SOVEREIGN WEALTH FUNDS
Dickinson: Some SWFs are facing pressure to diversify their investments
Many of these countries have sought to manage their wealth by setting up investment funds, charged with not only preserving the fund’s initial capital but investing it for higher returns. These funds, which include government investment corporations and some central bank and government pension assets, as well as stabilization funds that put aside reserves or money earned from exports for a rainy day, are grouped together under the umbrella term sovereign wealth funds (SWFs).
Although SWFs have existed since the 1950s, as influential “power brokers” in the global economy their presence has only largely been felt in the past 18 months to two years. While other investors were bailing out of banks, in late 2007 and early 2008 sovereign wealth funds shored up their position in US and European financial institutions. Some of their more high-profile investments included Singapore-based Temasek Holdings’ $4.4 billion stake in US investment bank Merrill Lynch; Government of Singapore Investment Corporation’s £5.5 billion investment in ailing Swiss investment bank UBS and its $6.88 billion investment in Citi; Abu Dhabi Investment Authority’s $7.5 billion bailout of Citi; China Investment Corporation’s $3 billion stake in US private equity firm Blackstone Group and the $5 billion in convertible securities it bought in Morgan Stanley in late 2007; and Kuwait Investment Authority’s (KIA) investments in Citi and Merrill Lynch totaling $5 billion.
While the KIA, Temasek Holdings and the Abu Dhabi Investment Authority have existed since the 1960s and mid-1970s, Gerard Lyons, chief economist and group head of global research for Standard Chartered Bank, says seven of the 20 largest SWFs only emerged since 2000, and in recent years a number of smaller funds have also been established. Lyons estimates the combined size of SWFs to be in the region of $2.3 trillion, which, according to consultant McKinsey, constitutes approximately 1.3% of total global assets. Given an average growth rate of 19.8%, Standard Chartered predicts that SWFs could reach $13.4 trillion in a decade.
In the past 12 months, there have been marked shifts in sentiment toward SWFs. While some saw them as riding to the rescue of companies in financial distress, they were equally maligned by Western political leaders whose fears of funds, particularly those from Russia, the Middle East and China, reflected the West’s greater distress at its declining economic power. At Davos last year there were calls from Western leaders for greater transparency around SWFs’ investment strategies. While some funds are transparent, particularly those in Norway and Singapore, Chinese and Middle Eastern funds are more opaque.
Last year the International Monetary Fund published the Santiago Principles, which aim to ensure SWFs’ contribution to the global financial system is one of stability and to help newly established sovereign funds “develop, review or strengthen their organization, policies and investment practices.” Scott Dickinson, head of sovereign wealth at BNP Paribas Securities Services, says, “If anything comes out of the Santiago Principles, it will be a consistency of approach rather than each fund demonstrating enhanced transparency over what they do today.”
However, a lot has happened in global financial markets since the principles were published last October, and calls for SWFs to be more transparent have been silenced by the overarching need on the part of Western governments and banks to recapitalize their coffers. As SWFs are long-term investors, increasingly they are viewed as a much-needed source of liquidity. However, one threat these funds face in the coming months is increased political risk with US president Barack Obama and European leaders such as French president Nicolas Sarkozy making protectionist noises about foreign investment in so-called national champions.
Many believe that 2009 will see a major reversal in investment strategy by SWFs, particularly those that got their fingers burned by piling into Western banks. According to Monitor Group’s SWF survey, sovereign wealth fund investment in financial services declined from $43 billion in the first quarter of 2008 to $4 billion in the second and third quarters. SWF investment in real estate also declined from $13.7 billion in the second quarter of 2008 to $3.2 billion in the third.
Like many investors, the SWFs are retreating into cash as equity markets worldwide continue to struggle. “China Investment Corporation [CIC] made some aggressive initial investments which have not given it the sort of returns they were looking for and have incurred some significant paper losses,” notes Dickinson. He says the CIC has since announced its shift away from equities into cash. This, according to Dickinson, goes against its original investment objective of enhancing returns.
Dickinson says some of the larger and more experienced SWFs have diversified into alternatives such as private equity and hedge funds. “They are not normally viewed as risky investors,” he points out, “but having fulfilled most of their actual or perceived liabilities, they are prepared to take on some additional risk.”
Analysts also predict that 2009 will see more SWF money flowing into emerging markets. “Sovereign wealth funds in my view will start to invest more in the nascent equity markets around the emerging world,” Lyons of Standard Chartered stated at a roundtable event last year. According to Monitor Group, SWF investment in OECD countries declined from $37 billion in the first quarter of last year to $8 billion in the third quarter. Meanwhile investment in emerging markets accounted for 54% of second- and third-quarter deals by value, the highest share of total deal value since 2005.
This year “is going to be an emerging market, local story,” says Drosten Fisher of Monitor Group, pointing out that investment flows between the Middle East and Asia stood at a remarkable $14 billion in the second and third quarters of 2008. Monitor Group also noted a shift toward local or domestic investment, which accounted for 46% of reported deals in the third quarter 2008, the highest percentage since 2003.
“Domestic pressures and actors have become more important in decision making,” notes Fisher, pointing toward local pressure on funds such as the KIA and the Abu Dhabi Investment Authority to invest in local capital markets. Dickinson of BNP Paribas believes that those SWFs that derived their wealth from trade-driven surpluses will be increasingly drawn into a national debate centered on the question of what amount of reserves should be allocated toward maintaining market stability. “There is a lot of talk for some of these resources to be diverted toward infrastructure projects to improve quality of life,” he says.
For those SWFs that rapidly accumulated wealth on the back of high oil prices, wealth accumulation in 2009 is also likely to be slower as oil prices continue to slide. “Until the oil price recovers back to $50 a barrel, we are unlikely to see the same sort of growth from excess returns on oil,” says Dickinson.
KEY SWF DEALS
A number of SWFs have acquired significant stakes in foreign financial companies. Some of the more notable deals include:
China Investment Corporation – CIC invested $3 billion to acquire almost 10% of the initial public stock offering of US investment fund Blackstone Group. It later raised its stake in Blackstone to more than 12%. It also has a 9.9% stake in Morgan Stanley.
Kuwait Investment Authority – In January 2008 KIA invested $5 billion in US banks Citi and Merrill Lynch.
Temasek Holdings (Singapore) – In July 2007 Temasek invested $2 billion in UK bank Barclays. It planned to invest a further $3 billion upon completion of Barclays’ proposed merger with ABN AMRO, but that merger never went ahead. Temasek also holds a more than 17% stake in Standard Chartered Bank.
Qatar Investment Authority – QIA holds a more than 20% stake in the London Stock Exchange Group and bought a 9.98% stake in Nordic Exchange OMX (Sweden), which it later sold. In July 2008 Qatar investors also bought an 8% stake in Barclays Bank.
Istithmar (Dubai/UAE) – Istithmar invested $1.2 billion US dollars in Standard Chartered Bank. It also has a 3% stake in hedge fund GLG.
Dubai International Capital – DIC purchased “substantial stakes” in HSBC Holdings (May 2007) and in Indian bank ICICI Bank (July 2007).
Sources include Thomson Financial and Standard Chartered Global Research, October 2007