passive core with more high-alpha requirement around the periphery.” That has some knock-on effects for asset allocation. “That can manifest itself in more direct investing, or in areas where they can get higher yield,” says Tolchard. “Real estate and infrastructure are the two asset classes that seem to be the main beneficiary.” Hedge funds and private equity have not benefited to the same extent.

One theme widely talked about some years ago, but less so since, is thematic investing around megatrends – scarcity, security, environment. Instead, a bigger priority is more sophisticated risk management. “We’ve seen them move beyond capital-based asset allocation to risk-based,” says Tolchard. “Those are the themes that have taken over from investment in water, and so on; it’s more driven by the numbers, in terms of where they can have liquidity and a reasonable long-term return.”

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To go deeper than that macro picture, let’s take a tour of the region. ADIA is the logical place to start: the biggest, the most open, and a regional role model. It is understood that, prior to the fall of Gaddafi at least, the Libya Investment Authority had a long-term plan to model itself on ADIA.

There are several interesting things about what we know of ADIA’s approach to asset allocation.

One is that the emerging markets equities component of the fund can run as high as 20% of the whole portfolio, and is believed to be towards that figure today. (Across all asset classes, 25% can be in emerging markets.) That’s comparatively high, and others have followed it. Singapore’s GIC, for example, a natural comparison to ADIA because of its scale and sophistication, only really started shifting to emerging market equities in 2011, reaching a level of 15% by March 2012. Other funds in the region, notably the KIA in Kuwait, are also prioritising emerging market investments.

Another standout is that alternative assets are a comparatively large part of the ADIA allocation, and have been for many years – ADIA started in alternatives in 1986 and private equity in 1989. A cursory glance at the benchmark suggests that alternatives are 5-10% of the portfolio, which does not sound particularly high; but in ADIA’s definition, alternatives are just hedge funds, commodity trading advisors and active commodities. Private equity occupies another 5 to 8%, infrastructure 1 to 5%, and real estate 5 to 10%. In theory, one third of the whole fund can go into alternatives.

Curiously, it rolled its 15-strong infrastructure team, set up in 2007 by former Canada Pension Plan Investment Board man Chris Koski, into the real estate team in 2011, but still alternatives are a clear priority. Most of ADIA’s biggest hires of recent years, such as alternatives veteran Ben Weston (formerly CEO of Merrill Lynch Alternative Investments and Helvetica Wealth Management Partners – part owned, it’s worth noting, by the State of Qatar) as head of alternative investments and Colm Lanigan as head of principal investments in private equity, have been in this area. Again, it’s a regional leader; the KIA is also known to have prioritised alternatives in RFPs in recent years.

When ADIA’s first annual report came out, the two figures that leapt out at international asset managers were that ADIA outsources 80% of its money to external managers, and that 60% of the portfolio is passive.

The outsourcing figure is exceptionally high, and was a surprise to most of the industry when it came out. Generally, sovereign wealth funds start out by outsourcing a lot while they build competence internally, but having done so, take money back in-house, particularly on the more simple stuff, leaving the external allocations to high-alpha mandates, often in alternatives. There are many examples of this, from Singapore’s GIC and Temasek to newer funds like the Korea Investment Corporation, where the proportion of funds managed externally has fallen from 60% in 2009 to 28.1% by December 2011.

What stands out about ADIA is that so much of the outsourced work is clearly passive. Putting 60% of its money into index-replicating strategies is perhaps not unusual. But it had long been assumed that ADIA handled that money in-house – it has 1,275 staff, after all – rather than outsourcing it. This, too, may have implications elsewhere in the region; clearly it’s not just the market-neutral hedge fund work that gets outsourced, but the simple stuff too, for the right fee.

