Sovereign Wealth Funds - Sources of Investment in Qatar & Dubai - Case Study Example

Sovereign Wealth Funds- Sources of Investment in Qatar and Dubai Sovereign Wealth Funds- Sources of Investment in Qatar & Dubai Introduction: Sovereign wealth funds investment is one of the most debatable topics in recent times. Due to rapid growth in international markets and foreign exchange reserves, governments have accumulated vast amount of foreign assets. These circumstances raise question about the management, transparency and accountability of these investments and its effects on financial markets. The Gulf countries being the hub of resources like oil and natural gas play a substantial role in SWFs and its investment globally. Due to SWFs importance gained in the recent times many researches are being conducted in order to deal with the concerns and problems identified in its current position and in the expected growth that is to occur in future. Sovereign Wealth Funds (SWFs) and Investment: Sovereign funds investment is a government owned and controlled investment fund. Such an investment fund is called Sovereign Wealth fund (SWFs). There is no one accepted definition of SWFs; however these funds are usually funded by fiscal (government) surpluses or foreign exchange reserves. The sources of foreign exchange reserves could be profit and surpluses from exports of commodities and other means like investment in international markets. Government is involved in various revenues generation activities, the revenue obtained can be invested within the country or sometimes it is invested in foreign countries. The investment of these funds is put up in foreign financial assets like stocks and bonds of different international companies. (Truman, Edwin.M. 2010) Establishment of Sovereign Wealth Funds in Qatar and Dubai: About 60% of the SWFs were formed after 2004 when the oil and gas sector faced a sudden boom and the countries involved in exports of these commodities piled up large reserves of foreign exchange. The biggest SWFs in the world are found in Asia due to the availability and export of oil and gas and their resulting profits on these exports. The largest SWF of the world is owned by UAE (Abu Dhabi) known as Abu Dhabi Investment Authority established in 1976. As mentioned the Gulf countries hold a significant position is possession of natural resources, Qatar and Dubai have SWFs funded by natural resources exports too. Qatar’s SWF is known as ‘Qatar Investment Authority’, established in 2005; while Dubai’s SWF is called “Investment Corporation of Dubai”, established in 2006. The total funds of Qatar Investment Authority and Investment Corporation of Dubai are 70 and 82 billion dollars respectively in 2009-2010. (Truman, Edwin.M. 2010) Structure of Sovereign Wealth Funds in Qatar and Dubai: The Persian Gulf countries dominate global SWFs. UAE, Saudi Arabia, Kuwait, and Qatar combined accounts for more than half of the world’s assets. Researches show that regardless of countries have a current account deficit or surplus, SWFs are generally associated with countries involved in exports of oil, gas and natural resources and have piled up large foreign exchanges due to these exports. Qatar and Dubai invest most of its foreign exchange reserves directly in SWFs international assets and therefore do not have large reported foreign exchange reserves. These countries buy dollars and invest in SWFs internationally rather letting their exchange rate appreciates. Oil sales being dollar- denominated has made it easier for the gulf countries. This leads to drop in the value of dollar due to excessive dollars in the market which results in preserving the value of SWFs when expressed in local currency terms. In 2008 UAE reported US$ 751 billion in its SWF international assets and only US$ 32 billion as foreign exchange reserve while Qatar showed US$ 70 billion in its SWF international assets and only US$ 10 billion as foreign exchange reserve which showed their positions relatively low on foreign exchange to GDP ratio in comparison with countries which reports large amount of foreign exchange reserves. (Truman, Edwin.M. 2010; Raphaeli, Nimrod, Gersten, Bianca.2008) Investment Strategies and Diversified Portfolios: IMF provides classification of SWFs investment strategies in three categories; First being stabilization funds, are used by countries that are involved in exports of natural resources in order to stabilize fluctuation of prices in international markets. Second being saving funds are invested for longer term and usually includes diversified investments in equities, bonds, real estates, hedge funds etc. in order to keep the risk level low. The third being reserve investment companies usually deal in pension funds and reserves investment and tend to invest the excess of pension payments. (Bassan, Fabio. 