The sovereign wealth funds of the Middle East and North Africa may control assets worth more than $1 trillion, but their strength is in many cases weakening. As the value of stock markets and other assets drops around the world, the funds are having to adapt their strategies.

In response to the downturn, many government-owned funds – which had been fed by the current account surpluses accumulated during the years of high oil prices – are opting to invest more conservatively and closer to home. However, there is still room for some opportunistic overseas deals.

While the Gulf economies are suffering, there is no doubt that their sovereign wealth funds are too. In February, members of Kuwait’s National Assembly (parliament) revealed that the Kuwait Investment Authority (KIA) had suffered a $30bn decline in the value of its assets in the last nine months of 2008.

Fund dominance

More recently, on 23 April, the UAE’s Mubadala Development Company published its accounts, which show it made a loss of AED11.8bn in 2008, after significant write-downs on some of its investments. In the previous year, it had booked a profit of AED1.3bn.

Despite these falling asset values, the region’s sovereign wealth funds still dominate the sector. About 45 per cent of all such funds are based in the Middle East, according to International Financial Services London (IFSL), which promotes UK financial services firms abroad.

Asia has the second-highest concentration of funds, including Malaysia’s Khazanah Nasional and the Singapore Investment Corporation.

Within the Middle East, the UAE and Saudi Arabia have the largest funds, although estimates of their relative size vary. According to IFSL, the Abu Dhabi Investment Authority (Adia), which was set up in 1976, has $875bn worth of assets. It ranks Saudi Arabia second with $433bn worth of foreign assets controlled by the Saudi Arabian Monetary Agency (Sama), the country’s central bank, followed by the KIA with $265bn, Investment Corporation of Dubai with $82bn and Qatar Investment Authority (QIA) with $60bn.

North African funds also rank highly, according to IFSL, with the Libyan Investment Authority estimated to be the 14th largest, with $50bn worth of assets. Algeria’s Revenue Regulation Fund follows in 15th place with $47bn worth of assets.

The dominant position of the funds controlled by Abu Dhabi is highlighted by other IFSL data. According to its research, the UAE controls 25 per cent of all assets held by sovereign wealth funds around the world.

In contrast, US think tank the Council on Foreign Relations puts Sama’s fund at $501bn, compared with $328bn for Adia. In a report released in January – GCC Sovereign Funds: Reversal of Fortune – the council estimates that Adia’s portfolio lost 40 per cent of its value in 2008, while the more conservative investment approach taken by Sama led to a 12 per cent decline in its assets.

The council estimates that the total assets of the Gulf’s sovereign funds and central banks peaked at more than $1.4 trillion in July 2008 and they are now worth closer to $1.2 trillion.

While these funds have invested much of their wealth overseas in the past, a combination of falling international asset values and a need to boost their own economies means that they are now directing more of their cash to domestic investments.

The KIA, for example, has injected an estimated $7.5bn into the local stock market since September 2008, in an effort to reverse market losses of KD12bn in the preceding two months. Sama put SR14.4bn into Saudi banks in December 2008, while Adia has an undisclosed stake in another fund, the Abu Dhabi Investment Council, which has a more local investment slant, with stakes in two large banks: Abu Dhabi Commercial Bank and National Bank of Abu Dhabi.

As these examples demonstrate, government-owned sovereign wealth funds in the Middle East have a key role to play in reviving local economies affected by lower oil prices.

In September 2008, 19 countries with sovereign wealth funds, including Kuwait, Qatar and the UAE, agreed a code of conduct known as the Santiago Principles. As their funds begin to comply more fully with this code and the transparency it demands, their role in reviving their domestic economies will become more clear.

Despite the increased importance of domestic investments, the fortunes of global stock markets will still have a major bearing on the funds. The Council on Foreign Relations says the assets of Adia, the KIA and the QIA have all been hit hard because of their policies of allocating a high proportion of their investments to stock markets, emerging market funds and private equity, which has resulted in the value of their assets falling.

An estimated 50-60 per cent of Adia’s investment portfolio is in equities, with 14 per cent of that in emerging markets.

Despite the pressure to use their resources to support their struggling domestic economies, some sovereign wealth funds continue to seek investments overseas. For example, the Libyan Investment Authority is seeking further investments in European property after acquiring a London office tower in December 2008 in a $180m deal with German property giant IVG.

Meanwhile, Saudi Arabia has established a new fund, Hassana Investment Company, that will invest in real estate and commercial projects, as well as in stock markets in the Middle East and Europe.

The international investments that are still being made are in part opportunistic, as assets can now be bought more cheaply because of the financial downturn.

Global losses

In March, Abu Dhabi’s Aabar Investments, an affiliate of the state-owned International Petroleum Investment Corporation (Ipic), paid e1.95bn ($2.65bn) for a 9.1 per cent stake in German car marker Daimler. At the time, the car company’s shares were 60 per cent lower in value than they were in 2007, and the deal makes the Abu Dhabi fund the company’s largest single shareholder.

One week later, Ipic continued its spending in Europe by buying 37.5 per cent of shares in Spain’s largest oil company, Cepsa. The $4.4bn purchase takes Ipic’s stake in the company to 47 per cent, just behind the 48.8 per cent controlled by French energy company Total. Similarly to Daimler, Cepsa’s shares had lost 56 per cent of their value in the preceding 12 months.

However, with the Middle East’s sovereign wealth funds deriving their wealth from oil revenues, the current low oil prices mean their income is in many cases being eroded after years of growth.

Sovereign wealth funds have enjoyed average annual growth of 18 per cent for the past three years, but growth is likely to slow because of the drop in the price of oil since last year and continued high levels of government spending.

The Council on Foreign Relations says that if the oil price were to average $75 a barrel, an extra $100bn a year would flow in to the funds. However, if prices average $50 a barrel, which is close to the current price, most Gulf governments will need to draw on their sovereign funds to maintain spending levels.

Such figures only serve to highlight the mutual reliance of the funds and the Gulf’s oil-dependent economies, whether their investments are made domestically or not.