Sovereign Wealth Funds on the Global Stage
Sovereign wealth funds (SWFs) are essentially the assets of a given nation managed for preservation and accumulation of wealth for the benefit of current and future generations. Each government determines the purpose and use of its funds, whether for current public works or future needs of its citizens or employees.
SWF assets are segregated from other government funds for the purpose of long-term investing. As long-term investors, SWFs have investment portfolios with allocations to alternative investments, such as private equity and real estate – where a return on investment may take several years to come to fruition – or strategies with more volatile short-term returns.
While SWFs have been active for more than 50 years, today’s market context has given SWFs high visibility. Reasons for this include:
The largest SWFs in the world today, which are those with more than US$200bn or more in assets, are from the United Arab Emirates (UAE), Saudi Arabia, Singapore, China, Norway, Kuwait and Russia. Of the 49 SWF funds followed by the Sovereign Wealth Fund Institute, the top 10 have US$3.2 trillion (81%) of the global assets under management.
New sovereign funds generated by foreign currency reserves are likely to be on the horizon for Brazil, India, Japan and Thailand.
SWFs may have in-house investment staff, but many frequently use third-party asset managers – referred to as sub-advisory relationships – in the management of their portfolio. Traditionally, most SWFs have been fairly conservative, investing in equities and fixed income products in developed markets. Over the last several years, SWFs have made, or increased, portfolio allocations to alternative investments, such as private equity, real estate and hedge funds, as well as put greater investment in emerging markets.
Given the large sums of money available to invest, the only prudent course of action is to diversify investments outside of the domestic economy. Generally, the countries from which SWFs originate do not have large domestic markets to absorb their asset levels. Many SWFs invested heavily in the US financial market only to find themselves now running for cover from US financial institutions. For example, Tamesek reported a loss of 31% of its value in the eight months through to 30 November 2008.
Table 1 lists some of the high-profile investments by SWFs over the last year. At this point, SWFs are looking for investments outside of the US and more than likely to regions closer to home such as Asia. Many of these regions are growing markets with less negative impact from the global credit crisis.
Investments are also occurring in reverse, where developed market participants are investing in the Middle East and Asia. For example, US firms are partnering with SWFs and developing market companies for new business ventures in these regions.
Market participants, legislatures, regulators and SWFs will continue to discuss the role of SWFs in the marketplace, a new-found attention and a more visible role in the capital markets due to their sheer size assure this development. Table 2 describes the perceived advantages and disadvantages of SWFs in the market:
In October 2008, the International Working Group of Sovereign Wealth Funds (IWG)1 published 24 principles called The Generally Accepted Principles and Practices for Sovereign Wealth Funds (GAPP) – a voluntary framework to guide the appropriate governance, accountability arrangements and the conduct of appropriate investment practices by SWFs.
The group’s four-month effort included goals such as a common set of voluntary principles established from existing frameworks to encourage the free flow of cross-border investment and open and stable financial systems. Over the next several weeks, IWG members are recommending GAPP to their respective governments and monitoring agencies for adoption. A finalised document will be made public later this year.
The IWG has also proposed that a standing group of SWFs be formed to continue the effort and facilitate dialogue between SWFs and the marketplace. Some SWFs bristle at the idea of responding to transparency calls. They believe that an investment portfolio is a private matter and any accountability is owed to constituents at home, not abroad. While this is generally true, the size and potential influence of SWFs in the capital markets will likely require a compromise of some sort.
SWFs have taken a hit along with the rest of the investing community. However, over the long term their portfolios will rebound and SWFs will continue to be a force in the market. SWFs are a positive factor in the capital markets providing much needed capital.
For many years, the western world has spoken of greater participation in capital endeavours and advancing the developing economies of the Far East and the Middle East. SWFs represent the free movement of capital with developing nations putting their assets to work to improve their financial position, enhance the lives of their citizens and participate further in a global economy.
Certainly, it is a government’s job to do its best to create orderly markets, protect national interests and assure the safety of its citizens. In numerous instances, there is existing regulation pertaining to all investors, for example foreign direct investment regulation, filings required for ownership stakes as a percentage of outstanding, etc, that protects these interests. A potential course of action may well be about validating the processes in place and following those regulations. All too often in the US, domestic scandals have demonstrated ineffective law enforcement.
Again, governments must balance national security and national self-interest with the free flow of capital in order to further global growth and prosperity. Domestic economies often depend upon cash inflows from a variety of sources. Legislation leading to protectionism cuts off these inflows, reduces global partnership opportunities, minimises innovation, and shuts an economy out of the evolutionary changes required for progress.
The prognosis is that a good number of SWFs will likely acknowledge the IWG’s GAPP, or issue their own set of principles in an attempt to assuage market concerns. In a world opening to communication and commerce, the reality for SWFs is that doing so is in their best interest.
1Member countries include Australia, Azerbaijan, Bahrain, Botswana, Canada, Chile, China, Equatorial Guinea, Iran, Ireland, South Korea, Kuwait, Libya, Mexico, New Zealand, Norway, Qatar, Russia, Singapore, East Timor, Trinidad and Tobago, the UAE, and the US. Saudi Arabia, Oman, Vietnam, the Organisation for Economic Co-operation and Development (OECD) and the World Bank participate as permanent observers. Co-chairs of the working group are a senior representative of the Abu Dhabi Investment Authority, and the director of the International Monetary Fund’s (IMF) Monetary and Capital Markets Department, both of whom were selected by participating SWFs. The IMF provides a group facilitator.