Expanding beyond the resource rush
Mongolia, Kazakhstan and Uzbekistan are sitting on some of the world’s most coveted natural resources. Uzbekistan’s Muruntau, for example, is the world’s biggest open-pit gold mine, and Mongolia’s Oyu Tolgoi and Tavan Tolgoi are the world’s largest undeveloped copper and gold, and coking coal fields respectively. In 2009, China Investment Corporation (CIC) alone acquired US$1.54 billion in resource-related assets in Mongolia, Kazakhstan and Russia, according to Eurasia Capital’s estimates. IPA has previously reported on Temasek Holdings’ investments in various Mongolia-focused assets such as SouthGobi Energy, the iron ore miner Lung Ming and Iron Mining International.
Alisher Ali, chairman of Eurasia Capital, an investment bank focusing on Central Asia and Mongolia, sees two investment trends among sovereign funds: Those from Asia tend to invest into mining and other resource assets because of domestic demand. Middle Eastern sovereign funds tend to take a different route, Ali says: “SWFs from the Middle East have been actively investing or forming partnerships with local players. For Middle Eastern SWFs, investing into sectors other than natural resources is part of their diversification strategy.”
Oman’s State General Reserve Fund and Uzbekistan’s Fund for Reconstruction and Development, for example, agreed in 2009 to establish an investment fund for Uzbekistan’s energy, oil and gas, construction and tourism sectors.
But there are anomalies to the general trend. Ali points to the investment fund jointly established by China’s CITIC group and Kazakhstan’s Samruk-Kazyna Sovereign Welfare Fund, which aims to finance companies in non-oil and gas sectors such as infrastructure in Kazakhstan and China.
“We believe that joint investment funds set up by SWFs with local partners are more likely to invest into non-resource sectors such as financial services, real estate, bonds and other assets. Large infrastructure projects are expected to attract interest of SWFs in the short-term future when the host countries fully develop proposals and plans,” Ali says.
Some sovereign funds established by Central Asian governments also tend to invest primarily at home, for the purposes of developing the domestic socio-economic system. Samruk Kazyna, for instance, owns 100% of Kazmunaigaz, 100% of Kazakhstan Railways and either full or partial stakes in a variety of industries ranging from telecoms to insurance.
Regardless of sectors and asset type, Ali discerns a universal requirement of all sovereign funds before investing: good corporate governance, proper risk mitigation and a viable overall investment climate in Central Asia. As in any fledgling market, there are multiple risks. While natural resources underground are abundant, potential investors come away wondering how, with little infrastructure and skilled workers, those resources can be mined, processed and transported efficiently. The World Economic Forum’s Global Competitiveness Report 2010-2011, which measures competitiveness by 12 pillars including infrastructure and institutions, ranked Kazakhstan 72 out of 139 countries, demoted from the previous year’s rank of 67. Mongolia ranked 99, an improvement from 117 in the previous year.
But Ali thinks that in Mongolia at least, railroads and energy supply will be available by the time production begins at the major mining sites, because infrastructure has been the Mongolian government’s priority. There are also macroeconomic and political risks. Ali is concerned about Mongolia’s 2011 budget, which he thinks will place the country into fiscal difficulties. “The 2011 budget included more cash handouts and a 30% increase in government employee salaries, which the World Bank estimates will result in up to 20-25% inflation in 2011. Such fiscal policy runs the risk of a wage-inflation spiral or the Dutch Disease in Mongolia. With 2012 being an election year, fiscal discipline and declines in spending are unlikely in the 2012 budget, with the possibility of continued election promises of cash handouts presenting the risk that inflation will continue to be high for the foreseeable future and must be factored into any investment decision.
External events can also have material effects on Mongolia, as the country’s growth depends on outside demand for minerals, particularly from China. With China’s attempts to cool its economy by slowing building projects and tightening bank lending, appetite for raw materials might also decline. “A one-dimensional economy is a risk for Mongolia in the mid-to-long term. The country needs to diversify its economy and export markets. With fast economic expansion, Mongolia may face equitable wealth distribution issues. An increasing gap between the rich and the poor may bring about social unrest in the mid-to-long term period.”
But Mongolia is currently the most attractive Central Asian market for sovereign funds, partly because of CIC and Temasek’s recent investments, Ali says. “We expect new major IPOs by state-owned enterprises, banks, business groups or their key subsidiaries in the next two to three years will be an attractive opportunity for SWFs. On private equity front, we expect along with the resources sector, banking, property and infrastructure will generate a particular interest among long-term investors.” Further into the future, Ali foresees Central Asia, especially Mongolia, becoming viable destinations for pension funds too, as these markets become more liquid.
The ground work is now being built for meeting the needs of more conservative investors. In January this year, Silk Road Management, an investment firm specialising in Mongolia and Central Asian markets, launched an index of companies listed worldwide but with significant exposure to Mongolia and Central Asia. At launch, the US-dollar-based Silk Road Composite Index contained 60 companies with a total market capitalization of US$100 million. The component companies are listed on stock exchanges in Mongolia, Kazakhstan, London, New York, Toronto, Hong Kong and Sydney.
Also in January, the London Stock Exchange signed an agreement with the Mongolian government for the former to help privatise and develop the Mongolian Stock Exchange. The LSE is expected to appoint the management team for this process, which may include upgrading the MSE’s capital markets infrastructure and market operations and rules.
Until liquidity and operational issues can be sorted out, the Mongolian market ―although the world’s best-performing in 2011 with a local-currency gain of 138.4%―won’t be suitable for conservative investors such as pension funds. Illiquidity can result in high volatility as a research note from Eurasia Capital points out: From February 26 to March 31 this year, the MSE Top Index fell 23% after gaining 123% from January to February 25.