By Ashby Monk
This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the fifth installment of what is now a routine segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Rachel Ziemba of RGE Monitor. While Ms. Ziemba’s views are her own, her perspective helps to further debate and facilitate understanding.
Ashby Monk: Thanks for joining us today, Rachel. It’s clear from some of your writing over at RGE Monitor that you have taken a keen interest in SWFs. Why?
Rachel Ziemba: It’s wonderful to join you – For us at RGE Monitor, the management of sovereign wealth (investment funds, central bank reserves, state investment vehicles) epitomizes a very important macro and financial trend- the change in capital flows from developed to developing countries – a reversal from a decade ago – which has made many sovereign investors key actors in the global economy. Shortly after I joined RGE, my work with Brad Setser (now of CFR) tracking petrodollars, and later China’s reserves, plunged me into the study of the sovereign wealth universe. While sovereign funds are not new, the growth in their assets under management and evolution of investment strategies have given them a higher profile. Many take private sector models like endowments, pension funds and private equity, increasing their risks and adding exposure to commodities etc. In the last year, with some private actors on the sidelines, they took a major role in recapitalizing global banks. Some of the largest new flows now come from countries that are competitors to the U.S. and Europe – though the U.S. allies in the Gulf still account for some of the largest flows today after China – and these are countries with a large state role in the economy – has led to some unease from recipients. Furthermore, sovereign wealth fund investment exposes key issues of corporate governance, asset management strategy and economic policy at home and abroad.
The more we (collectively) learn about sovereign funds, the more they have to be assessed individually – and the more their asset allocation (in aggregate) resembles those of other institutional investors or alternative asset managers. Sovereign investors are one of many pools of capital seeking to increase risk to meet future liabilities, increasing exposure to equities, alternative asset classes, making more direct investments and commodities.
Ashby Monk: What’s your view of the IMF International Working Group on SWFs? Are you encouraged by the recent accord in Santiago?
Rachel Ziemba: Well the accord details haven’t been made public yet, so its hard to assess its impact. Its likely to be a relatively loose set of principles, perhaps an extension of those agreed upon by the US, Singapore and Abu Dhabi last fall, so the process itself may bear more fruit than the principles themselves. Hopefully this was an opportunity for sovereign funds to (in some cases) improve risk management. The fact that it took place amid wealth destruction in the global markets, in which sovereign funds were unlikely to have survived unscathed, probably added to the pressure to improve risk management. The IMF process is only one prong of a policy regime being pursued by recipients – the other involves national level responses. The other involves national level responses in which foreign investment, tax and other policies are being assessed.
We are in the midst of a crisis triggered in part by inadequate regulation and transparency, so more information about all actors is beneficial in my view – and I think many funds are discovering that a bit more transparency pays off. We may see a number of funds issuing annual reports in the next few months. The other major outcome has been the release of some aggregate data on sovereign funds collected from the 20-some members of the working group – for example how many invest in leveraged funds.
Ashby Monk: Much of the concern voiced about SWFs revolves around the issue of investment objectives-whether SWFs are investing to pursue commercial or strategic ends. As someone who knows a great deal about SWF investment targets, what’s your view on this debate?
Rachel Ziemba: In my view, sovereign wealth funds are commercial actors, pursuing commercial objectives. However the commercial objectives of say Abu Dhabi Inc or China Inc are different from a public company. In other words there is a fine line between commercial and strategic aims when a nation state is involved, particularly one that is not subject to democratic oversight. A strict financial return on an equity stake might be only one of the hoped for objectives – others might include jump starting a local sector, perhaps the sports or financial sector- meaning an investment in an exchange might be intended as a way of increasing market share, gaining expertise etc. The direct investments of government investment companies like Mubadala and the investment arms of Dubai World include investments in sectors prioritized for economic development at home, a fact that poses some conflict of interest worries. However, it probably makes them better partners for those that receive their funding. But many sovereign funds could face pressure to support the foreign investment of domestic companies abroad.
We can’t have it both ways – one part of being a commercial actor is that these funds will seek out good returns and they are unlikely to invest for good will alone. Sovereign investors flight from U.S. Agency bonds is a good example seen in July and August. We can’t expect foreign governments to keep on buying assets that might lead to a loss.
Furthermore, as ostensibly long term investors, these funds could be the ideal investors, not subject to redemptions, willing to take a long-view, increasingly seeking out partnerships. But on the other hand, the willingness of some to be passive investors may weaken the role of other stakeholders.
Ashby Monk: Are you worried about a protectionist trend emerging in response to SWFs?
