Kuwait Investment Authority moves to active investment

The Kuwait Investment Authority (KIA), the state-run organisation which manages the country's billions of dollars of financial surpluses, announced recently that it was looking to invest in Indian healthcare and education projects. Some months earlier, the KIA’s senior managers announced that they intended to “double or treble” their exposure to Japan.

These statements demonstrate the way the organisation’s strategy has evolved from the ultra-conservative approach that been the key characteristic of the world’s oldest sovereign wealth fund. Founded in 1953, the KIA, which is estimated to have at least $200bn of funds under its management, making it one of the largest sovereign wealth funds in the world, traditionally invested in blue-chip Western companies and US treasuries – in the early part of this century, only 2.5% was invested in real estate and 1.5% in private equity funds.

KIA has not abandoned the blue-chip companies, such as Chrysler and BP; and investments in Citigroup and Merrill Lynch (then transferred into a stake in Bank of America) demonstrate that it is not neglecting opportunities to buy into Western financial institutions whose value was destroyed by the 2008 banking crisis.

But, under the leadership of Bader Al-Sa'ad, who became managing director in 2003, there has been a radical reworking of the strategy, designed to change the slightly bureaucratic and sleepy image of the organisation and its policy of being a long-term holder of its investments.

Fresh approach

Following a review by Mercer Investment Consulting, which compared the KIA's practices with those of the Yale and Harvard endowments, Mr Al-Sa'ad overhauled the KIA’s approach. The results are clear to see today. The fund’s managers say they still seek to keep the vast majority of its returns in line with traditional market benchmarks like stock and bond indices – 60% of the portfolio is in stocks – but this, said one banker, marks a significant reduction in the allocations made to traditional asset classes. The KIA is now increasing its investments in non-traditional and uncorrelated asset classes and emerging markets, including India and China. Some of the first evidence of this change in approach appeared in 2006, when the KIA paid $720m for shares at the initial public offering of Beijing's Industrial & Commercial Bank of China (ICBC).

According to one banker, about “$30bn, or about 15% of the fund, is invested in emerging markets, buyout funds and hedge funds”. And the KIA has said that it plans to look at the financial sector in emerging markets such as South America, where there are growth rates of 8% to 10%. Mr Al-Saad has also expressed an interest in leveraged buyouts, which would have been anathema to his predecessors.

The KIA’s size means any change in strategy is analysed closely by global markets. Its mandate is to invest funds held in the Reserve Fund for Future Generations – estimated to be currently $250bn – and for the General Reserve Fund, which is estimated to have matching assets and liabilities. With the economy currently growing at about 4% due to the continued high oil price, National Bank of Kuwait chief economist Randa Azar says that Kuwait's surplus this year is likely to be $15bn, of which 10% must be transferred to the Reserve Fund, the bulk of which will be invested by the KIA.

The need to diversify

The diversification of strategy was necessary if the KIA was to hold on to its position as one of the world's leading sovereign wealth funds, as this has now become a very crowded part of the investor market. Where once such institutions were rare and the KIA was arguably the most prominent, there are now about 60. And, according to this year’s Preqin Sovereign Wealth Fund Review: “The aggregate value of these vehicles was $3980bn at the start of 2011, increasing from the $3590bn recorded in 2010.”

The key question, say some analysts, is whether the KIA now has the capacity to make the leap from a relatively passive investor, whose aim was a performance to match the major indices, to a more proactive one with expertise in more exotic and volatile markets.

Some have their doubts. "The biggest challenge for the KIA, as it is for other regional sovereign funds, is acquiring the expertise to be an effective investor in global markets. It needs to acquire expertise in all markets – and a presence there – so it can compete with other sovereign funds. It is not yet clear that it is prepared to take this step," says Professor Gordon Clark, co-author with Dr Ashby Monk of a forthcoming paper on the subject.

Good timing

And it is also said that Mr Al-Sa'ad benefited from lucky timing. The new strategy began just as emerging markets were booming in the middle part of the decade, and the Western economic collapse in 2008 presented the KIA with an unprecedented opportunity to buy at the bottom of the market. “Had he taken over a decade earlier, the KIA might have been a victim of the 1998 dot-com and emerging market crashes,” says one critic.

Against that, others point out that the old strategy was not itself immune from failure. In the 1990s, the fund lost as much as $5bn in Spanish investments, just as plunging oil prices and the fallout from the 1991 Gulf War left the government struggling to balance its budget. And they say that the new system of more active investments has been successful. The KIA made a $3bn investment in Citigroup, which it sold less than two years later for $4.1bn, a 37% profit. The investment in ICBC has also been successful, with the shares at one point more than 150% higher than the IPO price.

The one certainty is that it will be very hard for anyone on the outside to measure the KIA’s performance. Although Kuwait’s National Assembly has attempted to shine some light on its activities, it remains a highly secretive organisation and meaningful statements by its senior executives are rare.

Its investment strategy is designed to enable it to buy and sell without being identified. According to one banker, “The KIA likes to take small stakes in companies, so it is easier to sell, and this gives a greater degree of flexibility because the holdings are under the threshold for disclosure.” The KIA used to have a 6.9 % stake in Chrysler, but that has now slipped below 5%.

This means that when the KIA takes more substantial holdings, it tends to make headlines and spurs endless speculation about how and when it might sell. These include the Citigroup episode, the $2bn investment in Merrill Lynch (which at one stage showed a 37% loss with the stake’s transfer to Bank of America) and the recent $600m investment in Areva, the French nuclear energy company, making the KIA the third largest shareholder with 4.8% of the shares. The interest in private equity is reflected by the $300m stake in the Texas utility TXU, which it holds alongside the private equity giants KKR and TPG.

Another change in strategy, brought about the global economic crash, has been for the KIA to invest in local markets. It supported the Kuwaiti financial sector during the 2008 banking crisis, as well as investing in local corporations such as Gulf Cable and Electrical Industries Company, Mobile Telephone Systems Company and Kuwait Investment Company.