While ADIA itself has brought welcome clarity to its approach, it’s not so straightforward to work out where its responsibilities stop and other sovereign entities start. The picture has always been a little opaque, not helped by the fact that two different institutions – the Abu Dhabi Investment Company (now InvestAD) and Abu Dhabi Investment Council (now known as The Council) have had exactly the same acronym, ADIC. That’s without considering private equity-like Mubadala or the International Petroleum investment Company. And the blurring has got worse in recent years.

In particular, the 2007 set up of The Council, which owns stakes in local businesses like National Bank of Abu Dhabi and has a dual diversification and direct investment mandate, muddied the waters. There’s no question that The Council is another sovereign fund, and that it overlaps considerably with ADIA. It has an active investment strategies department, for example, which partners with hedge funds in relative value, hedged equity, macro, event driven and CTA strategies – a lot like ADIA’s alternatives division. It invests in global and regional large cap, small cap and emerging market equities, and a range of sovereign, credit and inflation-linked debt securities – exactly like ADIA. It has infrastructure, real estate and private equity divisions.

“Originally, ADIA was going to be international, ADIC local and regional, but that’s changed and they clearly overlap,” says one fund manager. “During the Dubai debt crisis you saw a lot of cross-investing going on: if you’re a fund with a mandate that’s largely international, you want to get a good return, and if something attractive appears locally, you’re likely to be interested.”

On the ground, received wisdom has it that the main reason The Council was set up was because ADIA had just got too big. It was no longer nimble. One can argue indefinitely about just how big ADIA is, but few think it is anywhere below $500 billion; it’s difficult to deploy cash like that opportunistically. The Council, being smaller, was meant to be able to take advantage of opportunities ADIA could not. It has, for example, a special situations unit that appears to have no equivalent in ADIA. “ADIA is beta and The Council is alpha,” says one fund manager.

This trend is here to stay. A recent report by Invesco, which interviewed key institutional investors including sovereign funds in the Middle East, found that 28% of sovereign funds in the region felt they were in competition with other sovereign funds in their own country.

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While ADIA is the biggest, Kuwait’s KIA is the oldest. It carries a particular kudos in sovereign wealth circles, partly because, where some speak of sovereign funds as being for a rainy day, Kuwait’s rainy day was the nation’s invasion by Iraq and the immolation of 700 of its oil wells, removing the country’s principal source of revenue for three years. During the occupation the management of the KIA shifted to its London office, the Kuwait Investment Office, which effectively became the central bank in absentia; after liberation, the fund spent more than US$85 billion on reconstruction. The KIA, it’s fair to say, saved the country.

The KIA also stands out because it’s the only Middle East sovereign fund to report into any kind of a democracy. Kuwait has a surprisingly vibrant parliament, to which the KIA must report; this is one reason that the KIA’s drab public sector offices are so utterly outshone by those of, say, ADIA. “The KIA,” says one manager, “has some of the best quality people in the worst quality office.” The KIA is one of the most transparent funds in the region in terms of its governance, it’s just that it doesn’t disclose most of that information to the general public.

The KIA adopted a new strategic allocation seven years ago that increased its risk profile, put it into high yield debt, added small cap and emerging equities, and introduced alternatives; much of the intervening period has been spent putting it into practice. Beyond that, and the long-term positions in blue chips like BP and DaimlerChrysler, KIA never discloses allocations. However, a detailed study by Cerulli Associates in 2010, written by this author, found that in 2007 58% of the fund was in equity, 15% fixed income, 23% cash, 2% alternatives and 3% real estate (rounding differences explain why this totals more than 100%). Since then, it is understood the cash balance has come down in favour of alternatives, real estate and debt. The group’s strategic asset allocation geographically then was believed to be 40% US, 40% Europe, 15% Japan and Asia, and 5% other emerging markets, though again there has been a clear drive towards emerging market investing. For example, it is known that the KIA has looked at ways of building expertise in sub-Saharan Africa, and at thematic investment methods such as renewable and green technology. This year it confirmed a $500 million investment in partnership with the Russia Direct Investment Fund.

