Deep inside a fortress of government ministries in Kuwait City, Bader M. Al Sa’ad moves billion-dollar chunks of wealth around the world like chess pieces. Slim and stately, the head of the Kuwait Investment Authority manages $213 billion on behalf of his government. His portfolio, one of the biggest so-called sovereign wealth funds in the world, is constantly replenished with money that flows into Kuwait in exchange for the oil that flows out. As prices top $100 a barrel, Kuwait’s coffers are swelling.

With portraits of the emir and crown prince looming above Al Sa’ad’s desk, one might expect the 50-year-old money manager to be tight-lipped about his investment strategy. But Al Sa’ad, who has held his post for just four years, is in a chatty mood. He says he wants to invest more in China and Brazil and other hot emerging markets—and less in Britain and France. He’s also keenly interested in leveraged buyouts and wants to spend at least $4 billion on big stakes in blue chip companies, especially American ones, on top of the roughly $17 billion he already holds. He’s even interested in U.S. mortgage-backed securities, a contrarian play if there ever was one. Al Sa’ad says he has about 15% of the fund in emerging markets, hedge funds, and private equity, up from almost zero when he started. “We have been quiet for a while,” he says. “But now we are knocking on doors.”

Pounding is more like it. Sovereign wealth funds from the Persian Gulf are changing the face of global finance in ways that unnerve many Westerners. In recent months Gulf funds have bought large chunks of Citigroup (C), the private equity giant Carlyle Group, semiconductor heavyweight Advanced Micro Devices (AMD), planemaker European Aeronautic Defense & Space (EADS), and many other big companies. Gulf funds are also getting into leveraged buyouts, sometimes alongside private equity firms and sometimes by themselves—despite having little experience operating companies. “Large sovereign wealth funds have become major players in private equity, not only as investors but also as competitors,” says David Rubenstein, a founder of Carlyle, which sold a 7.5% stake to an Abu Dhabi fund in September. Soon, says Gregory A. White, managing director at Thomas H. Lee Partners, “they will be the industry. We will be working for them.”

BusinessWeek recently paid visits to four of the region’s most powerful money managers: Kuwait’s Al Sa’ad and Dubai’s Sameer Al Ansari, Soud Ba’alawy, and David Jackson. Their rise from relative obscurity has been breathtaking; rarely have so few come to control so much, so quickly.

The fund managers insist that Western businessmen and politicians have nothing to fear. Al Sa’ad ticks off a well-rehearsed list of reasons why CEOs should rejoice at the prospect of having Kuwait as a major shareholder. Reason 1: His fund will agree to multiyear lockups, providing long-term capital. Reason 2: Al Sa’ad expresses concerns to CEOs behind closed doors, not in the press. “If I were a CEO, I’d look for stability,” he says.

But recent actions by some funds belie those soothing sentiments. The $50 billion Qatar Investment Authority, run by Qatar’s Prime Minister, Sheikh Hamad bin Jassim bin Jabir al-Thani, is working with hedge fund activist Nelson Peltz to shake up British beverage company Cadbury Schweppes (CSG). Dubai Holding was so aggressive in its pursuit of OMX Group of Sweden last summer that it ran afoul of regulators there. Even companies that do business with Gulf funds are on alert. Dubai International Capital, which manages a $12 billion fund for Dubai’s ruler, Sheikh Mohammed bin Rashid Al Maktoum, flabbergasted Wall Street last fall when its chief, Sameer Al Ansari, shot off letters to Morgan Stanley (MS), UBS (UBS), Goldman Sachs (GS), Citigroup (C), and other top investment banks asking them to pony up $50 million each for a new fund or risk losing future business. Several, including Goldman and UBS, complied. “So far,” says Roger Altman, chairman of Evercore Partners (EVR) and a former U.S. Deputy Treasury Secretary, “sovereign wealth funds have been more stabilizing than otherwise. But everyone is waiting to see how this evolves.”

