Dubai: Sovereign wealth funds (SWFs) in Gulf Cooperation Council (GCC) countries are functioning as both diversification engines and shock absorbers during times when oil prices fall, according to Bruno Daher, chief executive officer of Credit Suisse in the Middle East and the Indian subcontinent.
The funds were created to provide future generations with a safety cushion, given the heavy reliance GCC economies have on oil. When oil prices are high, governments generate strong fiscal surpluses that are channelled into SWFs. But when prices fall below the fiscal budget break-even oil price, governments often dip into their reserves to fund the deficit.
“While a drop in oil price may in theory mean that some SWFs will reduce their volume of transactions, the need to diversify away from oil revenues is now even more urgent and could translate in some SWFs increasing their transactions in the medium and long term,” said Daher.
Most SWFs adopt a very conservative investment approach that focuses on international diversification by region and by asset class
“Indeed the bulk of Abu Dhabi Investment Authority’s (ADIA) assets are in passive investments, with limited exposure to exotic and alternative investments,” Daher said. “In addition, a portion of the assets are kept in liquid money market tools that can be used at short notice.”
Any reaction to oil price falls will be dictated by expectations of what levels oil prices will stabilise at from a long-term perspective. Although oil prices have dropped sharply, Credit Suisse expects a recovery to around the $70 per barrel mark in the second half of 2015.
“We view it as unlikely for a SWF to react to a drop in oil prices [even large ones] when such a fall is expected to be temporary,” he said.
Analysts say the immense financial strength of SWFs provide a sizeable buffer to governments. According to estimates by rating agency, Moody’s, the assets of SWFs can cover government expenditures for several years ranging from 7.6 years for Kuwait to 1.2 years for Oman while these assets stand at several times the size of government debts in GCC countries.
Sovereign funds are tasked with specific geographic mandates which determine where they are allowed to invest. For instance, the Abu Dhabi SWFs, Mubadala and the International Petroleum Investment Company (IPIC), are required to invest in the UAE in order to support the government’s economic growth and diversification objectives.
In contrast, ADIA is required to invest outside of the UAE in order to provide diversification benefits.
Despite the strong mandate to invest in global markets, historically, those SWFs which can invest locally, do invest in local equity markets in times of distress.
“Such action serves two purposes: firstly it allows long-term focused SWFs to take advantage of short-term price dislocations, thus generating added growth for the fund itself; secondly it provides support to local markets both by providing needed liquidity and acting as a signal of value to the broader market,” Daher said.
Such actions do not result necessarily in an equity market recovery, as such is dependent on broader economic and financial market developments.
“Given the recent sharp fall in local equities, we expect some SWF assets will have been diverted into local investments, most likely through funds and external managers,” he said.
