Ashby Monk
I just came across a provocative paper by Patrick J. Keenan and Christiana Ochoa entitled, “The Human Rights Potential of Sovereign Wealth Funds.” The paper is, in large part, a critique of World Bank policy. Specifically, it focuses on Zoellick’s plan to funnel 1 percent of global SWF assets into Africa through the International Finance Corporation and the Sovereign Funds Initiative.
In my view, the Sovereign Funds Initiative has merit. For starters, it will seek to generate 15 percent net internal rate of return, which means that profit seeking SWFs will be very interested (especially since African investments offer portfolio investors important diversification, as returns are typically uncorrelated with global returns). In fact, average internal rate of return on IFC’s investments over the last 20 years has exceeded 20 percent, so the above may be a conservative estimate. Moreover, the over-arching goal of the Initiative is to connect long-term commercial capital from state-owned investors with the substantial investment needs of private companies in developing countries. This is something I can get behind.
Still, Keenan and Ochoa have some concerns:
“Zoellick’s proposal and the nascent Sovereign Funds Initiative have the potential to provide real benefits to poor people in Africa if structured appropriately, but must first resolve an important and difficult problem: additional wealth can reduce welfare…African states have received influxes of wealth many times before, but this wealth has not produced meaningful economic development or improved the lives of ordinary people.”
In short, these authors worry that “unconditional” investments—like those made by Chinese entities in Africa—will destroy local welfare even if it results in some wealth creation. So, they want the Bank to set some conditions on investments made by the IFC.
I am sympathetic to these authors’ position: there is no point investing in an environment that has poor governance. The money will simply be wasted. But I have trouble understanding how the IFC Asset Management Company, which will be the steward for the Sovereign Fund Initiative, is all that different from what these authors are proposing? You simply can’t make a 20% CAGR by investing in poorly governed companies.
Nonetheless, the authors of the paper are calling for a venture capital type arrangement in which the funds are invested strategically, which is a way of saying that the investor takes direct stakes in specific companies and then engages with the companies to improve corporate governance (and profitability). The investment professionals will seek out firms and enterprises that have good governance—or are willing to make some changes to achieve good governance—so as to ensure that the fund generates wealth and welfare. In this sense, the fund will reward the firms that show promise and avoid those that don’t.
So long as the “conditions” don’t become politicized (and remain focused on creating an environment ripe for investment), I tend to agree with the above (who wouldn’t?). I used to be a consultant for a large US pension fund that wanted to expand its investments into emerging markets. In order to help the pension understand certain countries’ suitability for investment, I personally traveled to Asia and Africa to evaluate local governance (corporate and government) standards. I saw how important receiving investment from this pension fund was to these countries; they desperately wanted to create an investment climate that met this pension fund’s internal requirements (i.e. “conditions”). It was almost a matter of pride. What I found most interesting was to watch the governance ratings of these countries improve year-over-year, as they “shaped up” so as to tap into the pension’s capital.
So, when investors set these types of governance standards and conditions, they do, in my anecdotal experience, have an effect (both on firms and governments). After all, these investors are creating a powerful incentive for change. That said, I still don’t really see how the IFC Asset Management Company is altogether different from what the authors are proposing. I can’t imagine that any commercially driven investor would kick off an African investment program (or any investment program) without some sort of internal policy dictating the “conditions” for investment, be it governance, industry, performance, or anything else. This is especially true for an investor that has had such a positive track record of making returns in developing countries…
Anyway, the paper can be downloaded here.