Combine the Gulf funds’ new, tougher tactics with their staggering wealth and relative inexperience managing companies, and you have the potential for trouble. Six Gulf states—Abu Dhabi, Dubai, Kuwait, Oman, Qatar, and Saudi Arabia—account for nearly half of the world’s sovereign wealth fund assets. They control some $1.7 trillion, as much as all of the hedge funds in the world and more than the $1 trillion private equity industry—and Morgan Stanley predicts the total will grow by about $400 billion annually over the next several years. There’s even talk that Saudi Arabia may soon unleash a new $500 billion-plus fund. Bankers estimate that Gulf funds earned about $180 billion from their sovereign wealth fund investments in 2007—more than half of the $315 billion they collected in oil and gas revenues.

Wall Street veterans worry in particular that Gulf funds are moving too far, too fast into private equity. Buying and running companies is vastly different from taking passive stakes in them. Even seasoned pros like Henry Kravis of Kohlberg Kravis Roberts have trouble managing a company when its industry hits the skids, debt payments become untenable, and key people jump ship. Nemir A. Kirdar, CEO of Bahrain money management firm Investcorp, says Gulf funds “should rely on professionals.” In November, some bankers labeled Qatar’s fund an “amateur” after it backed out of a $19 billion deal for British grocery chain Sainsbury at the 11th hour. “They’ve given Middle Eastern investors a bad name,” says one.

The Gulf funds’ lack of experience shows in their compensation practices. Historically, they’ve been unwilling to pay anywhere near as much as private asset managers for top talent, a tendency that has hampered their recruiting efforts and led to high turnover. Al Ansari acknowledges that the Gulf region is “very talent-poor.” A senior banker in Dubai says “90% of the people who work in the region are second-rate. Only very recently are experienced individuals coming in.”

Such problems wouldn’t be so worrisome but for the fact that these massive funds are situated in a handful of tiny, oil-rich city-states in one of the world’s most volatile regions. The tiny Gulf emirates rely on the U.S. military for protection from the likes of Iran and Iraq—and they rely on guest workers for much of their labor. It’s a precarious situation, to say the least.

The Gulf funds, meanwhile, are nervously preparing for the day when the oil money stops flowing. For decades they mainly used the currency reserves that piled up from oil sales to buy safe investments like U.S. Treasury bonds. Now funds are trying to build the foundations for new, diversified, post-oil economies. To do that they must take more risk.

Kuwait’s Al Sa’ad feels intense pressure to generate returns, satisfy his political bosses, and gain Wall Street’s respect. In the 1990s, the fund, which receives about 10% of Kuwait’s revenues annually, lost as much as $5 billion in Spanish investments just as plunging oil prices and the fallout from the 1991 Gulf War left the government struggling to balance its budget. “We want to restore [our] name as a professional, global money manager,” he says. The fund already generates profits about the size of Kuwait’s national budget, but he plans to double its assets.

Al Sa’ad has long sought to outmaneuver markets. His father, Mohammed, was a successful merchant, but finance mesmerized Al Sa’ad, the seventh of 10 children, from a young age. After graduating from Kuwait University in 1980 with a degree in accounting, he got a job as a foreign exchange trader with a local bank, picking up new moves in the U.S. during training stints at Chase Manhattan in New York and the First National Bank of Chicago. In the 1990s, a local investment bank tapped Al Sa’ad to expand its merchant banking division, and his attention shifted to buyouts. In 2003 Kuwait’s Finance Minister asked him to run the emirate’s investment fund, already one of the biggest portfolios in the world. Al Sa’ad, intrigued with the idea of managing money, accepted. He asked to take a pay cut, he says, to reduce the salary gap with his underlings.

Al Sa’ad keeps the hours of any high-stakes money manager. He typically gets into the office at 7 a.m. and leaves around 3:15 p.m. to have lunch with his wife, Ola Al Mutairi, deputy editor of the women’s magazine Osrati, and his five children. Then it’s back to the office for several more hours. So far, Al Sa’ad has enjoyed success; his fund returned 13.3% in the fiscal year ended in March, 2007. But he isn’t content. “We can be more dynamic,” he says.

