Oil crunch forces Middle East funds to hunt for alternative assets

The move by SWFs to tilt their investment portfolios more toward alternative assets is a worldwide trend, a direct result of the crash in the oil price four years ago, according to a report by the global consultancy PricewaterhouseCoopers (PwC).

SWFs now allocate almost a quarter of their assets under management to alternative investments, with “lower oil prices for longer” driving the funds to broaden their investment strategies. Investment in fixed income instruments, such as government bonds, had dropped from a peak of 40 percent in 2013 to 30 percent in 2016, PwC said.

The report, titled “The rising attractiveness of alternative asset classes for sovereign wealth funds,” said that although the funds faced adverse conditions in recent years when asset growth began to stall as a result of falling oil prices, total assets under management still grew to $7.4 trillion in 2016, albeit at a slower pace than in earlier years.

PwC said it expected the growth rate of assets under management to increase in the coming years as SWFs invested in non-fossil sources and diversified their portfolios to include alternative investments.

Laurent Depolla, PwC Middle East sovereign investment funds leader, said: “Middle East SWFs, in general, have been following the global trend by allocating more capital toward alternatives. Over the five-year period their average allocation to the alternatives asset class has increased from 3.7 percent to 6.1 percent of total assets, while their average target allocation rose from 6.5 percent to 8.6 percent.

“This can be attributed to new sovereign wealth funds entering the asset class as well as continued appetite from those already active.”

Infrastructure was also a large focus of SWFs in the region. The data firm Preqin said that European infrastructure deals were particularly attractive for Middle Eastern SWFs, with some “possibly looking to deploy capital at even lower preferred rates of return.”

Commenting on the key influences facing investors in the Middle East, Tarek Shoukri, PwC sovereign investment fund director, said: “Middle East SWFs seeking to generate superior returns under challenging economic conditions have started to adjust their investment strategies. Due to the drop in the oil price in recent years, there have been less inflows from their traditional revenue sources.”

However, the funds’ attempts to maintain return objectives by investing in certain alternative asset classes was not without risks as most alternatives were highly illiquid, the PwC report warned. One exception was gold, an asset with “one of the highest rates of daily volumes exchanged and one that can provide protection against short and medium-term market corrections.”

Will Jackson-Moore, PwC’s global head of sovereign investment funds and private equity, said: “SWFs play an important role helping governments stabilize the economy and exchange rates. We expect alternatives to be prominent in SWF portfolios in the future as they can offer increased diversification, principal protection, a hedge against inflation, and an increase in portfolio performance.”

But Jackson-Moore cautioned that finding the right allocation strategy for these asset classes was crucial. Monitoring of portfolios and investments was essential, he said, and capital would sometimes have to be reallocated to reflect economic developments.

“Overall, though, the benefits seem to outweigh the costs, as the varied nature of alternatives provides SWFs with the ability to select an asset class specific to their investment needs,” he said.