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UAE to retain 'power broker' status with growth in foreign assets

The value of oil-exporting nations' foreign assets will grow at an average rate of 12 per cent per annum over the next five years to hit $8.9 trillion, with the UAE posting the largest gain within the GCC, new research shows.

"The compound annual growth rate of 12 per cent [is] significantly lower than the 25 per cent pace seen between 2002 and 2007 but faster than the rate of growth of other power brokers or institutional investors," McKinsey & Company said in a report titled The new power brokers: How oil, Asia, hedge funds, and private equity are faring in the financial crisis.

The consultancy said Russia continues to be the largest holder of foreign assets among the oil exporters, with its foreign wealth increasing by $1 trillion to reach $2.2 trillion in 2013. Norway's foreign assets will grow by $600 billion over the same period, to $1.5 trillion.

GCC countries see their foreign wealth climb by $1.3 trillion, to $3.5 trillion in 2013. "Within the GCC, the UAE posts the largest gain in foreign assets in absolute terms ($470 billion); although it does not have as much oil as Saudi Arabia, it spends a smaller share of its oil revenue and enjoys substantial appreciation on its already massive foreign wealth," the report said.

Among GCC states, Qatar and Kuwait continue to experience the fastest rates of growth -- at 18 and 17 per cent respectively.

McKinsey has positioned four diverse groups of investors as the "power brokers" of the future. These include oil exporters, Asian governments, hedge funds and private equity.

"A new generation of GCC leaders increasingly recognises the need to spur local development, both to create jobs for the rising number of young people entering the workforce and to develop more robust economies that will outlive the oil boom," McKinsey said.

According to the firm's research, the GCC has collectively planned $1.4 trillion in spending on infrastructure and construction projects from 2009 to 2015. This includes Saudi Arabia's plans to build several entirely new cities as economic hubs and to expand its petrochemical industry. Abu Dhabi is building new cultural institutions, such as a branch of the Louvre Museum, and aims to build the world's first carbon-neutral city, Masdar.

However, the global financial crisis of the past two years has altered the paths of the four influential groups of investors. "In a 2007 report, we labelled these four the 'new power brokers' because their growing wealth and clout reflected a dispersion of financial power away from traditional institutions in Western developed economies and toward new players and other parts of the world.

"But the crisis has raised questions about the power brokers' future growth and influence. By our estimates, the power brokers' collective assets totalled $12 trillion at the end of 2008, roughly the same as 2007. While this was better than the sharp declines in wealth of most institutional investors, there is no denying that the crisis has abruptly halted the power brokers' rapid ascent," McKinsey said.

Hedge funds and private equity were hit hard last year when credit markets seized up, depriving them of the leverage that amplified their influence in global financial markets. They were battered further by the decline in global equities, which erased much of their investors' wealth.

"As we write this report, the hedge fund industry is smaller and still shrinking, while private equity firms are searching for other investment opportunities as the buyout market lies dormant. Both industries will have to adapt to a new environment of tighter credit and potentially more regulation."

Oil exporters and Asian sovereign investors have fared better. Soaring oil prices in the first half of 2008 created a windfall for petrodollar investors -- though falling financial markets erased much of the gain in the second half of the year.

Asian sovereign investors' assets increased despite a sharp falloff in the region's trade surpluses at the end of the year. This growth was due entirely to China whose assets now exceed $2 trillion. In 2008, oil investors and Asian governments combined provided the world's financial markets with roughly $4.5 billion per day in new capital -- up from $2.5 billion in 2007, the report said.

Petrodollars

Oil-exporting nations reaped an enormous revenue windfall in the first seven months of 2008, as petroleum prices skyrocketed to a record high of over $145 per barrel in July.

These riches enabled the countries' central banks, sovereign wealth funds, high-net-worth individuals, and other petrodollar investors to invest more than $1.3 trillion in foreign financial assets in 2008 -- a 58 per cent increase over the previous year. Growing crude exports also enabled more investment in local economies, which reached $970 billion. But oil and stock prices tumbled in late 2008, drying up new capital and erasing significant portfolio wealth. The central banks and sovereign wealth funds that had invested more heavily in global equities, such as Norway's Government Pension Fund-Global, saw their investment losses exceed new capital in 2008.

The vehicles that had invested more conservatively in government bonds and other fixed-income securities, including those of Saudi Arabia and Russia, performed better. By the end of 2008, the foreign financial assets of all petrodollar investors totalled $5 trillion, slightly less than a year earlier, leaving this group still the largest of the four power brokers, McKinsey said.

"Petrodollar foreign investment activity has been minimal since the financial crisis escalated in September 2008, and some investors are reportedly reviewing their investment strategies. However, most will maintain their fundamental focus on long-term returns.