The fund seeks to keep the vast majority of its returns in line with traditional market benchmarks like stock and bond indexes—60% of the portfolio is in stocks—while putting a sliver into riskier ventures like private equity and hedge funds. In 2006 it paid $720 million for a chunk of the initial public offering of Beijing’s Industrial & Commercial Bank of China, a deal Al Sa’ad says kept him up at night. “If something goes wrong, I’ll be under fire,” he says. (ICBC’s stock has zoomed 156% since the IPO.) Last year the fund invested $300 million in Texas utility TXU alongside private equity giants KKR and TPG. But Al Sa’ad is taking private equity slowly. He admits the fund’s 400 employees, mostly civil servants who had limited contact with major buyout firms until recently, don’t know how to operate companies. “We don’t like to own 100% of businesses,” he says.

By contrast, Sameer Al Ansari, manager of Dubai International Capital’s relatively small $12 billion fund, displays some of the swagger of a private equity king. A compact, athletic man, Al Ansari, 45, wears designer suits and does business not from a drab civil service complex but sleek, sun-drenched quarters high up in a gleaming office building. His investment capital comes from Sheikh Mohammed’s umbrella company, Dubai Holding, which invests 30% of its cash flow in Dubai International Capital and other funds.

Born in Kuwait of Palestinian parents and brought up in Britain, Al Ansari graduated from Loughborough University in 1985 with a degree in accounting and financial management. In demand as an Arabic speaker who could make sense of numbers, he soon moved to Dubai to take an accounting job with Ernst & Young. His work in cleaning up Dubai Aluminum, a large government company beset by problems, attracted the attention of Mohammed Gergawi, a close confidant of Sheikh Mohammed and now chief executive of Dubai Holding. Gergawi hired Al Ansari to be chief financial officer of the Sheikh’s executive office, where he helped straighten out the ruler’s sprawling business interests and set up Dubai Holding, which now manages most of those assets. After Al Ansari expressed alarm that almost all of the Sheikh’s wealth was tied up in real estate, Gergawi gave him the go-ahead to set up Dubai International Capital, to diversify.

Despite his lack of buyout experience, Al Ansari has jumped in headlong, allocating about 60% of his portfolio to private equity. (A quarter is devoted to stakes in large companies and 15% to emerging markets.) In addition to co-investment deals with private equity firms, he has engineered six solo buyouts, including wax museum operator Tussauds Group, which he bought from Charterhouse Capital Partners for $1.6 billion in 2005. (Less than two years later he sold Tussauds to Blackstone Group for $2 billion in cash and a 20% stake in an entertainment company valued at more than $200 million.) Last year Al Ansari, who still speaks with a clipped British accent, nearly scooped up his beloved Liverpool soccer club, but lost out to a North American group that included buyout mogul Tom Hicks.

Al Ansari, like Al Sa’ad, seeks to double the size of his portfolio in a couple of years. To boost his firepower, he has taken on lots of debt from such banks as HSBC (HBC), Barclays, and Royal Bank of Scotland. His Global Strategic Equities Fund, which now holds stakes in Sony (SNE), HSBC, and EADS, borrows $4 for every $1 of its own money. The fund also buys derivatives to limit its losses. One former employee says: “Dubai plays a very shrewd game.” But he worries that “it’s leverage on leverage on leverage.”

Al Ansari spends much of his time hunting up deals abroad. When he’s in Dubai he typically spends 10 hours a day in the office, mostly taking meetings with investment bankers and private equity people pitching ideas. He says he’s invited to three to six social events a day and usually goes to one or two. “Dubai is a work-hard, play-hard kind of place,” he says—for better and for worse. “My career has gone from good to great in the past two years, but my personal life from bad to worse.” Al Ansari’s two sons, 17 and 14, live with him, while his daughter, 10, lives with his ex-wife. Over lunch at a Lebanese restaurant near his office, he confesses that trotting the globe for buyouts has only added to his exhaustion.

Looking for help in coming up with new deals, Al Ansari last year began courting hedge funds. With the help of JPMorgan Chase he agreed last November to a $1.1 billion, 9.9% stake in Och-Ziff Capital Management (OZM). Al Ansari met with Och-Ziff founder Daniel S. Och several times in New York and London; the two sealed their bargain over dinner at the swank New York restaurant Daniel in a private, glass-walled room overlooking the kitchen. When Och visited Dubai after his firm’s November, 2007, IPO, Al Ansari took him to the Al Muntaha restaurant, which rests 700 feet above the Gulf on top of the Burj al Arab Hotel, where rooms start at $2,000 a night. The two talked of Al Ansari’s hopes to tap Och’s global team for co-investment ideas and deal research, while helping Och-Ziff raise money in the Gulf. “We are very pleased with the relationship at this point,” says Och.