Rachel Ziemba: I think we are already seeing a protectionist trend – and with the global economy slowing, such backlash against trade and investment flows would not surprise me. A few dozen countries are engaged in a reassessment of foreign investment regimes – the U.S. Canada, Australia and many European countries included. Many developing countries are also protectionist – having obstacles to investment and blocking off some sectors. Despite the sell off in Asian equities, everyone wants to invest more in Asia, given its growth rates – however, its not clear that Asian countries are ready to accept more net investment, particularly if it pushes prices up. Even Europe has been wary of the effect of inflows on the euro. However as I’ve argued, the costs of doing business in Germany are probably a greater determinant of investment than the obstacles.
More predictability from recipient countries- rather than having loose requirements that a takeover have net benefits for the country (as the Canadian law reads) that would be a positive outcome for all investors The U.S. has been lucky in that it has been able to have incredible power to set the terms in which foreigners invest – sovereign investors have needed to place funds as much as the U.S. needed to attract funds. And much of the petro-wealth remains in dollars. But that leverage (or co-dependency) is based on the size of the U.S. market and its ability to create financial assets to recycle the revenues of oil-exporting and Asian economies.
Ashby Monk: What, in your view, is the path towards SWF acceptance in the West? Investing through credible intermediaries? Partnerships with highly respected actors?
Rachel Ziemba: I think SWFs are becoming more familiar to many officials (and vice versa) and to a lesser extent the public (they were already familiar to some regulators and asset managers). This process has eased some concerns. The six or seven Congressional hearings are part of this process – as is a willingness to meet with officials. The countries with the newest and untested funds, like Russia and China have prompted the biggest concerns. And new funds Their sovereign funds have been proceeded by activist state owned enterprises – though my hunch is that Russia’s national wealth fund will not resemble Gazprom when it finally diversifies its assets away from the government bonds it now holds (a new investment strategy is due to emerge in the fall, though the freefall in the Russian equities may discourage funds from investing abroad). One clear way to get legitimacy is to be more transparent about risk management., overall strategy, becoming a more predictable actor and that comes with time and building up a track record. But that doesn’t mean that all funds need to or should resemble Norway. There are about three reasons that few worry about Norway’s investments 1) its purchases tend to be small 2) it discloses its holdings and asset allocation 3) it has domestic oversight, even though its risk management may have revealed some flaws in recent quarters (like private sector counterparts). While it may not seem fair, government actors are held to as high or higher standard, in part because they are political actors.
Partnerships are a key way to do so they can provide political cover, investment expertise and open doors. Such benefits don’t just accrue in the West, sovereign funds have been seeking out partnerships in developing countries too.
Ashby Monk: How have recent market events (collapse of Lehman and AIG) affected sovereign wealth funds and their role in the financial sector?
Rachel Ziemba: Since we’re talking in the midst of a heightening crisis emanating from the U.S. financial sector, many people are asking what role sovereign investors will play. Sovereign funds have been virtually absent from recapitalization of key financial institutions in recent months, being in wait and see mode-sovereign investors have been present-mainly in the form of central banks whose purchases provided a stream of capital to the U.S. Several reasons might explain their absence-Losses on equity and alternative assets, sufficient exposure to the global financial system and worries that this crisis is more protracted than many hoped. Furthermore despite being relatively cash rich, sovereign funds aren’t really equipped to take on management roles in foreign banks. And with contagion spreading to domestic markets, many governments may prefer to invest at home – though funds would probably be better spent on developing productive capacity than propping up domestic equity markets. Furthermore, a fall in the oil price does reduce the potential future resources available for investment. With $90 a barrel, less than half the revenues are saved by big oil exporters – and overtime the share will fall further unless the oil price reaccelerates. However the biggest implication is that the failures of these major institutions reveal how pervasive the weaknesses are in the financial system, how difficult it is to price assets and institutions and indicating how far we may be far from the bottom of this market, something that would make sovereign funds (and many non sovereign investors) reluctant to step in the water.
Ashby Monk: Fascinating stuff. Thanks, Rachel, for taking time out of your busy schedule to chat with us today.
eleased 
Miracky said that SWFs are actively avoiding a “PR problem or a regulatory backlash,” and that part of the evidence is “where and when they take controlling stakes.” In general, SWFs avoid taking controlling stakes in industries that would alarm OECD citizens. Also, the Monitor report concluded that recent heavy investments in financial services in the US and Europe were “atypical and opportunistic,” reflecting the 2007-8’s credit crunch.
Truman, who has 
