from Follow the Money

A Saudi investment authority?

December 23, 2007

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The FT broke a major story -- at least in my world -- late on Friday. The Saudis are about to set up a sovereign wealth fund:

Saudi Arabia plans to establish a sovereign wealth fund that is expected to dwarf Abu Dhabi’s $900bn and become the largest in the world.

The new fund will be a formidable rival for other government-owned investment funds in the Middle East and Asia, which are playing an increasingly active role in channelling capital to western companies, particularly financial companies hard hit by the US mortgage meltdown.

….  The effort is likely to be spearheaded by Saudi Arabia’s Public Investment Fund, which has a mandate to invest only internally. Previously, the Saudis’ oil wealth had gone partly to the kingdom’s central bank, the Saudi Arabian Monetary Authority, and partly into the coffers of the ruling family.

While the balance sheet of SAMA is public information, bankers say the figures capture only a small percentage of the total wealth of the country. The myriad investment vehicles of the various members of the royal family have never been transparent.

Until now, SAMA’s investment policy has been conservative and largely limited to investment in bonds, especially US Treasuries, and shares. That contrasts with the mandate of its peers in the Gulf, which is increasingly geared to higher returns for when oil runs out, by investing in alternative assets such as private equity and hedge funds.

…. King Abdullah, Saudi Arabia’s ruler, is believed to be a key sponsor of the investment initiative.

This is big news, in a lot of different ways.


Five reasons: 

1. The Saudis have a large existing stock of government assets.   SAMA has close to $300b in non-reserve foreign assets (at the end of October, international deposits and securities held by SAMA as non-reserve foreign assets totaled $275b -- a total that no doubt increased further in November and December), the Saudi government pension funds hold some additional assets (also managed by SAMA, I think) and by all accounts, a lot more is stashed away in “various investment vehicles.”  If the Saudi investment agency managed the royal family’s funds as well as the country’s excess reserves, it could quickly surpass Norway, Kuwait and China and become the world’s second largest sovereign fund …

2.  The Saudis should also have lots of new funds to invest.  The Saudis current account surplus will be close to $100b in 2007, or about half of the GCC country’s current account surplus.    No other oil exporting economy has as large a potential to provide a large ongoing cash infusion to their investment fund from ongoing oil revenues.    My guess is that the Kuwaitis had about $40b to hand over to their investment fund in 2007, and Abu Dhabi had around $30b.    If oil averages $90 a barrel in 2008, the Saudis export around 9 mbd of oil and if the Saudi budget (and current account) balances at an oil price of around $50 a barrel, the Saudis could – at the limit – direct roughly $130b to their sovereign fund in 2007.  Over time, the Saudi fund should top Abu Dhabi’s fund -- in other words, the size of countries' oil funds should, after adjusting for population, roughly parallel the size of countries' oil reserves.

3. The Saudi investment authority’s funds will come in effect from saved oil revenue – not borrowed money.   They have the potential to gear up.    The China Investment Corporation, by contrast, is investing borrowed money.

4.  A new investment fund could produce a major change in Saudi Arabia's asset allocation.  Up until now, the Saudi Arabian Monetary Agency has invested the increase in its assets (around $50b in 2007, or about ½ the current account surplus – clearly there are other accounts that have swelled in size) fairly conservatively.   Who knows about the “private” assets of the royal family.  The Saudis also seem to have maintain a high dollar share in their portfolio.  If their investment fund maintains a high dollar share, they will be buying a lot of dollar assets.  If not, they could put substantial pressure on the dollar,  though that might make it even harder for the Saudis to keep the riyal pegged to the dollar. 

5.  The Saudis are not exactly models of transparency.  They do not allow the IMF to publish its Article IV report on their economy, for example.   A major Saudi investor didn't want to disclose their stake in UBS. To be fair, though, SAMA has been far more transparent than ADIA -- but unless something changes, I wouldn't count on the Saudis to be a strong voice arguing in sovereign wealth management circles for Norwegian-style transparency.

Combine a new Saudi fund with the possibility -- though not certainty - that the CIC might receive another $200b in 2008 on top of the $60-70b they will have to invest externally from the initial $200b (the rest has been used to buy Huijin and its existing stake in three state banks/ slotted for bank recapitalization) and it is quite possible that financial world truly will start to look quite different quite soon.    

$200b from China and $100b plus from Saudi Arabia would push annual inflows into sovereign wealth funds from around $100-$150b a year (with Norway’s transparent and passively managed government fund accounting for around $50b of that total)  to around $400b a year.  Adding in funds shifted to Libya's investment authority could increase that total to around $450b.    Some of that money could be leveraged, magnifying its impact.  

Even if the CIC spends 2008 investing just the roughly $60-70b of its initial allocation that is left over after buying/ recapitalizing the domestic Chinese banks and buying a stake in Morgan Stanley, adding Saudi Arabia to the mix would dramatically increase the share of the annual increase in aggressively-managed sovereign assets.

A Saudi investment authority is unlikely to face quite the same domestic pressure to support Saudi firms that the China investment corporation faces.    But the Saudis' traditional lack of transparency will only add to the controversy swirling around sovereign funds.    The current IMF policy response – as described by Bob Davis of the Wall Street Journal last week – seems too modest to address the concerns of the public in the countries likely to host large sovereign investments.   

I personally do not think it is an accident the countries that have moved most rapidly to create sovereign wealth funds generally have not been democracies.    Democratic governments face more pressure to use their wealth at home, more pressure to account for how they are investing government money and generally have less appetite to take big risks.   I don’t see any democratic country lining up to use their reserves to recapitalize large US banks or broker-dealers right now …

It is also noticeable that countries experiencing rapid reserve growth have moved more rapidly to create new ways of managing their burgeoning assets than to change the policies that give rise to their enormous surpluses.   

The Saudis cannot be blamed for high oil prices, at least not entirely.   The absence of any effective US energy policy has also contributed to tight global markets, as has rapid Chinese growth.   But the Saudis have resisted allowing the riyal to appreciate against the dollar.   That means the only anti-inflationary tool available to the government is fiscal restraint.   So long as the Saudis are serious about containing inflation, they really have no choice but to restrain domestic spending and build up assets abroad.    

One last note: the Saudis seem motivated, at least in part, by worries that Abu Dhabi’s investment fund has more money than they do.     The Saudis are supposed to be the richest Gulf state of them all – and keeping their assets out of the public light has meant keeping their ranking in the various league tables down.    However, those league tables themselves may paint a somewhat misleading picture of the wealth of their main rival.

For example, I am not sure that the Abu Dhabi investment authority really has close to a trillion dollars -- a number than increasingly appears in the press.    Moshin Khan of the IMF has cautioned that some estimates for ADIA are too high:

“Mr Khan played down some estimates of the size of assets under management at the world’s biggest, but opaque, sovereign wealth fund – the Abu Dhabi Investment Authority, saying figures of $875bn were exaggerated.” 

Work that Rachel Ziemba and I have done suggests ADIA has something more like $600-700b (paper here; RGE subscription required)

That estimates assumes that ADIA had about $200b at the end of 2000 (as reported in the Wall Street Journal back then), received around $150b from Abu Dhabi’s oil revenue from 2001 through 2007 (with most of the inflow from 2005 on), and obtained Harvard-like investment returns – including returns of over 20% from 2003 to 2006 -- on its portfolio.   We could of course be very wrong.  ADIA doesn’t disclose its total assets – and it isn’t entirely clear, at least to me, if the reported size of ADIA represents the funds of “Abu Dhabi” the state, the al-Nahyan family or a mix of both.   But unless ADIA starts reveals a bit more, well, a bit of caution is in order.   

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