The Evolving Role of Institutional Investors in the Gulf

Institutional investors are typically defined as “specialized financial institutions that manage savings collectively on behalf of small investors, toward a specific objective in terms of acceptable risk, return-maximization and maturity of claims.”

The most important types of institutional investors are pension funds, insurance funds, and mutual funds. Institutions play a critical and dominant role in mature capital markets by enabling individual retail investors to tap the capital markets through the services of professional asset managers. They can thus help improve capital market efficiency, access to capital, and corporate governance. Their long-term, informed investment decisions have in many countries resulted in a transition from volatile retail investor-driven bourses to much more stable and liquid capital markets.

The relative lack of institutional investor presence remains one of the defining characteristics of the GCC stock exchanges. Retail investors still typically account for 90 per cent or more of trading on the markets. The low capital market participation of institutional investors is especially striking in view of the fact that savings in the region are highly institutionalized, with the existence of a large number of long-standing state pension and social insurance institutions, as well as sovereign wealth funds (SWFs).

By contrast, institutions dominate the established Western capital markets. Their total assets under management were $70 trillion in 2008, almost equal to global bank assets. Their holdings as a percentage of GDP jumped from 141 per cent, 56 per cent and 117 per cent of GDP to 211 per cent, 76 per cent, and 171 per cent in the US, Germany and France of GDP respectively in 1995-2007.

Boosting the role of institutional investment remains one of the most pressing priorities for the GCC financial markets. Their growth will be critical for effectively channeling regional savings in a way that will best protect the long-term financial investors of savers and effectively ensure access to capital by regional companies and even government-related entities.

At the same time, a growing role of institutions will foster the growth and diversification of the regional capital markets by encouraging more IPOs and debt issuance. The experience of Poland after its comprehensive pension reform serves as one of the most compelling success stories globally in this regard and has made the Warsaw Stock Exchange one of the most successful bourses in Europe. However, similar experiences have been repeated in a number of emerging and even established capital markets.

As pressing as the need for a greater institutional presence on the GCC exchanges is, progress has been mixed to date. This has a great deal to with the limited range and profile of large institutional players even if the situation is beginning to change.

The pension funds – a leading category of institutional players in most mature markets – are largely confined to the government pension and social security funds. All the currently existing schemes are at least partially funded and some of them fairly old by international standards, most notably the Saudi Public Pension Agency established in 1958. Nonetheless, they have begun to significantly diversify their assets into regional securities only fairly recently.

Although some GCC companies offer occupational pension schemes, there is no regulatory framework for private pensions. This remains a major missing element of the GCC financial sector and one that could be fairly easily rectified by converting the end-of-service benefits typically provided under the GCC labor legislation into funded occupational retirement schemes. A nearby precedent of doing this can be found in Egypt.

The regional insurance sector is relatively young and modest in size. To this day, the GCC remains the most underinsured market in the world with average insurance depth (premia as a percentage of GDP) of 1.0 per cent in 2008, which is far behind the global average of 7.1 per cent and even the emerging market average of 2.7 per cent. However, the sector has been growing very rapidly. Gross written premiums in Saudi Arabia since 2003 grew at an annual 24.4 per cent to a total of SAR10.9bn in 2008. They are projected to nearly double to SAR20.4bn in 2012.

Although insurance density (per capita expenditure on insurance) has risen rapidly, it remains low at SAR440, compared with the GCC average of SAR850 and global average of SAR2,300. Under the circumstances, insurance companies are well on their way to emerge as increasingly important institutional players in the region, even if the starting point is modest by international standards.

Mutual funds have a relatively established history but remain small by international standards. Mutual funds are widely available in the key asset classes, most notably equities, money market, fixed income, and even property. The GCC mutual fund industry only dates back to the late 1990s but has been growing rapidly in recent years. Independent estimates of all mutual funds sold in the Gulf, including cross-border funds, are pegged at $80–100 billion.

The Saudi mutual fund industry alone expanded from $3.3 billion in 1992 to $10.3 billion by the turn of the century and further to $36.5 billion by 2005 at the height of the liquidity-driven global bull-run. Recent regulatory innovation augurs well for their further development with the launch of exchange traded fund hopefully eventually making it easier for investors to tap a growing range of asset classes.

Government and corporate funds are an important institutional investor in the region. Although the traditional institutional investors are relatively less important in the Gulf than in the West, the relative importance of government funds is greater. This is little surprising, given the importance of large capital windfalls during periods of high oil prices. The regional cumulative current account surplus in 2003-2008 was some $1.0 trillion.

A key challenge with these funds is to determine their management and ultimate use in a way that best reflect the needs of the economy. For instance Norway has converted its transparent Petroleum Fund into a national Pension Fund. Also the private sector has large concentrations of capital, not least to the presence of important family offices, some of them of very long standing.

The modest role of institutional investors has been not entirely due to their size. Most regional institutions with large assets under management have been conservative in their investment strategies, partly as a result of regulatory and human capital constraints. This has led to large-scale off-shoring of fund-management and, consequently, funds. Fostering the emergence and local management of institutional investors remains one of the most important and attractive growth opportunities for the GCC financial sector.

Email the writer: