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How Are GCC (and Other) Sovereign Funds Faring? An Update

February 21, 2009

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This post is by Rachel Ziemba of RGE Monitor where this post first appeared. Thanks to Brad for letting me fill in.

Recently,  Reuters reported that the assets under management of Kuwait’s sovereign wealth fund fell to 49b Kuwait Dinar ($177.6 billion) at the end of December from 58 billion Kuwait Dinar ($218 billion) in March 2008. – a face value decline of about $31 billion. Given that Kuwait had record oil revenues in 2008 (and a record fiscal surplus even if revenues tailed off in the second half) and KIA likely received record new capital, this implies that investment losses were even larger. It is significant for two reasons. One it shows that the estimates of fund performance (including those released in a recent paper by Brad Setser and myself) are on track and two, it could suggest that within limits there may be increasing amounts of transparency among sovereign investors. It also will provide an interesting test case of how the population and opposition react to the losses on the national wealth.

Unlike funds of its neighbors, Kuwait’s fund has to routinely report to its parliament and at such times information on its assets usually is released to the press. Doing so increases the robustness of estimates of their performance and may also open up channels to domestic pressure concerning how the national wealth is being managed. Domestic politics has influenced decisions in the past - Kuwait Petroleum’s deal with Dow Chemical was reportedly withdrawn under political pressure. So it will be a case to watch, as will the funds of Singapore which have also noted investment losses in response to legislative questioning.

The numbers seem to refer to Kuwait’s future generations fund, the larger of the two pools of money managed by KIA. The other, the General Reserve Fund,  is smaller, perhaps around  $40 billion. It is on the one hand more liquid as its name suggests but also holds the countries holdings in domestic equity and property markets. KIA itself though was also authorized to invest in the domestic equity market to prop up prices.

In out paper, Brad and I estimated that KIA’s foreign assets  (including the assets of the general reserve fund) fell to $228 billion in Dec 08 from $265b in March. Since evidence suggests that the GRF has an AUM of around $40b, that means we are pretty close, estimating face value losses of $33 billion.  Taking account of the net inflows received in 2008, the valuation losses on the equity and alternative asset-heavy portfolio might have been well over $90 billion – only partly offset by inflows of over $50 billion. This pattern manifested itself across most of the gulf funds as well as other funds with similar asset allocations like funds of Norway, Singapore and many university endowments.

Given the performance of risky assets in January and February (especially the deterioration of the last week) KIA has faced  further losses. In fact, based on our model the assets under management for the big GCC pools of capital (ADIA, KIA, QIA, SAMA) are estimated to have fallen to $1085 billion at the end of January from $1115 billion in December 2008 and $1165 billion in December 2007.  This takes the estimated total assets of GCC sovereign funds and central banks to $1.16 trillion by the end of January down from. $1.12 trillion in December. If asset prices end February where they closed yesterday (Feb 20), the AUM might fall to $1.13trillion at the end of this month.

All of these estimates assume no major changes in the asset allocation of these funds. This may not be correct. There is evidence that the funds of the gulf are increasing their allocation to liquid assets. This can be accomplished in two ways 1) not rebalancing to maintain an allocation share or 2) allocating new funds, if any, in a new way or selling one asset class to raise funds to buy another.

These valuation losses, come at a time when GCC countries (and many other sponsors of sovereign funds) are starting to need more liquidity and when oil prices have fallen below budget break even points even as oil production has fallen. Some governments may already be drawing on their savings to finance deficits. The foreign assets of Saudi Arabia’s central bank and pension funds fell around $5 billion in December, which may only be the start of the trend as Saudi Arabia runs a deficit at current oil prices and production.

The following charts update those in the paper, showing among other things that even if the oil price were to inch back up to $75 a barrel, GCC foreign asset purchases would fall far short of those in 2006 and 2007, when oil prices averaged slightly less.

Moreover, assuming modest investment returns, it would take a long time for the GCC’s portfolio to return to the peak of early 2008.

A few recent trends to note in the world of sovereign wealth.

1)    Sovereign funds are likely to privileging liquid assets as their needs for it increase. Oil funds are particularly vulnerable as their new funds have dried up. However, the other many source of surplus funds has also tapered off with capital flows to emerging economies reversing.  China’s pace of reserve growth has slowed and most others have reversed. As a result these countries may be pickier about how they allocate their assets. Korea is unlikely to allocate more funds to a sovereign fund now that it needs a higher cushion of fx liquidity.  Data in Singapore’s balance of payments which appears with a lag suggests that GIC’s pace of portfolio investment began slowing in Q3 2008. With the Singapore economy contracting sharply, it plans to draw on its reserves, some of which are managed by GIC, to finance its fiscal deficit.

2)    Instead of Investing abroad many are investing at home. If they do invest abroad, they may prioritize sectors consistent with domestic development goals. The latter trend began in 2007/08 but may have been accentuated by the reduction in available capital. Funds like Mubadala may find it easier to attract funds than others. Domestic banks also require capital and many countries are implicitly guaranteeing the debt of their corporate sector. All in all fewer funds are available for investment and other domestic outward investors may win out. .See here for a list of domestic investment by sovereign funds or their parents.

3)    Uncertainty about valuations may be deterring investments. Despite losses, sellers may not be willing to take current prices, mean the gap between buyers and sellers in key resources is.

4)    When they do (return to) invest, the sectors of interest may be shifting. Consumer focused goods may not be so appealing. The investment in the banks is well under water. Resources and other real assets may return to being attractive for a range of sovereign investors, especially those in Asia. Chinese loans to cash-strapped resource companies are only one example.  Some sovereign funds are talking about adding to real estate holdings. Norway’s fund in is talking about finally beginning to implement its planned new allocation to property and CIC officials also raised the possibility. But with prices yet to bottom out in the U.S., Europe, China and elsewhere, this may not yet be the time.

5)   Those funds that maintained conservative asset allocation outperformed their more diversified colleagues in 2008.  Those funds that planned to give more cash to invest in a range of diversified assets may shift their plans. There are some exceptions. Libya seems now to be planning to use its cash to buy Italian companies and Banks (it owns stakes in ENI, Unicredit and announced a recent plan to co-invest with Mediobanco).

6)    Funds that were reliant on leverage or who needed to raise capital in order to make investments have gone silent and are trying to sell some items. The funds of Dubai are a prime example. Isthithmar was reportedly trying to unload Barneys, a rumor it sought to quash. Even if that is untrue, many of the purchases made at the peak are under water and the leverage involved makes them vulnerable. No wonder various of the funds have been merging and seeking out new strategies, seeking investments that will hold their value in the downturn.

As always, its very hard to generalize across sovereign funds, but in general with fewer funds available, expect them to continue to be less active than some of the more optimistic observers thought this time last year and focused much more internally.

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