"When financial markets stabilise, they may look for future opportunities in commodities and in emerging markets. Sovereign wealth funds are taking advantage of the exodus of talent from Western banks to build their own investment capabilities," the report said.

"In the Middle East, there is a growing focus on partnerships with foreign companies that will also help promote local economic development.

"Looking ahead, we see petrodollar investors poised for future growth in almost any scenario. Their foreign assets reach nearly $9 trillion by 2013 in our base case, and more than $13 trillion if the economy recovers more quickly," it said.

Asian sovereigns

The global financial and economic crisis has curtailed Asian exports while triggering a record outflow of foreign capital from the region. "Nonetheless, Asian sovereign investors -- the region's central banks and sovereign wealth funds -- saw their collective foreign financial assets grow by nine per cent in 2008, reaching $4.8 trillion by year-end. Although this growth rate was far slower than in the past, this group was the only one of the four power brokers to increase in size last year."

China accounted for virtually all the growth, with the assets of its central bank and sovereign wealth fund climbing 28 per cent to more than $2 trillion. Across the rest of Asia, Japan's and Taiwan's foreign assets grew just slightly, while the foreign wealth of most other Asian governments declined.

Asian sovereign investors' investment strategies are unlikely to change substantially despite the recent turmoil, the firm said. "On the margin, they may seek to invest more in currencies other than the dollar and to hedge the risks of higher global inflation, in part through investments in commodities.

"Changes within Asian sovereign wealth funds are also apparent. They have increased transparency to allay concerns about their investments and have accelerated their hiring of outside financial professionals, many from foreign financial institutions. These moves reflect maturing and increasingly sophisticated investment organisations that may eventually become less dependent on external investment managers."

Hedge funds

The breakdown of global credit and capital markets in September 2008 sparked a dramatic reversal of fortunes for the hedge fund industry. Liquidity evaporated and investors fled to cash and other safe assets.

Total assets under management dropped 27 per cent in 2008 to $1.4 trillion, reflecting both investment losses and net asset withdrawals by investors. Hundreds of hedge funds have closed, and as many as 30 per cent of those left may be at risk of liquidation because their portfolios' worth has fallen so far below their peaks, McKinsey said.

"Our research shows that a significant portion of hedge funds has delivered higher and less volatile returns than investments in public equities and bonds over time, and investor commitment to such funds remains high.

"The industry's assets may shrink further in 2009 as investor redemptions continue and more funds close. But funds with long track records of good performance will survive and will likely gain scale," it said.

The firm's base-case projections show the industry in 2013 with assets under management of $1.5 trillion. "This is below the industry's peak, but significant nonetheless. If financial markets and investor portfolios recover more quickly, hedge fund assets could grow to $2.4 trillion. In either case, it is clear that while the industry's meteoric rise since 2000 has been interrupted, it will remain an important part of the capital markets' landscape," the report said.

Private equity

Leveraged buyout (LBO) assets under management rose to $1.25 trillion in 2008, up from $900 billion in 2007. Assets managed by the broader private equity industry -- consisting of venture capital, distressed debt, infrastructure, real estate and other types of investment funds -- also rose, reaching $2.9 trillion at the end of 2008.

"However, these figures mask deeper problems for the buyout industry. With credit markets frozen, the global value of buyout deals fell from $580 billion in 2007 to just $150 billion in 2008, of which just $18 billion occurred in the final quarter of the year. The decline in the largest megadeals -- worth more than $3 billion each -- accounts for two-thirds of the drop.

"With banks still facing huge credit losses, funding for these largest deals is unlikely to revive anytime soon. The industry should hope that history is not a guide; after the buyout peak in 1988, it took 20 years for megadeals to return," the report said.

Meanwhile, many private equity investors lost substantial wealth in the stock market declines of 2008 and are struggling to raise liquidity. New fundraising for buyouts fell to an annualised $89 billion in the first quarter, down 78 per cent from the prior year. Investor sales in the secondary market for private equity commitments have increased, driving their value down to 50 cents on the dollar, the lowest point in five years.

"And a marked-to-market valuation of buyout assets deployed would reduce their value to around $900 billion, by our calculations, indicating significant losses for investors ahead," it said.

"With the LBO business on hold, some buyout funds are exploring alternative investment avenues. We estimate that buyout funds have $535 billion of dry powder or capital committed by investors but not yet deployed, which could be a significant source of capital while financial markets recover.

"In the long term, when buyouts resume, fund managers' focus will return to mid-market deals rather than the megadeals of recent years. In our base-case scenario, assets under management of leveraged buyout funds remain flat at $1 trillion through 2013, under the assumption that megadeals do not recover. Over the same period, however, total private equity industry assets under management grow slightly, reaching $3.4 trillion in 2013," it said.

By Yazad Darsha

© Emirates Business 24/7 2009