US Open to Sovereign Wealth Funds

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Abu Dhabi Investment Authority (ADIA) is reshuffling its portfolio and has been given the support of a key US official.

During a visit to Abu Dhabi on June 2, US Treasury Secretary Paulson reassured the US-United Arab Emirates Business Council that "America will keep our markets open at home to investment from private firms and from sovereign wealth funds". "We reject measures that would isolate us from the world economy," he added.

Paulson's comment about sovereign wealth funds (SWFs), which are government-owned investment funds, has particular resonance in Abu Dhabi. The emirate's own SWF, ADIA, is generally considered to be the world's largest, and has been actively making acquisitions over the past year. Most famously, in November 2007, ADIA extended a $7.5bn loan to Citibank, the US's largest bank, in a deal that effectively gave the SWF a 4.9% share in the firm - the largest single stake.

Paulson's comments are also pertinent given a 2006 controversy surrounding Dubai Ports World (DP World), a subsidiary of Dubai World, an investment company owned by the government of Abu Dhabi's neighbouring emirate. DP World divested itself of US ports that it had acquired through its purchase of Britain-based P&O after a barrage of opposition from US Congress over what are now widely considered as hugely exaggerated "security fears".

The dispute caused some Gulf investors to question the US's openness to investment, particularly from Muslim countries, and American attitudes towards the increasingly wealthy countries in the region.

Paulson's message was that he is anxious to ensure that there is not a repeat of the DP World fiasco. Nonetheless, he also drew attention to "practice principles" that the US has drawn up with the government of Abu Dhabi (and that of Singapore, which also has an active SWF). These are expected to include guidelines on greater transparency - one of the major criticisms of SWFs has been their secrecy.

Paulson's visit comes at an important time, as ADIA is restructuring its portfolio. According to press reports quoting ADIA, the SWF is divesting itself of much of its hedge fund portfolio in exchange for so-called "passive funds" which follow a set selection of stocks, and are often linked to the fluctuations of a specific index. Hedge funds are "managed funds" that tend to chop and change their portfolios regularly. According to reports, around a third of ADIA's investments are in "alternative investments" including hedge funds.

A statement issued by ADIA suggested that the fund is not getting good value from its hedge fund-managed investments.

"ADIA is keen on identifying real management skills and real talent and is not prepared to pay the usual fees charged by hedge funds for strategies that can be replicated in an index," ADIA's executive director Saeed Mubarak Al Hajeri, has been quoted as saying.

Investments by SWFs such as ADIA have been partially responsible for the strong growth of hedge funds in recent years, but now it seems that the tide may be turning.

Paulson's visit has been viewed as active wooing of ADIA, perhaps as a response to evidence that the funds are turning away from developed markets to the emerging world. It also demonstrates a new understanding of what SWFs can bring to the US's sagging economy.

A recent report by The Monitor Group, a US-based consulting firm, asserted that "the facts don't demonstrate that these SWFs are behaving as anything but prudent investment vehicles for their governments," according to Emad Tinawi, vice president of Monitor in the Middle East and North Africa. The report largely dismisses the notion that SWFs are making "political" investments.

For American banks, and indeed other companies, suffering from the credit crunch and economic slowdown, a shot in the arm from SWFs could be very welcome. Citibank, reeling from large write-offs attributed to the collapse of the subprime lending market, could attest to this. Some analysts have referred to the process of Gulf SWFs injecting liquidity into the US and European financial system as "recycling funding" - that is dollars spent by Western consumers on oil being put back into their economies.

Meanwhile, for ADIA, the benefits of investments in Western companies are clear. Given the current economic downturn in the US and Europe, attractive prices are available for SWFs, and investments like ADIA's in Citibank are expected to act like recovery stocks when the market recovers. The investments are a good way of diversifying oil-based economies' economic base quickly as a hedge against a drop in the oil price and future depletion of hydrocarbon resources.

Furthermore, ADIA helps ease Abu Dhabi's soaring inflation rate, currently in double figures, by pumping some excess liquidity out of the domestic market.

The US is now apparently rather receptive to SWFs. Considering that many banks are still suffering from the credit crunch, possibly facing more write-downs, and that many firms are finding it hard to access capital, the time may have come for ADIA to advance again.

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