Secured for the future: Sovereign funds provide a safeguard and aid diversification

Like many countries fortunate enough to post regular budget surpluses, Kuwait has sought to put its excess liquidity to work in international markets. According to the Sovereign Wealth Fund (SWF) Institute, the Kuwait Investment Authority (KIA) represents the sixth-largest SWF in the world. Furthermore, although it has a broad mandate to invest both at home and abroad, its development reflects the extent of its foreign outlook, given its establishment as the Kuwait Investment Board back in 1953 in London, eight years before the nation’s independence from the UK. For decades its branch office there served as a base from which it could invest in Western economies across a wide range of asset classes. More recently, the rise of Asia as an economically vibrant region has seen the sights of the KIA traverse eastwards. In 2009 Kuwait inked a bilateral cooperation agreement with China, laying the groundwork for the creation of the KIA’s first representative office in Beijing, which the authority describes as its “gateway to expanding the KIA’s investment throughout Asia”.

FUNDS: Today, the KIA administers two large funds, the General Reserve Fund (GRF) and the Future Generations Fund (FGF), as well as all other funds that the minister of finance entrusts to it on behalf of the state. The GRF is the repository for all of Kuwait’s oil revenues, as well as the profit from the GRF’s investments. In 1976, as much as 50% of the GRF’s balance was used to establish the FGF, which is topped up each year by 10% of the net income of the GRF and 10% of total state revenues. The purpose of the FGF is to diversify Kuwait’s oil assets into long-term financial investments for the benefit of future Kuwaitis. As with many SWFs in the region, details regarding the KIA’s investment activity are sometimes difficult to ascertain. Within Kuwait, the KIA’s activities are subject to oversight from the minister of finance, the State Audit Bureau, the Council of Ministers and various committees of the National Assembly, but granular data regarding asset allocation is not made public. The SWF Institute grants the KIA a score of six on its Linaburg-Maduell Transparency Index, where scores of eight and above are considered adequate in terms of transparency. In regional terms, this places the KIA ahead of Saudi Arabia’s SAMA Foreign Holdings, which has received a rating of four, but behind the UAE’s investment vehicle Mubadala, which is one of the most transparent SWFs in the world. In January 2013 local newspaper Al Qabas reported that the fund’s total size was around KD73.63bn ($263bn), 47% of which was invested in stocks. The SWF Institute, however, places its total size at approximately $342bn as of 2013.

INTERNATIONAL ACTIVITIES: What information has been made publicly available shows that the GRF consists of investments in Kuwait and the Middle East and North Africa (MENA) region, as well as hard currencies held on behalf of the government. Among the GRF’s holdings are government assets, including those derived from the country’s participation in initiatives like the Kuwait Fund for Arab Economic Development and from its participation with bodies such as the World Bank and IMF. The FGF, on the other hand, invests outside Kuwait and the MENA region, and its holdings are distributed across various asset classes according to a periodically reviewed strategy established by the board of directors. The strategy is defined according to three main weightings: regions of the world; different asset classes; and different types of fixed-income assets.

While little more is known about the KIA’s investment strategy, its recent activity demonstrates that the enthusiasm for Asian markets it voiced on the opening of its Beijing office was in earnest. In 2012 the fund announced that it would invest $150m into the $2bn initial public offering (IPO) of Malaysian firm IHH Healthcare, KIA’s biggest capital outlay since it invested in an IPO by the Agricultural Bank of China in 2010.

According to the current legislative framework, the assets of the GRF are available for use by the state as the government sees fit. The generational aspect of the FGF, however, means that all of its investment income is reinvested, as required by Law No. 106 of 1976. Therefore, any transfer from the fund would require a change to existing legislation. The importance of the fund to the nation’s development strategy was demonstrated at the end of 2012, when Kuwait’s Cabinet instructed the Ministry of Finance to increase the percentage of state revenues that the FGF receives each year from 10% to 25%, with the change to take effect within that current fiscal year ending in March 2013. The move was welcomed by some observers as a sign that the government is placing more emphasis on Kuwait’s future needs rather than the excessive spending on current items, such as public sector wages, which have taken a greater share of the nation’s revenue in recent years.

The country’s youth, meanwhile, have become more involved in decision-making. “The innovative solutions which the youth have proposed for economic diversification, judiciary reform, housing, environment and health care are a breath of fresh air which will help realign funding and programmes to be more effective and sustainable in the long run,” said Sheikh Salman Sabah Salem Al Humoud Al Sabah, the minister of information and minister of state for youth affairs.

However, some questions over the decision remain. There has been no official announcement as to whether the measure will extend beyond the current financial year, for instance, and concerns surround the effect the move will have on government spending on the National Development Plan, the implementation of which is already behind schedule.

PRIVATE WEALTH: The government is not alone in recognising the benefits of investing abroad. According to the IMF, Kuwait’s private sector had invested around $51.4bn overseas as of June 2012, which amounted to some 41.4% of GDP.

The scale of this transfer has led to speculation regarding the exposure of Kuwait’s private sector to external shocks, and therefore the destination of the nation’s capital outflows is a matter of some interest. The GCC is the most popular target for Kuwaiti capital, accounting for 40% of portfolio investments and 50% of foreign direct investment, which makes Kuwait vulnerable to regional financial market adjustments.

In the first half of 2013, the fall of oil prices below the $100 mark caused concern over the potential effect on GCC economies, but analysts rejoined that even if the price fell lower over the year and budget revenues were reduced accordingly, there would be little direct impact on business activity as this income would have largely been saved rather than spent. Kuwait’s exposure to regional economies is, therefore, not seen as a problem for most market participants.

“In our view… the latest fall does not alter the main narrative of a region set for solid economic growth over the next couple of years. We had long expected oil prices to weaken in 2013 from last year’s average of $112, as the soft outlook for global oil demand combines with rising supplies (including from the US, Iraq and Libya) to loosen market fundamentals. The recent fall merely moves prices more or less into line with our expectations for this year,” stated a recent report from the National Bank of Kuwait.

The MENA region is of more concern to most analysts. With political strife hindering economic growth across North Africa and traditional markets such as Egypt facing severe fiscal challenges, exposure in this area is seen as carrying particularly high risk. However, the potential for damage within Kuwait as a result of the ongoing transitions in the MENA countries is limited, with Kuwait’s private sector exposure to MENA (excluding the GCC countries) standing at a modest 7%.

Similarly, IMF data indicates that investment by private sector Kuwaiti firms in European countries considered as higher risk, such as Greece, Spain, Portugal, Italy and Ireland, is also relatively small.

With the IMF forecasting 1.1% total GDP growth and around 4% non-oil GDP growth in 2013, and most of the nation’s economic sectors having shrugged off the effects of the global economic downturn, the flow of Kuwaiti capital, both private and public, to international markets is expected to continue in the near term.