Middle East sovereign wealth funds shift focus to local economies

The third annual Invesco Middle East Asset Management Study analysed the revenues and investment behaviours of major SWFs in the GCC, which account for 35% of global SWF flows, representing $1.6 trillion.

The study found that the international flow of money directly from GCC sovereign governments and from SWFs has changed considerably in light of the political unrest in the region, with large commodity-linked surpluses in these regions increasingly being put to use locally.

The available surplus, or investable assets, of governments in the GCC is forecast to drop by 9% in 2012 (when compared to 2011) and surplus forecasts have been revised downwards since the Arab Spring, the study said. This is illustrated by the fact that forecast funding rates for the recipient SWFs have declined this year.

According to Invesco's study, in 2011 funding rates grew at 13% compared to an increase in GCC government revenue of 25%, this year funding rates rose just 8%, despite GCC government revenue increasing by 31%. Funding for sovereign pension funds on the other hand rose from 8% growth in 2011 to 13% growth in 2012. There is an expectation that spending will continue to increase over time potentially outstripping commodity prices and shrinking surpluses further.

Of the sovereign surplus that is available for SWFs, those with local objectives are expected to benefit, the study noted. Invesco forecasts SWF assets invested in benchmark driven SWFs who prioritise international asset manager products or ETFs have fallen by 1% since the beginning of the Arab Spring in 2011. At the same time sovereign wealth fund assets allocated to SWFs investing locally, in infrastructure for example, have risen by 10%, which illustrates a major shift.

"It's clear that sovereign states are redirecting revenues and SWF assets from international investments back into the Middle East," said Nick Tolchard, Head of Invesco Middle East. "The most common change across the region is money into local wage inflation, with healthcare and education a real focus for Saudi Arabia and Oman. Major infrastructure is a focus for Qatar due to the World Cup, and there are significant developments taking place in Abu Dhabi as it seeks to grow and set up as a major financial centre."

Tolchard added: "Western governments, including the UK, have approached SWFs from the Middle East to help with economic recovery, but many will fight a losing battle. There is certainly less money to invest internationally so the stakes are higher. Those courting GCC money from outside the region will only win with a deep understanding of what is driving the thinking of SWFs, and a long term commitment to building bi-lateral relationships which add value to their investment policy."

Last year, the study revealed that traditional investment SWFs appeared to be favouring developed markets, with around 54% of GCC SWF assets held in this region with the highest exposure to North America (29%) and to Western Europe (19%). Investment in North America is now down this year at 14% and Continental Europe down at 4%, as a result of the Eurozone crisis.

The clear shift in terms of geographic allocation of investment money has been towards the local region. Investment in assets related to the GCC moved up from 33% to 56%, with local bonds seeing a rise from 6% of SWF investable assets to 14%. Property and infrastructure have also take a large proportion of the investable assets from these SWFs, 13% and 14% respectively, the study found.

"The story this year is that it is no longer a given that large sovereign governments are going to direct their oil revenue surpluses around the globe, pumping cash into other global economies," Tolchard said. "There will be high profile, strategic investments like the proposed RBS deal, or indeed other large trophy assets, but it's a changed market. There will be contestable assets for fund managers in core relevant markets but with more money being deployed into the local economies it is likely to be a much more competitive landscape as long as the unrest continues."