Sovereign wealth funds adopt different mandates based in a country’s macroeconomic profile and the government’s priorities. Saving for future generations – as is the case with the Abu Dhabi Investment Authority (ADIA) or the Kuwait Investment Authority – is the widely adopted mission. But more recently, governments in the Middle East have begun to leverage their funds to transform their economies by adding an economic development component.
Consider Saudi Arabia’s Public Investment Fund (PIF), which has identified several economic development initiatives under its 2018-2020 programme. The priorities maximizing the value of PIF’s investments in Saudi companies, launching and developing new sectors, developing real estate and infrastructure projects and companies and understanding giga-project initiatives (developments costing more than 10 billion US-Dollar).
One reason countries establish sovereign wealth funds is to both professionalize and institutionalize the way the sovereign invests and manages its wealth. So the strong governance framework and an experienced investment team are integral for success. When pursuing an economic development agenda, sovereign wealth fund investment professionals have a complex dual role to fulfill. Not only are they instructed to look after and transform the existing portfolio, but they are also tasked with identifying and leading new investment opportunities. Transforming a direct investment portfolio occurs through initiatives aimed at improving the performance of portfolio companies. To improve performance, the first task is proper governance, often requiring the training or replacement of directors representing the fund on the boards of portfolio companies. In turn, boards become more business-savvy and again further clarity on the expectations of shareholders.
When the situation requires drastic actions – for example, when a direct investment operates at a significant loss – the fund needs to swiftly engage an external adviser to identify strategic options. Such drastic actions can be carried out when the sovereign wealth fund owns 100% of the company or has the majority control of the board.
Portfolio transformation also occurs when the fund decides to earn revenue from one of its portfolio companies. This can occur for various reasons, such as the need for cash to reinvest into more promising opportunities, or the need to eliminate excessive downside risk. In the Middle East, the sale of a state asset often requires an intermediary step consisting of corporatizing the entity. This process aims to transform state assets or government agencies into corporations with a legal structure and financial statements for the past three to five years. Going through this process is usually the first step towards a sale or an initial public offering (IPO). When it comes to new investment projects, sovereign wealth funds can operate in a structured approach. New investment opportunities need to be built on an understanding of the economic sectors and strengths of a country. Once this has been identified, an in-depth study should be carried out to confirm the opportunity, its profitability, landscope of potential partners, risks and employment potential. A compelling example is the concept for a downstream aluminum cluster pursued in Bahrain by its sovereign wealth fund, Mumtalakat which is by the way also the largest foreign shareholder in British McLaren.
One of its portfolio companies, Aluminum Bahrain, is building a sixth smelter line that will add 500,000 tons of aluminum per year starting from 2019. In parallel, Mumtalakat is teaming up and co-investing with international partners to create joint ventures in Bahrain that will utilize this additional capacity while creating 2,000 jobs. By developing a strong understanding of attractive sectors, sovereign wealth funds should be in a position to quickly form an opinion on an opportunity.
Funds with an economic development agenda represent a great opportunity to accelerate the development of their economy. Some African countries such as Angola (Fundo Soberano de Angola – established in 2012) and Nigeria (Nigeria Sovereign Investment Authority – established in 2012) set up their funds over the past decade and both have developmental components in their mandates.
Egypt for example passed a law last year in May to establish its own fund. One of its contemplated objectives is to manage state companies ahead of listing on a stock exchange. The Saudi PIF has a huge task ahead as it is expected to play a major role in the stimulation of the economy.
The large and rapidly growing value of assets managed by funds as well as the leadership expected of them in their countries’ economic transformation agenda is placing them in the public spotlight. To us, it does not come as a surprise that citizens want to know how their public funds are being used to their benefit.
In developed countries, governments have traditionally focused on the regulatory aspect of an industry, and then let the private sector flourish. On the contrary, in the Middle East and other developing countries, significant industries have often emerged from the will of the government. Sovereign wealth funds can be an effective tool to make this happen.