Some financiers in Dubai think Al Ansari is in over his head. “He’s a very smart guy, but he’s not a fund manager by training,” says one. While Al Ansari’s people say privately that the fund is making 20% annual returns, bankers are skeptical. “I question what that’s based on,” says a senior Dubai-based investment banker, noting that the portfolio’s private equity investments might not be easy to sell in today’s turbulent markets. Moreover, the stock prices of EADS and HSBC are down some 20% and 10%, respectively, since Al Ansari bought them, while Och-Ziff has tumbled 23%. Al Ansari stresses that his big stock positions are hedged with derivatives. If HSBC’s stock sinks further, he says, he might buy more. Och-Ziff, he insists, is misjudged.

For all the fixation on returns, sometimes a sovereign fund manager’s larger strategic goals are just as important. Soud Ba’alawy, 46, a former Citigroup vice-president in Dubai, was tapped in 2000 to become chief investment officer of Sheikh Mohammed’s office. His duties have since expanded greatly; he’s now chairman of Dubai Group and the point man for the ruler’s quest to turn the tiny emirate into the Wall Street of the Middle East. “We want to be the’ financial services company in the region,” says Ba’alawy of the Dubai Financial Group, one fast-growing wing of Dubai Group that he wants to take public this year for as much as $12 billion.

Unlike the British-tinged Al Ansari, Ba’alawy is still very much a man of the region. In Dubai he wears the traditional white robe and headdress and fasts during the month of Ramadan even when he’s on the road chasing deals, which he says is 70% of the time. Intensely private, he resists talking about how much money he manages (insiders peg his returns at around 20% annually), much less his family life. He has two young daughters, but as to the rest he says “Our personal lives are our personal lives.” Ba’alawy, a Dubai native, obtained a chartered accounting qualification from a small London school in the mid-1980s, and then returned to Dubai to work for his father’s printing business. He joined Citigroup in 1990, rising to treasurer for the Gulf region. “I always loved markets,” he says. “I wanted to be in the financial sector from the beginning.”

In 2000, while at Citi, Ba’alawy met Gergawi, the sheikh’s right-hand man, who was then running a real estate project called Dubai Internet City. Ba’alawy joined that effort but left a few months later to set up an investment office for the ruler that quickly mushroomed into what is now called Dubai Group, the conglomerate that includes hotel management and financial services.

Over the past two years, Ba’alawy has been wooing financial institutions around the globe to join that growing empire. Using the cachet of his boss, Sheikh Mohammed, as an entrée, Ba’alawy has snapped up a 40% stake in Malaysia’s Bank Islam and a 15% chunk of Oman’s Bank Muscat. In December, Ba’alawy raised eyebrows when he slapped down $1.1 billion for a 25% stake in Cairo investment bank EFG-Hermes—just two weeks after being contacted by its owner, private equity firm Abraaj Capital, which had paid $500 million for it the previous year. Ba’alawy insists EFG is worth the hefty price.

Ba’alawy’s biggest deal came in September, when he agreed to take a 19.9%, $2.1 billion stake in Nasdaq, part of an effort to bulk up the emirate’s new Dubai International Financial Exchange, which had languished since its 2006 launch. The deal capped a flurry of maneuvering that started with Ba’alawy’s March offer to take a stake in Sweden’s OMX Group. But OMX declined and quickly accepted a $3.7 billion offer from Nasdaq. On Aug. 9, Ba’alawy’s team quietly took steps to snatch up a 27% stake in OMX shares with the help of investment banks, a move that brought a reprimand from Swedish regulators. The idea, says someone close to the deal, was to make sure Dubai would be taken seriously. Later Dubai made a formal $4 billion offer for OMX, enraging Nasdaq but quelling the Swedish authorities.

