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GCC Sovereign Funds - Reversal of Fortune Authors: Brad Setser and Rachel Ziemba Source: Council on Foreign Relations, Working Paper Date: January 2009 |
The member countries of the Gulf Cooperation Council (GCC) boast some of the largest sovereign wealth funds in the world. Spurred by the high oil prices of recent years, these funds have invested heavily outside the Gulf region, but nearly all of them disclose little information about fund flows or investments and prefer discretion and inconspicuousness. Setser and Ziemba try to shed light on these funds. They design a model that can explain most of what is known about the funds’ inflows and asset allocation and that makes possible estimates of their past and future development.
They estimate that, with oil averaging just under $100 a barrel in 2008, the aggregate inflow to sovereign wealth funds and central banks of the GCC countries amounted to approximately $300 billion, clearly exceeding the $230 billion inflow of 2007. In 2008, however, the equity holdings of many sovereign wealth funds fell sharply in value, falls that are likely to have more than offset the inflows to most funds. The authors argue that these losses led to a reversal of fortune, in that conservative funds outperformed funds that had invested in riskier asset classes and that had performed better during the market upswing from 2004 to 2007. One such conservative fund is the Saudi Arabian Monetary Agency (SAMA), estimated to hold 80% of its portfolio in government bonds. Although SAMA lost about $45 billion on the equity share of its portfolio in 2008, this loss was more than compensated for by fund inflows of more than $162 billion. With estimated assets under management of $501 billion at the end of 2008, SAMA is now likely to be even larger than the Abu Dhabi Investment Authority (ADIA), which had long been considered the largest sovereign wealth fund in the world. As a result of its large share of equity investments, ADIA may have lost as much as $183 billion in 2008, while it saw inflows of only $59 billion for the same time period. This led to estimated assets under management of $328 billion at the end of 2008. According to Setser and Ziemba, the Kuwait Investment Authority (KIA) and the Qatar Investment Authority (QIA) met a similar fate.
The authors’ estimates of the size of ADIA funds stand in stark contrast to many other estimates. For instance, Deutsche Bank (Kern 2008) estimated the size of ADIA to be between $600 billion and $1,000 billion in 2008. JP Morgan (Fernandez and Eschweiler 2008) had similar estimates with a lower bound of $500 billion and an upper bound of $1,000 billion. However, other authors have suggested that the marked-to-market value of ADIA’s portfolio is probably closer to the lower end of this range (Seznec 2008).
On the assumption that these estimates appropriately describe the current state of the GCC sovereign wealth funds, Setser and Ziemba make some predictions about the future development of the funds. For an average oil price of $50 per barrel, the authors estimate that the region would need to tap into the interest and dividend payments it receives from its investments, as long as production cuts are not necessary. However, if keeping the price close to $50 a barrel required production cuts or if the price settled even lower, it would become necessary actually to draw on foreign assets and to delay or even cancel some prestigious domestic investments.
Setser and Ziemba conclude that oil-exporting countries whose goal is to use their investments to stabilise income streams should be wary of investing large fractions of their portfolios in assets that are likely to be correlated with oil. Otherwise, they run the risk of being unable to draw on their funds when oil revenues are low and the funds are most needed. In other words, the diversification principle of portfolio theory also holds for sovereign investors.
References:
Fernandez, D. G., and Eschweiler, B. 2008. Sovereign wealth funds: A bottom-up primer. JP Morgan Research.
Kern, S. 2008. SWFs and foreign investment policies – An update. Deutsche Bank Research.
Seznec, J. F. 2008. The Gulf sovereign wealth funds: Myths and reality. Middle East Policy. 15 (2), pp. 97-110.
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