Middle East Opportunity for EM Issuers

This time last week we presented at ARFI’s IR forum on the subject of investor opportunity in the Middle East. For the benefit of those who weren’t able to make the event, we thought it might be helpful to summarise the key messages.

  • Middle East (ME) based Sovereign Wealth Funds (SWFs) account for the vast majority (over 85%) of aggregated assets under management in the region. ME SWFs account for roughly 30% of all global SWFs under management (around $2.3tr). This compares to about $31.3tr in assets managed by mutual funds globally or $2.8tr by hedge funds.
  • To recap, ME SWFs are government-owned vehicles set up primarily to manage excess oil reserves with an overarching long term strategy to diversity away from oil. While each of the funds follow diverse investment strategies with varying emphasis on risk, safety and liquidity, in each case philosophy generally comes before asset appreciation. Therefore, until recently the majority of investment by these funds was held in cash/short term security deposits, sovereign bonds and equities managed by third party managers.
  • Over the last few years, SWFs have been steadily building up the capability to manage investments, including equities, in-house. Relatively speaking, equity assets managed by funds dedicated to emerging markets, and Russia specifically, remain small.  So while there are undeniably investment opportunities to explore in the Middle East and Asia, it’s worth maintaining a sense of perspective from an IR point of view when evaluating these relative to the US and Europe.
  • Internal versus external management and active versus indexing decisions are becoming more important for established SWFs as well as for intra-SWF collaboration, as shown by Saudi Arabia’s recent commitment to invest up to $10bn in Russia. The same themes are relevant for large developed market funds.

Change in demand for different Asset Classes by SWFs, ME and Global  2014 v 15

  • Outside of SWFs, regional second tier investment managers have a higher home market bias given the location of their liabilities and in some instances the regulatory constraints on asset allocation. Local asset managers also compete with global funds who have established offices in Dubai, Cairo and Riyadh to manage MENA (Middle East and North Africa) funds from the ground. Outside of MENA investments, the local funds have not yet reached sufficient scale to significantly broaden mandates and justify a review of internal versus external management for risk assets.
  • The third pillar is the region’s family offices. Given the persisting volatility in the global markets it is no surprise that they have been increasingly outsourcing their investments to wealth managers and advisory firms. This also partly explains the increase in international private banks setting up their operations in the Middle East during the last few years.
  • Saudi Arabia and Iran capital markets are opening up to international investors for the first time, presenting both local and global players hundreds of new investment opportunities. Regulators and exchanges in the region support best practice investor relations and in some cases (e.g. UAE) make IR compulsory for all listed companies.

Sources: Ipreo, Invesco, SWF Institute, KPMG, Closir. All data is as of Sep-2015, or the most recent available.

Developments in Sovereign Wealth

Invesco Asset Management recently surveyed 59 sovereign wealth funds (SWFs) worldwide and published a report outlining some of the key themes. A few points which we found particularly interesting:

  • Studying the investment preferences of SWFs, there is continued growth in emerging market allocations for new assets, however developed markets remain a preferred choice. Two headline corrections visible are: relationship between emerging market investment and infrastructure and relationship between developed markets and real estate. As discussed earlier, a number of funds are also beginning to targer frontier markets.
  • SWFs cite a number of factors which restrict their investment in emerging markets, such as political instability, corruption, regulation change and a lack of legal protection. These risks are of particular concern to SWFs because they cannot be quantified and many emerging market investments are prohibited by risk management guidelines irrespective of potential returns.
  • The biggest challenge for SWFs is sourcing new deals. Respondents explained that sourcing deals is toughest in infrastructure and is driving greater collaboration between SWFs, especially those across emerging markets. Good example of this is last week’s announcement of Saudi SWFs $10bn into Russia via its RDIF fund.
  • As we have noted earlier with some of largest pension funds, SWFs are relying more on in-house expertise to manage their funds in an effort to bring down costs and improve performance in the low-yield environment. The report points out that the percentage of global equities managed in-house rose to 34 percent from 26 percent at the end of 2013 (see chart below). Historically the vast majority of the fund’s equity investments were outsourced to external fund managers. It is a trend worth watching, and it continues it will mean that SWFs will continue to grow in relevance to Investor Relations Teams teams. Many of the largest funds are already frequently engaging management teams.

