Can the Saudis’ $2 trillion Public Investment Fund transition the kingdom to a post-oil economy?

Author: Gordon Platt

Sovereign wealth funds have become the primary means by which the GCC countries manage their national wealth. The role of these funds is shifting, however, from wealth preservation to a more active management of assets for higher returns. Saudi Arabia’s Public Investment Fund (PIF), which recently invested $3.5 billion in Uber, will be the largest sovereign fund in the world by 2020. Not only will it diversify the kingdom’s investments overseas, but it will also invest in new businesses in Saudi Arabia—outside the energy industry—to create a post-oil economy.

Founded in 1971, the PIF currently holds assets of about $87 billion, including shares of Saudi Basic Industries, a petrochemical giant, and National Commercial Bank, the country’s largest bank. The fund could receive $106 billion in cash from the planned public offering of a 5% stake in state oil firm Saudi Aramco’s parent company, according to the Sovereign Wealth Fund Institute. The initial public offering will place a market value on Aramco, which will be transferred from the government to the PIF, increasing the fund’s assets to more than $2 trillion.

“The PIF will not compete with the private sector but instead will help unlock strategic sectors requiring intensive capital inputs,” deputy crown prince Mohammad bin Salman, also known as MbS, said in announcing the Vision 2030 reform plan in April.

Riyadh-based Jadwa Investment’s analysis of the plan says it might help Saudi Arabia avoid a looming fiscal crisis. Jadwa’s internal model shows that if the kingdom doesn’t act, it will continue running big deficits over the next 15 years, depleting its fiscal buffers rapidly—even with a gradual recovery in oil prices.

Jan Dehn, Ashmore Group: New policies normalizing trade are bringing maturity to the market.

Jadwa said the reform plan “will not only help put the government’s finances on a sustainable path but also lay the ground for a set of detailed programs and initiatives that will address the very way the Saudi economy is structured—and shift the focus from the government to the private sector in being the central contributor to economic growth.”

There are skeptics, however. “There is little sign of a clear path for weaning the economy off oil, let alone tackling the vested interests that may scupper reform,” says Jason Tuvey, Middle East economist at Capital Economics in London.

Deputy crown prince MbS is popular with the younger generation, but not necessarily within the royal family, Tuvey explains, so when the next succession takes place, Vision 2030 could be cast aside. “The Saudis are good at putting mechanisms for change in place, but bad at using them,” he says. “All Saudi governments since the 1970s have outlined plans to wean the kingdom off its ‘addiction to oil,’ but, in practice, little has changed.”

Prince Mohammad bin Salman says implementing his plan “will require the formation of an advanced financial and capital market open to the world, allowing greater funding opportunities and stimulating economic growth.” The government is already building a $10 billion King Abdullah Financial District north of Riyadh, which is now mostly empty. To rescue the project by drawing tenants, the prince wants to turn it into a special zone, with internationally competitive regulations and procedures, similar to the Dubai International Financial Centre. The PIF would have its headquarters there and could assume ownership of the center, hinting at the sovereign wealth fund’s growing authority and prestige. The presence of the PIF should attract financial institutions seeking to profit from the growing pipeline of privatizations and initial public offerings as the economy is restructured. The Saudi Aramco IPO alone could generate $1 billion in fees.

Meanwhile, the Capital Market Authority recently announced a second round of measures to make markets more accessible to foreign investors, including sovereign wealth funds, effective in the first half of 2017. Qualified foreign investors (QFIs), who are currently required to have $5 billion of assets under management, will need only $1 billion. The settlement structure will be brought in line with international norms, and covered short-selling and securities lending will be allowed.

These steps to normalize trading help pave the way for Saudi Arabia to be included in the MSCI Emerging Markets Index in a couple of years, according to Jan Dehn, head of research at Ashmore Group, which was among the first firms to receive QFI licenses last year. “A broader range of investors will be able to hold a bigger share of the market, and institutions will be able to take positions on both sides of the market,” Dehn says. “This is a sign of maturity in the market.”

Inclusion in the MSCI Index would mean an automatic allocation of assets by large fund managers, with additional flows attracted by the sheer size of the market, according to economists at Samba Financial Group in Riyadh. “By 2020 we think that such [portfolio] inflows could be worth more than $20 billion a year,” they wrote in a recent report. “As with FDI, we assume that more Saudi capital will be tempted to stay at home if the local stock market is enlivened by increased foreign inflows.”

In neighboring Qatar the government has said the budget deficit will be funded entirely through debt issues, rather than drawing down assets from the approximately $300 billion sovereign fund, the Qatar Investment Authority (QIA). The Qatar government sold a record $9 billion of eurobonds in May, nearly double the $5 billion it was originally seeking. That leaves the QIA a pile of money in search of higher returns.

To get those higher returns, the QIA opened an office in New York last September to help it expand internationally. The fund says it will invest $35 billion in the US in the next five years. The Kuwait Investment Authority and the Abu Dhabi Investment Authority also have made significant investments in the US market, which has performed well in recent years.

Bahrain’s investment arm, Mumtalakat, said its profit in 2015 fell more than 68%, to $76 million from $244 million a year earlier, owing to “impairment losses on goodwill.” The fund holds stakes in Bahrain companies such as Gulf Air, Aluminum Bahrain and Batelco. In March 2016, it purchased 49% of Spanish aluminum company Aleastur.

“Mumtalakat intends to leverage its extensive aluminum industry expertise and strong regional network to enable Aleastur to tap into new export markets and reach its growth potential,” Mahmood Hashim Alkooheji, CEO of Mumtalakat, said at the time.

In May, Mumtalakat acquired a 49% stake in a $250 million portfolio of office buildings in Phoenix, Arizona and Dallas, Texas. The Abu Dhabi Investment Authority’s assets will fall to around $475 billion by the end of this year from more than $500 billion at the end of 2014, Fitch Ratings estimates. The government of Abu Dhabi is tapping into the sovereign wealth fund to bridge a budget deficit brought on by low oil prices. Fitch says it expects the ADIA’s assets to begin rising again in 2017. The fund is designed to hold enough liquid assets to meet the government’s needs in times of low oil prices, while long-term value creation remains its focus.

Altogether, the GCC countries hold about 40% of the world’s sovereign wealth fund assets. Although not entirely transparent, they are closely watched because of their ability to move markets. Middle East sovereign wealth funds surveyed by Invesco increased their allocations to Asia and Africa last year in search of higher returns. They also increased their allocations to the US, owing in part to favorable changes in tax laws related to sovereign investors buying property.

Saudi Arabia’s PIF plans to increase its proportion of foreign investments to 50% of its holdings by 2020 from around 5% at present. The fund’s $3.5 billion investment in Uber is the largest single investment ever made in a private company. As part of the deal, Yasir Al Rumayyan, a managing director at PIF, will take a seat on Uber’s board. The ride-hailing service is popular among women in Saudi Arabia, who are not allowed to drive. Ultimately, the kingdom aims to end its dependence on oil by increasing its investment income and entering new economic sectors. The region’s sovereign funds are no longer content to accept low returns on treasury securities.


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