While KIA’s presence in alternatives is far less entrenched than ADIA’s, it is significant and growing. KIA has a subsidiary called National Technology Enterprises Company that is basically a venture capitalist, and it has a long-standing involvement in real estate – not just through vehicles like St Martins, which has holdings in London, but more recently through Kuwait China Investment Company, whose China investments include real estate.

Indeed, KIA’s interest in China is characteristic of sovereign funds in the region. Both it and ADIA have secured quota under China’s Qualified Foreign Institutional investor (QFII) scheme, allowing them to make investments on the mainland in local currency; both are believed to be pushing for more quota, and to be seeking diversification into RMB generally as that currency becomes more available offshore.

The KIA also illustrates another trend in the region: investing locally, something that never used to be a role of the region’s sovereign funds. KIA has large stakes in some key local institutions, such as Kuwait Finance House, Kuwait Airways and telco Zain, and has long had a practice of seeding new investment management companies; to this day it frequently holds 50% of new mutual funds at launch. But this is something else: direct investment in Kuwait’s stock markets, particularly through the financial crisis.

This is becoming increasingly common across the region. “There is a certain amount of investment back into the regional market, particularly active management into regional equities, which I think is interesting,” says Richard Street at Citi. “It’s never entirely clear if it is done as part of a wider investment strategy or to support the market and help grow the economy locally, but there is more of that activity going on.” On one hand this seems odd – if sovereign funds exist to diversify, why come back? But Street takes a different view. “It’s exactly what the region needs,” he says. “It needs some of these significant investment dollars to come back and to help mature these local markets.”

Another common regional trend illustrated by the $300 billion KIA (it never discloses that number but one can always count on a parliamentarian to leak it from time to time) is that it’s getting bigger. Kuwait has increased the proportion of revenue it commits to the Future Generations Fund – one of two funds run by the KIA, the other being the General Reserve Fund – from 10% to 25% annually.

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So what to make of Qatar?

Clearly, the QIA is a world apart from its local peers. Asset managers get precious little from it in terms of external mandates; many are not sure that any are even awarded (Euromoney understands that some are, but not many). “We meet a number of people but it’s difficult to get a handle on what they’re doing in terms of overall asset allocation and strategies,” says one manager. “It’s hard to win mandates on traditional asset management business.” Another: “The QIA is a difficult entity to deal with. The interaction is very strange and sporadic. I’ve never met anyone who had a mandate with them.” A third: “I have a contact there and it’s like blowing in the wind whether they’re going to answer me or not.” A fourth: “I’ve been calling them for four years. I never get anywhere.”

Since the leadership generally doesn’t give interviews about the fund, the best information tends to come when a board member makes some remarks at a Doha conference. This last happened in April, when director Hussain Al Abdulla did so, and he appeared to confirm what had long been apparent. “We don’t have any geographic allocation or asset allocation or currency allocation,” he said. “We are very much opportunistic.”

Al Abdulla also revealed that the QIA has “much more” than $100 billion of assets, and said it planned to put $30 billion to work in 2012 alone. The most visible manifestation of this policy is Qatar Holding, the foreign investment arm of the fund, which is rarely out of the news: Total, Barclays, Volkswagen, Xstrata, Porsche, Harrods.

QIA has absolutely nothing in common with ADIA or KIA bar its location. “QIA is much more a new-style aggressive deal-driven sovereign than a KIA or SAMA who have been doing it for years and like to be more low profile,” says one asset manager. Another adds: “What the QIA is doing today is what the KIA used to do 20 years ago. They are very opportunistic, not like a sovereign wealth fund. In fact they’re more like a family office.” Another says: “It acts like a proprietary trading book, rather than a long-term savings vehicle.”

