Sovereign Wealth Funds Taste Bitter Losses
Not long ago the Western world was obsessed with sovereign wealth funds, those fast-growing pools of nationally owned assets fueled by oil money and trade surpluses. The fear was that they and their sometimes controversial owners would gobble up vast troves of trophy assets in the U.S. and elsewhere. But, after a brutal fall in the markets, that threat suddenly looks a lot less real. While the funds are cagey about saying what they actually own—and what they have lost—it's certain that they, like many other investors, have suffered big hits to their portfolios. They also have clearly lost firepower—and possibly some of their appetite for acquisitions.
One fund that does disclose its performance, Norway's $300 billion Government Pension Fund-Global, reported a negative 7.7% return against an international currency basket in the third quarter through September. That was the worst performance in the 18-year history of the fund, which invests Norway's oil revenues. And it doesn't include the likely further drubbings in October and November.
Stephen Jen, an economist at Morgan Stanley (MS) in London, estimates that the world's sovereign wealth funds have seen declines in their holdings of 18% to 25% for this year. He thinks the total losses are somewhere between $500 billion and $700 billion, bringing the funds' total value down to between $2.3 trillion and $2.5 trillion. Jen thinks these losses will make waves. "You don't lose 25% of your assets without consequences," he says.
Invest at Home, not Overseas
The reverberations will undoubtedly include closer scrutiny by the funds' boards over how they have been managing their assets. Coupled with other financial problems such as steep drops in local stock markets and the possible need for bailouts of local companies and banks, at least some of the funds have come under pressure to use their assets more for domestic purposes than for foreign investment. "The average Kuwaiti or Abu Dhabian can't get a mortgage or a car loan [because of the credit squeeze]. They wonder why [the funds] are bailing out the Citigroups of this world," says one banker in the Persian Gulf region.
Already the Kuwait Investment Authority (KIA), the country's stash for future generations, is being asked by the Kuwaiti government to pump money into the local stock market, which has fallen sharply along with others around the world. Angry local investors have protested their fate, calling for the government to do something to bail them out. One group of investors even succeeded in persuading a court to halt trading temporarily on the Kuwait exchange.
Indeed, losses look to have been particularly steep in the Persian Gulf region, where oil and money are pretty much the sum total of the assets held by the various states in the area. Analysts think that paper losses may have been particularly large at the Abu Dhabi Investment Authority (ADIA), which is considered the world's largest sovereign wealth fund. Some analysts think ADIA has about $450 billion under management, but others say it could have more than double that amount.
While ADIA won't disclose its total assets or precise allocations, officials at the fund, which is a sophisticated investor knowledgeable about the whole gamut of asset classes, earlier this year provided visiting BusinessWeek reporters with documents showing that the fund's benchmarks called for having 55% to 71% of its portfolio invested in equities and a further 12% to 28% in so-called alternatives: real estate, hedge funds, and private equity. Brad Setser, a geoeconomics fellow at the Council on Foreign Relations in New York who pegs ADIA's total holdings at the low end, figures the fund has notched around $150 billion in losses.
Opaque and Hard to Assess
If ADIA's portfolio is in the trillion-dollar range, as some knowledgeable people estimate, the losses would have been even larger. There is some suggestion that ADIA may have trimmed its equity positions below stated minimums as market turmoil increased. ADIA also may have received $40 billion to $50 billion of new cash during the year, cushioning the decline of existing investments.
Setser figures the KIA, which is more conservatively managed than ADIA, may have lost 30% of its $250 billion stash, while gaining $50 billion in new oil money. If it was already heavily invested in local stocks, the damage could run higher. Potential losses at the other big Gulf sovereign wealth fund, the Qatar Investment Authority (QIA), are harder to figure because the QIA is so opaque. It is also probably the most aggressive and unpredictable of funds. For instance, while most counterparts have shied away from banks—having taken big and embarrassing losses on earlier investments in outfits such as Citigroup (C) and Merrill Lynch (MER)—the QIA recently pumped money into Britain's Barclays (BCS), an innovative institution that carries a high risk profile.
In recent months the QIA and its Managing Director Sheikh Hamad bin Jassim al Thani have invested a total of about $6.4 billion in Barclays, with a further $2.2 billion possible if they exercise warrants they have received. That would bring their total ownership to 12.7% of the big British financial institution. Bankers say the QIA also has taken steep losses on a high-end real estate project in London.
Meanwhile, the QIA's 15% stake in the London Stock Exchange (LSE.L), now worth about $363 million, also has fallen sharply in value since it was acquired last year. The LSE's share price is down close to 70% in sterling terms over the last year. Dubai, which has more than 20% of the LSE, also has seen its investment wither.
Using leverage, Dubai went on an acquisition spree of financial institutions at what turns out to have been the top of the market. For instance, at the same time Dubai acquired its LSE stake last fall it also bought just under 20% of NASDAQ OMX Group (NDAQ). Dubai now faces the need to refinance about $4 billion in acquisition finance in a much tougher market.
Dubai is hunkering down and trying to figure out how to manage its hefty debt obligations over the next couple of years. With the once red-hot real estate market having turned stone-cold, the United Arab Emirates federal government already has stepped in to rescue Tamweel and Amlak Financial, two Dubai mortgage companies that one banker said were the UAE's equivalent to Washington Mutual and failed British mortgage lender Northern Rock.
The UAE federal government is largely financed by Abu Dhabi's oil wealth, but Dubai is hoping largely to manage its problems on its own. There are already rumors of capital injections from its wealthy neighbor. Certainly if Dubai needs money, Abu Dhabi is where the cash will come from. At the end of the day there is sufficient capital in ADIA and other Abu Dhabi institutions to pay for the worst-case financial scenarios in the UAE. But doing so may not be comfortable. "It's an interesting question whether Abu Dhabi has sufficient liquid assets to cover all of the emirates' needs next year if oil prices remain low," Setser says.
Setser thinks that the high allocation to equities at ADIA and other funds is now open to question. His reasoning: Oil prices tend to be correlated with equities. Both generally rise in response to increasing global economic growth and, as is happening now, fall when the world economy shudders. "They need to have some assets that hold value when oil falls," Setser says.
The big winners of the moment look to be the Saudis, who as far as is known, have largely eschewed risky investments for the safety of government bonds and other conservative instruments. Long derided for propping up the U.S. budget deficit in exchange for low returns, the Saudis now look well-positioned to maintain their own huge domestic development plans.
Will other funds radically change their behavior? It's too early to tell. Some are clearly eyeing the opportunities offered by distressed assets in the West and elsewhere. The sovereign wealth funds are also able to take a long view, with a decades-long horizon to smooth out any current losses. That said, caution is likely to prevail for some time. As one banker put it, what had been $300 million in commitments to new funds may now be cut to $100 million.