Screen Shot 2015-07-15 at 12.19.09

Perceived attractiveness of top 10 economies based on economic performance, private sector investment opportunities and investment opportunities for sovereign investors

Screen Shot 2015-07-16 at 11.31.19

SWFs assets in perspective

Total Mutual Fund AUM: $74.3 tr

Global Pension Fund AUM: $37.3 tr

Sovereign Wealth AUM: $7.3 tr

Exchange Traded Funds AUM: $ 3.0 tr

Hedge Fund AUM: $2.8 tr

Additional reading


Source: Invesco Global Sovereign Asset Management Study 2015

Global pension funds to increase in-house management of assets

According to research published this week by State Street, more than 80% of pension schemes globally plan to bring more asset management responsibilities in-house as part of a more proactive approach to investing. As long term investors, pension funds have historically played a somewhat conservative role in the financial system. However, in today’s fast-moving environment it seems they are taking their destiny into their own hands, in particular by insourcing asset management capabilities and overhauling their approach to risk and governance.

The research surveyed 100 pension funds and found that the trend of bringing asset management in-house is driven partly by cost, with over a quarter indicating it is becoming increasingly difficult to justify external management fees. Over half of the pension funds are expecting to embrace lower-cost strategies alongside increased adoption of technology platforms and software solutions.


“Can we insource some components of the process and outsource other components? Traditionally we’ve bought the whole car. Maybe we need to buy the engine or buy the brakes or buy the engineering capability and just build the car ourselves.” – Richard Brandweiner, Chief Investment Officer, First State Super


The survey also points to a number of other trends that will shape the pension fund industry over the next five years.

Driven by lacklustre returns in a low-interest environment, pension funds are re-evaluating risk, with over 77% predicting risk appetites will increase. Pension funds are also expecting to make major shifts in asset allocations, steadily moving away from equities and bonds to less familiar asset classes such as alternatives in order to drive growth and meet long-term liabilities. Private equity is emerging as an attractive area for investment, with direct loans, real estate and infrastructure all expected to benefit.

Pension funds are also showing greater interest in investing in hedge funds. Globally 29% of pension funds that already invest in hedge funds plan to increase their allocations, while 25% plan to invest for the first time. It also comes as no surprise that over half of the respondents are planning to make better use of low-cost investment strategies. Many are adopting what are known as “barbell strategies” which involve blending a passive investment strategy with a higher-growth/risk strategy such as alternatives.

Finally, the survey points to some interesting conclusions around pension funds’ approach to risk and governance. One particular area of interest is the complex relationship between the pension fund and its asset manager, with 58% of respondents saying it is a challenge to get an accurate picture of their risk-adjusted performance. More than half also say it is increasingly difficult to ensure the interests of asset managers they are working with are aligned with their own.


Are there any implications for Investor Relations teams?

Yes, there could be, as global pension funds will increasingly look to invest and engage with companies directly. To prepare in advance it may be beneficial for IR teams to have a solid understanding of the largest pension funds, especially in North America and Europe where the above trends have been most prevalent. According to OECD, assets under management of pension funds reached $21.8 trillion in 2013 – this was concentrated mainly in the US, UK, Australia and Japan. There are a large amount of online databases and resources which can help you in your research, and we are more than happy to point you to the right direction.


How can Closir help?

Closir is a platform for professional investors to learn more and engage directly with Investor Relations teams. The platform is marketed to global pension funds, especially those taking a more proactive approach to investing. Closir’s reporting can give listed companies a better understanding of how industry trends are impacting the company and help them to target the most active pension funds.


Full State Street report can be requested online

Additional Resources:

OECD: Pension Markets in Focus 2013