The Vital Role of Sovereign Wealth Funds in the GCC’s Future

03/16/09

Once defined by their very conservative investments, the sovereign wealth funds (SWFs) of the Gulf Cooperation Council (GCC) countries are broadening their investment portfolios and focusing on achieving far higher returns. Their new, more proactive investment stance will further integrate the GCC’s economies into the world’s economy—creating new opportunities for economic development and growth. As such, SWFs will likely be a tremendous source of wealth creation for the GCC nations for many years to come. The current economic downturn serves to underscore further their vital role in the GCC’s future.

Evolving Role of SWFs

Over the past decade the role of SWFs has been evolving. With globalization of international markets, SWFs worldwide are taking a more proactive investment role that aims to complement their countries’ socioeconomic strategies. For example, SWFs of countries like Malaysia and Singapore have very active roles in socioeconomic development in local and regional markets. One of the key principles for Malaysia’s Khazanah Nasional Berhad is growth through investment in equities that, in addition to providing good returns, help improve the productivity and skills of the Malaysian people. These funds also seek specific knowledge transfer through investments in private equities of technology and startup companies and in R&D investments and joint ventures with multinational corporations (MNCs). In Singapore, Temasek Holdings invested billions of dollars in the technology industry in addition to other investments in life sciences and telecommunications.

In the GCC region, the UAE plans to enhance socioeconomic development through strategic investments of its SWFs. Dubai International Capital (DIC), for example, invests in both established and developing primary markets, and its potential contribution to economic growth can go beyond investment returns. For example, its investments in ART Marine Holdings Limited, a holding company linked to the manufacturing and distribution of luxury yachts, provide it with the opportunity to develop the boating and marina sectors in the GCC region. Similarly, Mubadala Development Company’s 5 percent stake in Italian sports car maker Ferrari points to an increasingly strategic investment mind-set. The Ferrari investment brings with it the potential for increased tourism in Abu Dhabi as the Ferrari theme park nears completion in Yas Island. More recently, Mubadala’s $8 billion partnership with General Electric provides collaboration on healthcare and clean energy technologies, as well as aircraft maintenance expertise and other beneficial exchanges essential for the UAE’s socioeconomic development.

Mounting Calls for SWFs Regulation

With the rise in their number and financial reach, there has been a mounting call for the regulation of SWFs in recipient countries—led by the United States—concerned about the possible negative effects foreign investments can have on their markets and their control over their strategic industries such as banks. As a result, SWFs will likely face regulatory rules that would condition their investments in major developed economies.

Lessons from Global SWFs

There are lessons to be learned from SWFs’ evolution of investments in selected countries outside the GCC region. Three countries in particular are examples of the diverse characteristics of their SWFs: Norway, Singapore, and China.

Norway’s SWF is an important best-practices example because the fund operates in a well-governed and extremely transparent manner. Its governance and transparency have allowed it to optimize financial returns on revenues from the sale of oil and promote macroeconomic stability while being a responsible social agent. Norway’s GPF-Global has ethical guidelines for investments which identify corporations in which it will and, most important, will not invest.

Singapore’s success in promoting socioeconomic growth offers a positive example for the GCC SWFs. Singapore’s Temasek Holdings successfully manage government-linked companies, as well as champion the development of industries in technology, transportation, and logistics.

Finally, China’s SWFs are important to study because they reflect China’s break from previously conservative investment history, their pursuit of socioeconomic development and the way in which they deal with scrutiny in their investment targets.

Several lessons emerge from studying the history, attributes and performances of global SWFs and international best-practices:

SWFs are important both as savings and as stabilization tools.
Long-term investments are a key feature of successful SWFs’ investment strategies.
Successful SWFs seek both financial and social returns.
SWFs play an important role in their countries’ socioeconomic development by investing domestically to spur the growth of strategic sectors.
SWFs focus some of their foreign investments on sectors that further local economic growth strategies through knowledge transfers and FDIs.
Regional and global investments can increase regional and international cooperation.
SWFs can be transparent and continue to have good returns on investments, as in the case of Norway.
It is possible to group government-linked companies covering different economic sectors under one holding that acts like a private enterprise to take advantage of the economies of scale and scope. Temasek Holdings has done that successfully with reduced business risk and cheaper financing.
SWFs should gradually move towards better practices in structure, governance, and investment behavior.

Enhancing the GCC SWFs’ Socioeconomic Role

GCC SWFs play several favorable roles in the region including creating economic stabilization, investing for the long term, and seeking high financial returns. But there are additional steps they can take to further enhance their roles. These include helping transfer knowledge through investments, boosting economic activities by managing government enterprise and supporting strategic projects, fostering regional and international cooperation, and instituting best-practices reforms.

Although SWF assets will undoubtedly be revised in the aftermath of the world financial crisis, the outlook for SWFs is expected to be positive. With an eventual rebound in world economies, SWFs will continue to expand in size and number. Thus, SWFs in general and GCC SWFs in particular, will continue to be a growing financial power. More important, their role in socioeconomic development will remain significant despite any intermittent financial setbacks.