2011) There is a generalization that SWFs are mostly invested in equities, but that depends on the preference of the funds. The portfolio of SWFs usually comprises of 50% investment in equity i.e. bonds and shares, 35% to 40% in fixed income securities and the remaining in risky investments like hedge funds and derivatives. SWFs are invested in long term projects of innovation and technology too which can yield high rate of return and boost productivity. (Bassan, Fabio. 2011) Diverse portfolio of investment is required in SWFs. Now the trend is more towards investing in non-traditional asset classes, which includes private equities, real estate investment etc. rather traditional investments like US treasury bonds and equities of public listed companies. Dubai has a balanced, diversified portfolio of investment. As Dubai is not a hub of oil reserves its major economy and foreign exchange reserves comes from tourism and other international ventures, therefore they have opened their markets to foreign investors for real estate, tourism and other business ventures and corporations. Dubai’s SWF investments are made in stocks and acquisition of high-profile firms. Qatar’s SWFs investment also made up a diversified portfolio of equities and stocks, investment in real estates and acquisition of high-profile firms. The persistent problem in both the countries is the difficulty of differentiation between the respective emirs private wealth and public assets. The most recent example of this issue emerged in the acquisition of Japan’s Sony Corporation by Dubai International Capital, which is owned by Sheikh al-Maktoum. The difficulty comes in distinguishing what is public reserve and what is owned by the King privately. (Raphaeli, Nimrod, Gersten, Bianca.2008) Qatar Investment Authority has invested in various portfolios. It holds 24.9% shares in Sainsbury Plc, 10.58% stake in London Stock Exchange, 2% share in second largest Swiss Bank and a 6% share of Large French Defence contractor and 51% percent stake in Kuwaits National Mobile Telecommunications Co. Qatar also bought the Chelsea Barracks from the British Ministry of Defense as part of its investment of SWFs. (Seznec, J.F. 2008; Raphaeli, Nimrod, Gersten, Bianca.2008) Dubai’s SWFs hold its investment 3.2% shares of EADS which builds Airbus aircraft and 2.2% shares of Deutsche Bank. It has made successful acquisition of companies like Barneys department stores, MGM Mirage which manages casinos in Las Vegas and OMX- the Nordic Stock Exchange operator. (Raphaeli, Nimrod, Gersten, Bianca.2008) Importance of Sovereign Wealth Fund’s Investment: The main question arises about the needs for investing SWFs for external fund management. The first reason leading to these investments is to generate long term sustainable incomes from the export of natural resources. As these resources are subject to depletion there is a need to invest the proceeds in the inter-generational equity in order to benefit from these incomes in the long run. External investment of national funds can serve as a liquidity pool in times of crisis and fluctuation in prices of natural resource markets. Secondly the trade of natural resources solely is a risky asset as it’s subject to high fluctuation and instability, in order for a more diversified portfolio of investment it is important to invest in different assets. On the other hand by investing abroad, the risk of misallocation of capital is lowered down when the exports of these resources appreciates the exchange rate and therefore affects the other sectors of economy. (Kern, Steffen, Deutsche Bank Research, 2007) Growth in Sovereign Wealth Fund’s Investment: SWFs are a bigger industry than hedge funds industry, according to market estimation there is an investment and assets of over US$ 3.1 trillion globally. In the last few decades the international reserves have grown steadily due to increasing boom in the natural resources exporting world wide and emerging economies greater reserves are available in investing SWFs. The growth in the reserves is recorded as 13% in the last decade and 20% in the last 5 years which is expected to grow steadily over the years leading to more SWFs and related investment. (Kern, Steffen, Deutsche Bank Research, 2007) Due to constant growth in SWFs and large scale government transactions SWFs are a debatable issue through out. SWFs have changed the pattern of asset allocation, capital flows and prices of assets. SWFs are expected to maximize their performance in the future which will lead to growth in industrialization and demand of equities, bonds, shares and real estates. If SWFs grow in line with current projections it is expected to grow gross capital inflow of over US$ 1 trillion into global equity markets in next five years. The growth in SWFs is expected to lead to investment in different classes of assets which yield a high rate of return e.g. Stocks and bonds, replacing the investments made in money market instrument or short term government paper. The growth in SWFs will also require the growth in its management which will lead to increase in the providers of investment services. SWFs due to increase in activities will lead to outsourcing to funds managers, increase the needs of market analysis, investment evaluation, mitigation of risk of hedging , complex investment banking services like advisory, valuation, legal and accounting advice etc. thus an increased demand of services in many related sectors. (Kern, Steffen, Deutsche Bank Research, 2007) Criticism, Problems and Concerns Faced by Sovereign Wealth Fund’s Investment: SWFs faced criticism in relation to the globalization of the international financial system. Firstly SWFs introduced redistribution of wealth and reserves in national and international markets. Many established industrial countries and non-established, relatively new countries in the industrial sector and market entered the investment. The both type of countries felt that the new comers have no role in reshaping the system and only the major players controlled the international financial systems. (Truman, Edwin.M. 2010) The emerging economies and growth in SWFs has created many concerns. The first and foremost concern is the excessive accumulation of reserves; the risk is the wastage of this wealth. The view is to use the funds in domestic developments and social objectives rather investing in the international markets. The resulting effect of investment abroad is the privatization in the economy. Another argument in the same capacity is regarding the unemployment and lack of domestic development projects within the home country. Due to large reserves and accumulation of wealth which involves money, the issue and risk of corruption arises automatically. Therefore corruption can arise in the form of investments which benefits one individual and not the citizens of the country. The mismanagement of SWFs regarding the investment decisions is the rising concern for the host country. The second concern is about that SWFs exists solely for economic motives rather for larger strategic benefits and political, foreign commercial policy consideration. The government owns SWFs and they are political organization therefore SWFs are used to achieve commercial or economic power objectives. This also raises the issue of conflict of interest between public and private sectors and between governments. (Truman, Edwin.M. 2010) SWFs have an impact on financial market stability. Policy makers have increasing concerns regarding the destabilization that the large SWF activities can cause over the financial markets. The solution suggested is to increase the level of policy and transparency of state investment vehicle, more disclosures regarding their activities should be provided. This seems difficult to implement at the international level though as some might be reluctant to disclose detailed information regarding their activities. Additionally SWFs are not subject to legal and regulatory requirements and therefore have no rules regarding public disclosures which provide a great chance of mismanagement and corruption. (Kern, Steffen, Deutsche Bank Research, 2007) The Need for Transparency & Accountability: Due to lack of transparency and accountability regarding SWFs there is a need for more transparent framework which allows SWFs to disclose the information regarding their activities. These guidelines should include clearly stated policy objectives how and where the funds are invested, the portfolio of investment, management of the assets and their responsibilities regarding the portfolio management, investment and risk management policies to be followed. The responsibility of the government and the managers of the funds investment should be clearly indentified to provide clear lines of accountability. The guidelines should incorporate principles of corporate governance and ethical principles regarding dealing with public investment. A mechanism to ensure the compliance to these rules and principles should be in place too. The investment mechanism should be transparent in order to incorporate greater accountability to all the stakeholders, policy makers and general public. Quarterly or at least annual reports about their performance should be published. (Truman. Edwin.M. 2008) Conclusion: SWFs are usually associated with countries which earn large foreign exchange reserves from exports which are to be invested in different foreign assets in order to lower down different risks involved in exports of items subject to depletion. Dubai and Qatar’s SWFs have made investment in well diversified portfolios. The increasing concerns and problems with SWFs also need to be attended and many suggestions and researches have been conducted in order deal with their expected growth in the future. References Truman, Edwin.M. 2010. Sovereign wealth funds: threat or salvation? Raphaeli, Nimrod, Gersten, Bianca. 2008. Middle East Quarterly. Spring 2008 • Volume XV: Number 2 Bassan, Fabio. 2011. The Law of Sovereign Wealth Funds. Seznec, J.F. 2008. The Gulf Sovereign Wealth Funds: Myths and Reality Jean-François Seznec. Middle East Policy. Washington: Summer 2008. Vol. 15. Kern, Steffen, 2007. Deutsche Bank Research, Sovereign Wealth Funds- State Investments on the rise. Truman. Edwin.M. 2008. Sovereign Wealth Funds- The Need for Greater Transparency and Accountability Read More