Will sovereign wealth funds pour yet more money into the West?

Sovereign Wealth Funds (SWFs) are losing money hand over fist, which should leave one wondering whether their appetite for Western assets will continue to bolster those markets. Funds in Asia and the Middle East have been hit by a double-whammy of losses on existing foreign asset portfolios and weak domestic markets due to the fall in oil prices in the Mideast and an absence of de-coupling in Asia.

Originally, it was the SWFs’ investment in western banks during 2008, which helped to forestall a poor outcome in the United States, Britain and elsewhere. However, the Lehman collapse in September ended further widespread investments by SWFs in American and European banks, resulting in an unpleasant outcome which I predicted in June of last year.

Nevertheless, demand for assets in the West has held up strongly.

International demand for long-term U.S. financial assets rose more than economists forecast in December as foreign investors bought the most corporate debt since June.

Total net purchases of long-term equities, notes and bonds increased to $34.8 billion, compared with net selling of a revised $25.6 billion in November, the Treasury Department said today in Washington. Including short-term securities such as stock swaps, foreigners bought a net $74 billion, compared with net buying of $61.3 billion the previous month.

Stock prices rose and the dollar declined in the final month of 2008, when the Federal Reserve cut its benchmark lending rate. Investors abroad flocked to debt issued by American companies.

But, will all of that change going forward? My answer is yes for two reasons. First, economic conditions in the home market where the largest SWFs are domiciled are truly awful. Governments cannot be seen allowing domestically-controlled funds to be diverted to foreign assets in such circumstances, the risk being social unrest. Witness Dubai, one of the seven emirates of UAE, which has seen an enormous property bubble implode. Even the ritzy Atlantis Hotel is laying off workers. You should note that Dubai has no oil wealth to speak of.

Investors and home buyers in the United Arab Emirates may default on payments for properties that have yet to be completed, creating a liability for developers of as much as $25 billion over the next two years, UBS AG said.

“We believe delinquencies on payment terms will be a growing concern over the next few years,” Dubai-based UBS real estate and construction analyst Saud Masud said in an interview. “In our view investors are and will continue to default as per individual risk profile.”

Dubai property prices have dropped 25 percent from their September peak as banks reduced lending and speculators left the market because of the global financial crisis, Morgan Stanley said. Dubai opened its property market to foreign investors in 2002, and Abu Dhabi followed three years later, fueling a boom that was boosted by low interest rates.

“Our assessment of leverage in Dubai’s residential property market is based on the cost to developers to finish properties should investors default on the upcoming supply of 140,000 units,” Masud said in a Feb. 15 interview. “We estimate this liability to be roughly $20-$25 billion over the next two years.”

Based on conservative estimates, 30 percent of Dubai’s residential properties may be vacant by the end of next year as the population falls and the risk of oversupply increases, Masud said. The strengthening of the dollar against the pound, euro, ruble and the Indian and Pakistani rupee will make property less attractive to buyers using those currencies, Masud said.

Emaar Loss

Emaar Properties PJSC, the largest real-estate developer in the U.A.E., on Feb. 12 reported an unexpected loss for the fourth quarter because of writedowns at its U.S. unit and falling prices at home. The net loss was 1.77 billion dirhams ($481 million) compared with a profit of 1.74 billion dirhams a year earlier. Emaar’s results missed UBS estimates by 20 percent, Saud said.

Moody’s Investors Service said Feb. 12 it may downgrade banks and government-owned companies in Dubai, the second-largest sheikhdom in the United Arab Emirates, if oil-rich Abu Dhabi limits support to its own institutions. The emirate may have to refinance $15 billion in debt due this year from its total debt obligations of $70 billion, according to Moody’s.

But, more than that, SWFs are still losing a lot of money in the investments they already made. The latest such revelation comes from Singapore.

Government of Singapore Investment Corp., one of two sovereign wealth funds owned by the island, lost as much as S$50 billion ($33 billion) in 2008, the Wall Street Journal said, citing two people familiar with the matter.

The fund doesn’t plan to get rid of its investments including in Citigroup Inc. and UBS AG even as asset values plummet, the newspaper said. GIC expects the two banks to provide substantial long-term returns, according to the report.

Sovereign wealth funds in Asia and the Middle East have pumped money into global financial institutions to help replenish capital eroded by writedowns and losses that have topped $1 trillion globally. GIC, overseeing more than $100 billion of reserves, has invested about $18 billion in UBS and Citigroup since December 2007.

GIC’s losses are similar to those at Temasek Holdings Pte, the city-state’s other sovereign wealth fund, according to the Journal. “GIC does not comment on speculative reports,” Singapore-based spokeswoman Jennifer Lewis said today by phone.

The value of Temasek’s portfolio shrank 31 percent in the eight months to Nov. 30 as the global stock-market slump eroded the value of companies from Barclays Plc to Merrill Lynch & Co., Lim Hwee Hua, senior minister of state at Singapore’s finance ministry, said on Feb. 10.

Temasek’s assets were valued at S$127 billion, down from S$185 billion at the end of March 2008, Lim said then. The MSCI World Index declined 38 percent over the same period in U.S. dollar terms. The benchmark tumbled a record 42 percent in 2008.

GIC, along with Temasek, reduced equity holdings amid the global downturn last year “early in the crisis,” helping the funds to post smaller losses than the MSCI World Index, Finance Minister Tharman Shanmugaratnam said on Jan. 19.

I see the weak domestic market and the heavy losses as a one-two punch for Sovereign Wealth Funds. While these funds may have continued to invest heavily in Europe and North America through 2008, I cannot foresee a similar asset allocation going forward. This lack of demand is a downside for markets n those countries.

Sources
Foreign Demand for U.S. Long-Term Assets Gained in December – Bloomberg.com
U.A.E. Real-Estate Defaults May Cost $25 Billion, UBS Says – Bloomberg.com
Singapore’s GIC Loses $33 Billion as Assets Tumble, WSJ Says – Bloomberg.com
Dubai resort The Atlantis stages most expensive launch party ever – Telegraph
Atlantis The Palm Dubai website
Atlantis lays off 70 staff – National

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.