CHAVING RECENTLY RETURNED from the Arabian Gulf region I’m in no doubt that – oil aside – it offers enormous investment potential and is generally underestimated by many institutional fund managers. However, I must stay that while in London, Sarasin’s global fund managers highlighted it, RMB Asset Management International chief investment Officer Tom Joy told me its very definitely on his radar screen and I’m delighted Investec has just launched a Middle East fund.

Bahrain, Kuwait, Orman, Qatar, Saudi Arabia and United Arab Emirates – comprising what are known as the Gulf Cooperation Council (or GCC countries) – are witnessing breathtaking growth thanks largely to the quadrupling of the oil price since 2002.

The region’s GDP at around US$900bn is similar to Australia’s, or almost three times South Africa’s. Real economic growth has been around 7% over the past five years. Best current performer is Qatar, at 8,3% and the worst is Saudi Arabia, at 3,5%.

Per capita GDP is currently an estimated $21 3000, ranging between Quatar’s $67 700 (one of the world’s highest) and Oman’s $14 400. Those figures are infinitely higher than SA’s $4 500. Inflation recently reached a 15-year high of 6,7% thought it’s felt that might understate price pressures.

The region possesses 484 billion barrels – or 41% - of the world’s proved oil reserves and 1 459 trillion cubic feet (22,7%) of the worlds proved gas reserves. Current oil production is 18m barrels/day. Oil export receipts reached $381bn last year , 8% higher than 2006, while natural gas revenue rose 18% to $26bn, mainly driven by gas-rich Qatar. The region is rapidly diversifying and attracting high levels of foreign Investment, in marked contrast with previous decades. McKinsey Global Institute estimates potential Gulf investable capital (Institutional funds and private wealth) at $4, 1 trillion, translating to 30% of the US’s GDP. The non-oil sector is currently growing at an approximate 14% /year in nominal terms.

Traditional Western investment houses, I was told by bankers in Abu Dhabi, are falling over themselves opening up distribution outlets in Gulf region. Two that have dug in for some time have been HSBC and Credit Suisse, mainly through their private banking franchises. Goldman Sachs has been ranked the top adviser for mergers and acquisitions in the region, while Morgan Stanley leads the Investment Bank revenue league table. Both firms have set up shop in Dubai.

Though the exact size of the market for alternative investments is hard to assess, available data points to substantial growth. An Ernst & Young reports suggests that allocations by affluent and high net worth individuals to alternative investments (not including property) rose from 10% in 2002 to 22% last year. The compound growth rate of private equity funds was 105% year between 2000 and 2006.

Of course, hedge fund managers have been operating in the region for a long time. But what was is small fry. The Bank of New York predicts that investment hedge funds by Gulf institutions will increase from $29bn in
2005 to $101bn in 2010.

That’s fuelled mainly by the Gulf’s outstanding economic growth, the increasing appetite of investors and high liquidity. Add to that the surge in the demand for wealth management services from not only high net worth individuals but also institutional investors, including pension funds.

Likewise, Gulf money is making itself felt elsewhere. Most of the cash finds its way to the US and Europe, but with returns in developed markets slowing flows to less traditional markets are speeding up.

The Gulf states spend a record $83bn buying foreign companies last year, about double that in 2006, according to M&A tracker Zephyr. That represented 1.7% of overall global M&A for the year. For example, Dubai International Capital’s $2bn Global Strategic Equities Fund is now 30% exposed to Asia and has just taken a 5% stake in Sony. Gulf-based telecoms firms have spent more than $20bn in recent years, snapping up businesses from Algeria to Singapore. The biggest deal last year came from Saudi petrochemical producer Sabic, which bought General Electric’s plastics business for $11,6bn. Kuwait Petroleum bought five Dow global businesses for $9,5bn, Saad in Saudi Arabia bought a 3,11% take in HSBC (UK) for $6,6bn and Borse Dubai bought Swedish group OMX for $4,9bn.

On the petty cash side, Gulf portfolio investement has turned once-sleepy stock markets in Cairo. Casablanca and Amman into some of the worlds hottest performers and helped insulate them from global shocks.

Gulf investors are keenly interested in the Bric (Brazil, Russia, China and India) countries, but contact in the UAE failed to convince me that they’re madly enthusiastic about SA. Interestingly, they’re also wary of their neighbour, Iran.

They still see their security as closely tied to the US and consider containing Iran’s influence in the Middle East as their biggest challenge.

First published in Finweeks Finfund supplement 5 June 2008.