It’s clear, though, that QIA is about more than flashy London real estate and European blue chips. For some time now, the fund has been investing in commodities, and until recently had been expected to buy Morgan Stanley’s commodities business. While that deal appears to have stalled, Qatar Holding’s role in Glencore’s planned acquisition of Xstrata illustrates the increasing attention being paid to commodities. Infrastructure, too, is believed to be of increasing interest.

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And finally there’s Saudi Arabia, the biggest economy by far. For years, asset managers hoping to get mandates from the sovereign had to go through the Saudi Arabia Monetary Agency, which is first and foremost a central bank. SAMA does have some SWF roles: the country’s foreign reserves are run through its General Investment Department. But it is considered perhaps the most conservative of all sovereign wealth entities worldwide, with the vast majority of its investments in Treasury-like debt securities. As governor Mohammed Al Jasser said when asked about allocations in 2010: “I have made it a very explicit policy not to talk about this, except to say we put a lot of emphasis on safety first, liquidity second, and, third, risk-adjusted returns – in that order.”

But Saudi is interesting for two reasons. First is the scale of foreign assets, believed to be over US$400 billion; second is the recent proliferation of new, smaller entities that appear more interesting from an investment perspective.

Public Investment Fund, established in 1971 and affiliated with the finance ministry, announced in 2008 that it would manage a new sovereign wealth fund, in the purest sense – investing specifically for the state with a long-term investment horizon. The fund in question was named Sanabil al-Saudia and was launched on July 15 2008 with SAR20 billion in assets. Back then, it was expected to start investing six months later, with an initial focus on technology investments growing later into a global mandate across many asset classes with external advisors making investment decisions.

Some wild numbers were thrown around about Sanabil’s potential – one official was quoted as saying it could reach US$900 billion – but for more than three years almost nothing appeared to be happening. “Sanobil came in with a blaze of glory but so far as I can see there’s been no real activity,” says one asset manager. “It’s all been pushed back into SAMA: a compartmentalisation of assets within the central bank for the objectives Sanabil had been set up for. Certainly there’s an office, and someone running it, but no build-out of the office or infrastructure.”

The group does at least now have some senior people on board: in March, John Breen, formerly at the Canada Pension Investment Board, joined as a senior executive investment officer, apparently as head of direct investments. But the fact that former Morgan Grenfell Private Equity executive Scott Lanphere had been hired in pretty much that role the previous November, before leaving again a month later, suggests some teething problems at the new fund. Still, while the silly numbers are no longer being mentioned, it is understood that the private equity exposure is targeting $4.5 billion of investments.

In the absence of Sanabil doing much actual investment, many managers have been more excited about the endowment fund supporting the creation of the King Abdullah University of Science and Technology, or KAUST, at Thuwal, north of Jeddah. Early indications were that this could become the largest endowment fund in the world – it was reported to have been seeded with $10 billion – and it engaged Cambridge as a consultant in its early days. Fund managers speaking to the institution after its launch were excited, describing a Middle Eastern Yale endowment, interested in brave new ideas such as thematic and megatrend investing.

A big step came in March 2009 with the appointment of Gumersindo Oliveros, formerly director of the pension plan and endowments at the World Bank.  And KAUST is not invisible by any means – Oliveros spoke at a venture capital conference in March – but there is the same sense of initial fanfare not yet having been followed up by tangible progress on investment. For his part, Oliveros still resides not in Saudi but in the US, working from an office in Arlington, Virginia.

Still, these things take time, and asset managers remain optimistic. “In terms of the new funds springing up, you get the sense they are now starting to be funded,” says one manager. “I don’t get the sense they are in full flow at the moment, but they are starting to emerge in terms of making investment decisions.”

For regional asset managers, the messages are mixed. More and more money; but increasingly going into asset classes where it’s hard to intermediate, like infrastructure and real estate. Still, there’s no question that sovereign wealth funds remain the meat and drink of any asset management business in the Gulf. Invesco, in its study, tried to calculate what proportion of investable assets in the region came from the sovereign funds. The answer: 88%.