The Arab Spring and the eurozone crisis have compelled sovereign wealth funds to take risk management more seriously. Orlando Crowcroft reports.
The secretive and fabulously rich sovereign wealth funds of the Gulf states have long aroused fascination in the finance world, not least during the financial crisis, when they were among a minority of investors willing to open their wallets.
Whether it is Qatar’s billion dollar investments in British property, or Abu Dhabi pumping money into US banks, the moves of sovereign wealth funds are keenly followed. But as political turmoil in the Middle East combines with uncertainty in Europe, questions arise over how risk has become a factor in these funds’ investment strategies.
“We’re certainly seeing a focus on risk management among sovereign wealth funds, but its roots go back before the eurozone crisis, even before the global financial crisis of 2008,” says Mike Cowley, head of direct securities services for the Middle East and North Africa at Deutsche Bank.
“The most obvious manifestation is an increase in the hiring of risk management professionals in the region. Also, risk management has become a far more prominent topic in our regular discussions with clients.”
Cowley says clients want better to understand how custodians and sub-custodians are holding their assets. Taking omnibus or beneficial owner accounts as an example, clients want to know how assets are held and segregated by the sub-custodian or depositary.
“People are looking at settlement: when does transfer of title occur? And is the market truly DVP [delivery versus payment]? Clients want to understand the local laws that govern sub-custodian and counterpart insolvency. They put greater value on our knowledge of markets.”
Saud Masud, chief executive at consultancy SM Advisory Group, says sovereign wealth funds’ investment strategies have always tended to be conservative, and have had a stabilising influence in tumultuous markets. By investing in risky assets, sovereign wealth funds can serve to make those assets safer, which is better for them and other investors.
“Sovereign wealth funds typically seek long-term, non-activist positions across most asset classes and tend to be well diversified in terms of risk and geographic allocations,” says Masud. “At times a sovereign wealth fund position may be interpreted as political support, as we saw stakes being taken in US banks like Citi during the credit crisis.”
However, Cowley says surveys of the investment strategies of sovereign wealth funds indicate that, at present, capital preservation ranks above portfolio returns. “Everyone is facing the same headwinds, but I would expect that to be a temporary situation,” he says.
As for more localised risks: fluctuations in oil prices, threats from an increasingly aggressive Iran, the Arab Spring and economic turmoil in Egypt are all affecting sovereign wealth funds’ thinking. To a lesser extent, so are the intricacies of how companies are run. Corporate governance, transparency and good practice are as important to investors as they ever were, crisis or not.
“Investors in the region rightly keep a close eye on the political tensions because they’re ultimately capable of having a more dramatic impact on markets and prices than any concerns over transparency or corporate governance. Having said that, there’s no doubt that transparency and corporate governance are important considerations too,” says Cowley.
“Ultimately, most Mena markets are still frontier markets and the risks involved are a reflection of this. Some local markets, such as the UAE and Qatar, are making good strides to improve transparency and corporate governance as they seek to reach emerging market status.”
In light of their long-term strategies, sovereign wealth funds may be more inclined to abandon caution when investing in European markets, says William Jackson, an emerging markets economist at Capital Economics. “At a higher level, Gulf sovereign wealth funds are likely to look for relatively stable returns over a long time horizon. In this regard, they might be willing to overlook some near-term problems in Europe,” he says.
The recent activities of Qatari Diar, a property investment company, seem to support Jackson’s hypothesis. It was revealed in February that the property arm of Qatar’s sovereign wealth fund was the buyer behind a $950 million deal to purchase four luxury hotels in France, the largest transaction in the European hotel industry since 2011. Qatar will add these to a healthy portfolio of assets in London, which includes an 80% stake in the Shard (left), the tallest building in Western Europe.
“It’s worth noting a few things, though. The first is that the Middle East’s markets tend to underperform during times of political tensions in the region. This might encourage investors to put their money outside the region. The second is that sovereign wealth funds might seek to hedge exposure to oil prices. But it seems that asset prices, including oil prices, have become increasingly correlated over the past couple of years,” says Jackson.
©2013 funds global MENA