Saudi Arabia plans to merge two state investment funds into a $250 billion entity, but it will face increased pressure to improve its governance and sustainability practices, say experts.

While the investment focus of the new fund, which has yet to be named, will broadly remain in line with its constituents', its size will make it subject to wider scrutiny from the global investment community, believes Gary Smith, managing director of UK think-tank Sovereign Focus.

Gary Smith,
Sovereign Focus

“This merger of General Organisation of Social Insurance (Gosi) and the Public Pension Agency (PPA) takes them into the echelons of the biggest state pension funds in the world, and if you look at the list of those that are above them they all have extremely well burnished green credentials,” Smith told AsianInvestor.

Earlier this month, a Global SWF survey of leading sovereign investors, pension funds and official institutions found that Middle Eastern funds lag behind their peers when it comes to governance, sustainability and resilience (GSR). Saudi Arabian sovereign wealth fund Public Investment Fund, the 12th largest state-owned asset owner according to Global SWF data, followed just 10 out of the 25 GSR best practices on its proprietary scoreboard.

Smith noted that the world’s current top 10 pension funds by assets under management, which include Japan’s Government Pension Investment Fund (GPIF) and South Korea's National Pension Service (NPS), are proponents of their owner countries’ wider climate change mitigation goals.

“They have a responsibility to help the country achieve that [Paris-aligned net zero emissions] target both by their own direct investments, but also as a leader in the investment community in that country.”

Saudi Arabia is a signatory of the Paris Agreement since 2016 and has pledged to generate 50% of its energy from renewables by 2030. It has a lot to do, given that it is the world’s oil producer and its reliance on the fossil fuel makes it one of the top 10-largest emitters of carbon by country, according to the Union of Concerned Scientists.

GROWING BOND PLAYER

Diego Lopez, managing director of US consultancy Global SWF, believes that Saudi Arabia’s newly combined pension fund will narrowly miss a spot in the top 10 state investors, but nevertheless says it will be a major new player in the GCC (Gulf Cooperation Council)’s growing bond market.

Global SWF estimates that approximately 50% of the new fund’s assets will be in fixed income; 17% in public equity; 30% in real estate, infrastructure and private equity; and the remaining 3% in hedge funds.

Its portfolio will include large stakes in Saudi companies such as a $8.87 billion shareholding in Saudi National Bank and a $1.45 billion holding in the National Petrochemical Company. According to Bloomberg, the fund will also hold shares worth $207 million in AstraZeneca and $170 million in HSBC Holdings.

Source: Global SWF estimates

The merger, approved by the Saudi Cabinet on June 15, aims to improve operational efficiencies and therefore investment performance, Gosi chairman and finance minister Mohammed Al-Jaddan explained in a statement on Gosi’s website.

Diego Lopez Global SWF

According to Saad Al-Fadly, chief executive of Gosi's investment management arm, Hassana Investment Company, Gosi and PPA achieved returns above 8% over the last three years. As such, there would be no substantial changes to its investment strategy following the merger.

It is unclear what role Hassana and Raidah Investment Company – PPA’s investment agency – will each play once the new entity is formed. What's clear is the new fund will eliminate the duplication of back-office roles such as legal and compliance, as well as investment teams, while custody providers may well also be streamlined.

In addition, the combined headcount is likely to be sizeably cut, in a similar manner to other financial mergers, said Smith. "I have been through asset management mergers, and the expectation at outset is for a 25-30% reduction in headcount," said Smith.

"It's probable there'll be some culling of external asset managers as well," said Michael Maduell, president of the US-based Sovereign Wealth Fund Institute. The new entity will also save on costs by consolidating consultant and adviser contracts, he added.

In the long run, the merged fund’s size may give it greater clout to participate in more interesting deals, said Smith, but in the first instance the merger is all about efficiencies.

Experts with whom AsianInvestor spoke were not able to estimate by when the merger would be finalised or who would be appointed its chief investment officer. They also had little visibility on the funds' headcounts or number of consultants that they use.

EY and Mercer confirmed their involvement with the funds, and declined to comment for this article.

The Gosi-PPA merger follows others in the Gulf, including Abu Dhabi Investment Council (ADIC)'s merger into Mubadala Investment (MIC) in 2018, and the combination of two state investment funds into the Oman Investment Fund in 2020.

On the extent to which these mergers have improved perfomance, Smith said it depends on the market but "might be guessed at an average of 10%". This would be due to access to better tools and deals, and bigger funds to manage. 

"In terms of other regional mergers, they have generally been quite rapid (except for MIC-ADIC which is not even effective yet), once the board and management has been decided, which is often a delicate matter dependent upon families’ names and “wasta” (personal connections) rather than meritocracy," added Lopez.