Analysis - Economic Trends

Gulf Model

Future of Sovereign Wealth Funds as part of the global economy
Thursday، April 28، 2016
Gulf Model

The importance of sovereign wealth funds for the global economy has increased considerably in the past two decades, particularly during the period where crude oil prices went over US$100 per barrel and the accompanying rise in financial surpluses of oil-producing countries saw an increase in investment through these funds. As a result, an increased interest was seen by both oil-producing countries and countries seeking to attract more investment. Consequently, the flow of the role of sovereign wealth fund investments is now considered to constitute a positive factor in several areas such as helping restore stability to major industrial powers in the wake of the global financial crisis and the global economic slowdown.

These funds are looked at more positively in recent years because of an increase in the degree of transparency in their management, applying good corporate governance and focusing more on their role in states with high financial surpluses, whether by diversifying sources of income to help maintain economic stability or achieving fair distribution of wealth to benefit future generations when oil or natural gas will have depleted.

The emergence and development of Sovereign Wealth Funds

Sovereign wealth funds first appeared in the Arabian Gulf. Kuwait Investment Authority (KIA), the oldest sovereign wealth fund traces its roots to the Kuwait Investment Board, which was established in 1953, eight years before Kuwait’s independence. Currently, KIA manages US$592 billion in assets, according to the Sovereign Wealth Fund Institute, also known as the SWF Institute.

The fact that the first sovereign wealth fund emerged in an oil exporting country was not unusual. It also was not unusual that their appeal has long attracted the attention of producers of raw materials. That is because, in principle, these funds were created to serve two purposes. First, they help avoid the negative impact of sharp price fluctuations on economies that rely on producing and exporting raw materials, as these funds serve the goals of diversifying sources of income and achieving economic stability by using surpluses resulting from high oil prices to generate income and offset shortages when oil prices fall.

The second purpose relates to the nature of raw materials produced by states that take an interest in sovereign wealth funds where resources such as oil and gas can deplete in the future. Therefore, achieving a fair distribution of wealth to future generations means a percentage of the income generated by a state's major exports should be invested to generate future income when raw materials are drained.

However, it is worth noting that sovereign funds are no longer restricted to states producing raw materials; rather a number of countries, namely China, have established sovereign wealth funds to manage their surplus income generated from foreign trade, maximize the state's economic revenue and sometimes exercise political influence in regions that are of interest to it. This makes such funds an effective arm to exercise soft economic power on the global arena.

Current situation of Sovereign Wealth Funds

As of February 2016, the Assets Under Management (AUM) of sovereign wealth funds of fifty countries totaled US$7.1 trillion, of which US$4 trillion, or 57%, are investments linked to the oil and gas sectors, according to the SWF Institute. The remaining investments, i.e. US$3 trillion or 43% are in other sectors.

As for the nature of investments run by sovereign wealth funds, assessments by Preqin, a US-based alternative assets industry's leading source of data and intelligence, show that despite the fact that the major part of portfolios run by these funds are focused on public debt tools and stocks of public companies, they recently began to increase their investment in other assets. Fifty-five percent of sovereign wealth funds now invest in private equity, up from 47% in 2015, while 62% invest in both real estate and infrastructure. Additionally, more than a third (35%) of sovereign wealth funds are active in this private debt industry. Preqin's statistics also show that sixty-seven percent of all sovereign wealth funds were launched since 2000. In the past six years, fourteen sovereign wealth funds were launched.

Sovereign wealth funds can be ranked at several levels as follows:

  1. When ranked by country, China is considered the world's largest investor in sovereign funds. It owns five funds with US$ 1.9 trillion in AUM (27 percent of the total value of the world's sovereign funds). The UAE ranks second with seven funds valued at US$1.2 trillion (17 percent of the total value of the world's funds). Norway, which has one sovereign fund managing investments valued at US$825 billion, comes in third place, followed by Saudi Arabia with two funds holding US$638 billion, and Kuwait, whose fund, the world's oldest, manages US$592 billion of AUM.
  2. When ranked individually, the Norway Government Pension Fund Global is the largest sovereign wealth fund globally, holding US$825 billion in AUM accounting for 11.6%of all the world's funds, followed in second place by Abu Dhabi Investment Authority (ADIA) with US$773 billion in AUM (11%of all the world's funds), followed by China Investment Corporation with an investment portfolio worth US$747 billion, Saudi Arabia's SAMA Foreign Holding with US$632 billion, and Kuwait Investment Authority with US$592 billion.
  3. By region, collectively, sovereign wealth funds based in Asia, Australia, and New Zealand, represent eighty-three percent of all sovereign wealth funds worldwide, followed by Europe (twelve percent), the Americas (three percent) and Africa (two percent). It should be noted that, collectively, sovereign funds of the six members of the Cooperation Council for the Arab States of the Gulf (GCC) manage investments worth US$2.8 trillion (38.8 percent of all sovereign funds). With the addition of  five other Arab states - Libya, Algeria, Mauritania, Iraq, and Palestine – the Arab world’s GDP is valued at US$2.9 billion (40.5% of all sovereign funds).

Future of Sovereign Wealth Funds

Sovereign wealth funds are expected to play an increased role in the global economy because states that rely heavily on oil and gas revenue are working diligently to pursue two parallel economic courses building on diversification, one at home and the other overseas.

Domestically, the majority of these states have embraced development strategies that capitalize on competitive advantages other than oil and gas, a case clearly demonstrated by the UAE which pursues economic diversification strategies to reduce the share of the oil industry in its economic activity and promote the role of other sectors like travel and tourism, financial services, foreign trade, IT and sophisticated industries like aircraft components.

Overseas, these states are working to diversify their sources of income and protect their economies from negative foreign impacts - like plummeting global oil prices. Currently, the UAE ranks second globally as the world's largest investor in sovereign wealth funds, and in terms of the size of individual funds.

Within this context, it is noteworthy to mention one of the most important developments that took place in the last few days and can change substantially the role the world's global wealth funds play in the global economy. Mohammad bin Salman Al-Saud, Saudi Arabia's Deputy Crown Prince, second Deputy Prime Minister and Minister of Defense, announced a plan to set up the world's largest sovereign wealth fund with investments worth more than US$2 trillion to wean the Saudi Kingdom off oil in the next twenty years.

The envisioned mega fund, the Public Investment Fund (PIF), illustrates the efforts being made by major oil producing countries, especially because of  oil price volatility in the past one and a half years and the expectations that the barrel price will not rebound to more than US$100. As part of that strategy, Saudi Arabia will sell an estimated five percent of shares in Aramco’s parent company. The PIF ultimately plans to increase the proportion of foreign investments to 50 percent of the fund by 2020 from the current rate at 5 percent.

Such an approach will help strengthen the ties between global economy and economies that currently rely on oil, diversify their relationship beyond supplying hydrocarbons and invest in tools such as foreign government debts. As part of the current trend, investments in productive assets and major corporations involved in diversified and globally effective economic activities benefit both states that own the sovereign wealth funds and  states which are the destination of investments managed by these funds.

Keywords: GCCSaudi ArabiaEconomyUAESovereign Wealth FundsGlobal EconomyKuwait

Also Read