Oxford SWF Project

By Ashby Monk

The Oxford SWF Project is a source of open discussion and engagement on the topic of sovereign wealth funds. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the fifteenth instalment of our segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Eckart Woertz, Program Manager Economics at the Gulf Research Center. While Dr. Woertz’ views are his own, his perspective helps to further debate and facilitate understanding.

Ashby Monk: It is a pleasure to have you with us today, Eckart. As someone who lives and works in Dubai, what’s your impression of how the recent financial turmoil is impacting GCC SWFs?

Eckart Woertz: The Saudi Arabian Monetary Agency (SAMA) did well as they are mainly invested in bonds. Additionally they are mainly in US-dollars, so they profited from this dollar squeeze of recent months, which will be short lived in my opinion. All the others got hurt, sometimes presumably very badly. Abu Dhabi Investment Authority (ADIA) and Kuwait Investment Authority have over 50 percent of their assets in equities and alternatives, they have also been over weighted in Asia and emerging markets – it must have been carnage. The performance of the younger funds like Dubai International Capital and Qatar Investment Authority has probably been even worse as they were leveraging their equity and real estate acquisitions.

Ashby Monk: With oil prices coming down as well, do you see GCC countries drawing down on SWF assets any time soon?

Eckart Woertz: With oil prices at $50 dollars fiscal surpluses of the GCC countries are meagre to non-existent; Citibank has recently argued that in 2009 they will face even deficits at these levels. So they will need to take recourse to savings – not only for bailing out local banks and prop up local stock markets but for their normal ongoing expenditures and operations. KIA apparently has already withdrawn over $3 billion according to a Reuters report. The idea of Gordon Brown that they could spare “hundreds of billions” for the IMF is ludicrous. At least they do not have such sums in liquid form. Even if they were willing, which they are not, does Mr. Brown want them to sell Western bonds and equities into oblivion just to move the gained liquidity to the IMF? However, I believe that oil prices will be back to $100 over the next three years, tight supplies and dollar printing will overwhelm demand worries even in a recessionary environment.

Ashby Monk: Since it looks like some GCC SWFs will be investing more in domestic markets, I’m curious how foreign vs. domestic investment plays to GCC citizens and media?

Eckart Woertz: You do not have the same amount of public scrutiny and transparency in the Gulf as you have in the West, where the state is supported by society via taxes and owes it some sort of accountability in exchange. The rentier states of the Gulf support themselves and the society through the redistribution of oil rents – no taxation and no representation. Oil prices and oil savings are high enough to keep this social contract for the foreseeable future.

Still, the impact of the global financial crisis is now being felt and the various forms of nascent political participation (e.g. majlis ash-shoura) and a more outspoken press will start to ask questions about the performance of public funds and their usage, especially in Kuwait where you have a very vocal parliament. People expect the governments to bail out local banks first, not foreign ones.

Ashby Monk: In a paper with John Sfakianakis of the Saudi British Bank, you noted that the KIA, ADIA, the QIA, and the various Dubai investment companies are all “sophisticated fund management houses, employing in-house experts with rich backgrounds in finance and investment banking.” How have these funds managed to recruit this talent and get beyond the civil service mentality that is evident in some other SWFs?

Eckart Woertz: I am not sure whether some boring civil service mentality can be pretty performance enhancing in these markets, but once you make the decision to go beyond conservative central bank reserve management and invest in other vehicles than government bonds you basically need to offer enough money and a liveable place. Saudi Arabia and Kuwait are more difficult to live for expats but they have outsourced the sophisticated parts of the portfolio to outside money managers anyway. Otherwise the CVs of sacked bankers from New York and London are piling up on their desks these days. They can choose if they wanted to, but overall the financial sector in the GCC is probably not a net-hirer anymore.

The reason why they have moved beyond conservative reserve management and Asian countries only to a limited extent, lies in their different economies and liability structures: The Gulf countries’ assets are clean equity with no strings attached, a transformation of below ground capital into above ground capital, kept for future generations and current diversification drives. The Asian foreign assets come from sterilizing dollar export revenues and have a liability in local currency standing against them. Additionally their asset allocation is a function of a mercantilist policy of export led growth and a concomitant undervalued exchange rate – if the dollar should become worthless one day Asia would still have the capital stock that has resulted from the mercantilist policy, the Gulf would stay there with nothing. That’s why risk adjusted returns and capital preservation are much more important to the Gulf than to Asia.

Ashby Monk: GCC SWFs are frequently held up as some of the most secretive. Why do you think this is the case? Is there any credence to the argument that these funds keep asset allocation and investment portfolios secret in order to avoid any local fallout from investments in companies that could be seen to go against cultural or religious beliefs?

Eckart Woertz: Do you know the detailed financial statements of Bechtel, Bosch or other large, privately held companies in the Western world? Of course not, and they would not be eager to part this information with you for various reasons. So why should the Gulf SWFs tell you? After all they are “sovereign”. Never talk about your positions especially when they are large and you may follow strategic acquisitions here and there. And rich people tend to be secretive whether they live in the Gulf or in Switzerland.

But most of the secrecy probably stems from local politics and the above described social contract of the rentier state: bluntly put, you are paying off the constituency with welfare transfers and public sector jobs and in return they should be grateful and not demand participation. If the times are good you do not want them to know and demand too much. If they are bad, you do not want them to blame you for mismanagement. Maybe it is as simple as that. I do not think that religion or culture plays a role; I am not aware of debates in this regard. If you mean Islamic banking, it is overrated. Its similarities with conventional banking are larger than its differences. It is basically giving interest a different name by various legal constructs of “profit sharing” plus some ethically forbidden investments in alcohol, pork and gambling. In any case it is mainly in the retail market where Islamic banking plays some role, not so much in project finance or large internationally operating funds.

Ashby Monk: Thanks, Eckart, for your candid responses. Very interesting.