Opportunities in the Gulf: Distribution holds the key

There is a huge opportunity in the Gulf, that’s pretty much widely recognized by everyone," says William Wells at Schroders. "But how best to tackle it is another matter." And the biggest question for foreign managers in working that out is distribution.

Deciding on a distribution strategy requires a clear understanding of the distinct client bases in the Gulf, and what those clients want.

For most foreign asset managers, the sovereign wealth funds are the main prize. "That’s currently the majority of the business we have, and most international asset managers would be the same," says Wells. For many, it’s becoming a still bigger focus. "A good period of time is being spent on sovereign wealth funds, right now even more than in the past," says a Middle East asset management head at a major European bank. "They’re acting as liquidity providers and are more aggressive than anyone else right now. The top five to 10 addresses in the Gulf make up the bulk of our business." But what do these mega-clients want?

There are sovereign funds in four nations that really matter in the Gulf, and they differ in their approach and requirements. At the top of the pile is the Abu Dhabi Investment Authority (ADIA), the richest by far of them all and probably the largest institutional investor in the world, with perhaps as much as $1 trillion under management (nobody knows for sure but a commonly cited figure is $875 billion, quoted last year by both Deutsche Bank and Morgan Stanley). ADIA is known as being highly sophisticated, and rather aggressive relative to its peers, particularly in private equity; it takes an international approach to its staffing, rather than being dominated by UAE nationals. It has over the years been an early mover into areas like emerging markets and hedge funds, and has a highly sophisticated system for analysing and selecting potential managers. "They have more closely associated themselves with a US endowment like a Harvard than they would a central bank," says Douglas Hansen-Luke at Robeco in Bahrain.

Then there’s the Kuwait Investment Authority, set up in 1953 and the oldest sovereign wealth fund in the region, for whom the most commonly quoted figure from analysts is $200 billion–250 billion under management (again, it has never been disclosed). The KIA is also considered among the more professional of the sovereign funds, with a very strong in-house training programme and a record of employing the brightest people in the country. Until recently it had a track record for conservatism but is in the midst of implementing a much more market-savvy approach today (though one wonders how it has fared in this global environment). A review by an international consultant in August 2004, approved by KIA’s board the following June, has led to the fund establishing a target rate of return that would see it double its assets under management within 10 years. Among other things, this review brought about the creation of a separate division for alternative investments. The KIA is perhaps the institution most likely to outsource mandates to overseas managers; ADIA does so too but with reportedly a greater desire to handle as much as possible in-house.

Saudi Arabia differs in that it doesn’t have a single overall sovereign fund, but several institutions which between them amount to about $300 billion under management and all invest in the name of the state (the two most prominent would be the General Organization for Social Insurance and the Saudi Arabian Monetary Authority). These are considered much more conservative; some managers believe as much as 70% of the investments from some of these institutions are in US dollar fixed income, chiefly government paper.

And Qatar is the newer entrant, launched only in 2005 (reflecting the more recent arrival of wealth in Qatar, predicated mainly on the remarkably fortuitous discovery of the third largest natural gas reserves in the world in a country smaller than Connecticut). It may have as much as $70 billion under management already, and has become quite a celebrity in world markets already after its tilt for the British supermarket chain J Sainsbury, accentuated by high-profile purchases of 23.5% of the London Stock Exchange.

So what do these groups want from their fund managers, and how should they be approached? Despite high-profile stakes in big western institutions – KIA into BP, DaimlerChrysler, Merrill Lynch and ICBC; ADIA into Citibank – they are reasonably conservative groups. "Their current concern is the preservation of capital, particularly for the Saudis and Kuwaitis," says Hansen-Luke. "But over the longer term they have a willingness to make less liquid investments such as private equity, because they view themselves as funding the next generation."

Scott Callander, director, Middle East Institutional Advisory, AXA Investment Managers

This shift does present something of a challenge for foreign managers: as sovereign direct investment ability grows, the need to outsource drops back a touch. "Many sovereign managers are looking to develop their own expertise in investment management," says Nick Tolchard at Invesco. "It may be that they become more selective in terms of awarding external mandates. We’re already seeing more activity in terms of direct equity and private equity investment."