A standoff between Ba’alawy and Nasdaq CEO Robert Greifeld seemed likely. But Ba’alawy changed course, reasoning that Nasdaq’s big-name brand might be more valuable than OMX. In a series of meetings with Greifeld in New York, London, and Stockholm, the two hammered out a complex deal in which Nasdaq would buy OMX, Dubai would take a stake in Nasdaq, and Nasdaq would take a stake in the Dubai exchange, which would carry the Nasdaq brand. The terms were approved by U.S. regulators in December. “Nasdaq is coming to a market that is still virgin,” says Ba’alawy. “They will become an important catalyst for change.” A banker involved in the transaction says Dubai was willing to pay a stiff price for a move it considered strategic.

Ba’alawy’s team works late hours in the same new building as Al Ansari’s crew. One former staffer complains of a “chaotic” atmosphere and high turnover. “The priorities change constantly,” he says. “People find it very difficult.” Ba’alawy can be brusque, too. He recently barked at a new European recruit during a staff meeting for “needless playing with your BlackBerry to show how important you are.”

Westerners are still fairly rare at Gulf funds, some of which have existed since the 1950s. David Jackson, the 41-year-old American chief of Dubai’s Istithmar fund, has had a meteoric rise. With degrees from Princeton and Yale’s business school, Jackson had spent nine years at Lehman Brothers (LEH), most recently advising on buyout deals in Asia. In 2003 a friend who was advising Sultan Ahmed Bin Sulayem, one of Sheikh Mohammed’s closest advisers and chairman of Dubai World, asked Jackson to help him set up an investment fund, subsequently named Istithmar, or “investment” in Arabic, which launched a few months later.

At first Jackson was a one-man show. “It was difficult to get people to return my calls,” he says. Jackson made his buyout bones in 2006 when he acquired resort and casino operator Kerzner International for $3.9 billion alongside Goldman Sachs and other partners. Later that year he took a $1 billion stake in London-listed Standard Chartered Bank. Last June he bought a 3% stake in the $20 billion European hedge fund GLG Partners (GLG). And in September his fund bought retailer Barney’s, paying $942 million—after having been warned for 18 months that Barney’s owner, Jones Apparel Group (JNY), was interested only in bids for the whole conglomerate.

Now, Jackson says he’s keen on mortgage companies unfairly tarred by the subprime mess. He’s also eyeing stakes in private equity firms along the lines of Abu Dhabi’s $1.35 billion stake in Carlyle Group. And he’s weighing several co-investment deals with buyout firms.

Once Istithmar buys into a company, Jackson turns up the heat. In 2005, just months after the fund acquired a tiny 3% stake in Indian airline SpiceJet, the company installed a new CEO. “We needed people with more expertise,” says Jackson. SpiceJet has since quadrupled its revenues, to $327 million, and plans to nearly double again by 2010. (Istithmar increased its stake to 14.7% last year.) Jackson expects a lot from his own people as well. In one management meeting recently, about a dozen investment officers ran through an array of deals at various stages in industries ranging from live entertainment to finance. Twice, Jackson tossed a box of tissues to team members who confessed that their investments weren’t meeting expectations.

A bachelor who says he doesn’t even have time for a pet, Jackson spends 40% of his year on the road scouring for deals—sometimes brushing up against fellow Dubai fund managers. He rattles off his record against Al Ansari: “One time we won. Two times they won. One time neither of us won. I don’t think of them as any different from when I’m competing with Carlyle or TPG.”

Jackson encourages his team, which has swelled to 85, to think thematically rather than engage in the traditional “check-box investing” that other fund managers follow. “I don’t want to get into any rules,” says Jackson. The GLG Partners deal, for example, was a bet that mutual fund investors will migrate either to cheap index funds or expensive hedge funds. The Standard Chartered deal sought to gain exposure to many emerging markets at once.

As the credit crisis deepens, investment banks and private equity firms are stepping away from dealmaking to nurse their wounds. Gulf funds are eagerly filling the void. “Sovereign funds have been shown every interesting idea in the last quarter,” says Jeff Holzschuh, a Morgan Stanley banker who advised buyout firms on the TXU sale. “There is no question that they will change the deal world.” But there is a question as to whether the change will be for the better. “This is capital we need desperately,” says Felix Rohatyn, former Lazard Frères managing director and U.S. Ambassador to France. “But I don’t think we should have any illusions that these are totally benign investments.”