How Sovereign Wealth Fund Investment Patterns Are Changing
Victoria Barbary and William Megginson
Sovereign Wealth Funds don’t operate in a vacuum. Much like for other institutional investors, the first part of 2009 has been a time of reflection, reorganisation and realignment for SWFs. The assumptions about risk, economic growth, international trade and globalisation that underpinned investment strategies in 2007 and 2008 have either had to be disposed of unceremoniously (although some funds may have made a ceremonial bonfire of their original 2009 strategy document) or fundamentally rethought. In both cases, SWFs have not only had to think about how the financial crisis has affected their balance sheets, but also about how it will change the way in which they invest and what they are aiming to achieve.
Before 2008, the Monitor-FEEM SWF Transaction Database revealed three relatively clear-cut types of SWFs, although crossovers obviously existed. These were:
- Endowment-type funds (e.g. ADIA, KIA, GIC) that invested in equities and property globally, with a low-medium risk profile with a 10-15 percent cushion of liquid assets;
- Private-equity-style funds (e.g. Istithmar, DIFC Investments) which had deliberately high-risk, relatively illiquid portfolios, used leverage and derivatives extensively, and sought prestige investments in developed markets; and
- Development funds (e.g. Mubadala, Temasek, Khazanah) that concentrated on investing locally for the benefit of the domestic economy.
The credit crunch and financial crisis have blown these categorisations out of the water. KIA and QIA were forced to invest at home to protect their own banking sectors; Dubai’s private-equity-style funds have withdrawn from the acquisitions playing field; and Temasek invested in Barclays and Merrill Lynch.
So what now? After a very quiet first half of 2009, SWFs have been more active since July. As we see it, three trends are emerging in their investment patterns, but it is still too early to assess whether these are short-term reactions to challenging economic conditions or a deeper-seated reassessment of the motives and objectives of SWFs as investors.
1. SWFs still remain global investors, but recent transactions suggest that acquisitions will be smaller and more diverse. Diversifying portfolios spreads risks across asset classes, geographies and sectors, creating a lower risk profile with a greater hedge. Anecdotally, there have been suggestions that SWFs have been investing on the commodity markets, looking for assets that are negatively correlated with their equity investments. Allocating resources to hedge funds, like CIC has done, is another form of diversification that may be more widespread amongst SWFs than is publicly evident, while real estate investment in particular markets (notably London) are also appearing to be attractive targets once more.
2. SWF strategies may become more closely aligned with national interests. This has been most obvious in CIC’s drive towards investing in companies that produce or supply commodities and natural resources, which dovetails with acquisitions made by Chinese SOEs and the raw material and power requirements of their fiscal stimulus. Korea has also been open in its ambitions to use KIC to purchase energy assets. This trend may also reflect the international ambitions of funds’ sovereign government owners to play a greater role on the global political stage, which is particularly pertinent as the G8 is superseded by the G20. Will Abu Dhabi be viewed more favourably and taken more seriously in Germany because IPIC owns stakes in MAN Ferrostaal and Daimler?
3. SWFs may develop more proactive investment strategies. Traditionally, SWFs have been established either to convert non-renewable assets into a more diversified portfolio, or increase returns on foreign reserve holdings. These objectives have been pursued in a number of ways, exemplified by the type of funds we identified prior to 2008. In 2009, however, we are increasingly seeing all types of funds investing strategically abroad for long-term benefits. This may reflect a shift in opinion: the business of investing sovereign wealth is not simply about generating higher returns to provide for the needs of future generations, but ensuring that those future generations have a stronger, more advanced economy and a better standard of living. Abu Dhabi is the most obvious example of this. ADIA has been quiet over recent months, only making a couple of small publicly-reported investments; by contrast IPIC and Mubadala have been more active in pursuing investments in sectors targeted in the emirate’s economic plan “Vision 2030”. As such, SWF investment is used to develop and diversify the domestic economy through knowledge and technology transfer.
Whether this is a sea change in sovereign wealth investing, or a temporary shift in a long game is unclear. Ultimately, it may result in the eclipse of the (typically older) traditional endowment-type SWFs for leaner, more proactive investment vehicles that seek to invest to fulfil certain economic and political objectives, while achieving higher returns. This is not to say that SWFs threaten the sovereignty of any state in which they invest; it is not in their interest to do so, but maximising their returns on financial, economic and social levels? You betcha!
I think that dual-utility (investment plus political) arguments for CIC’s investing aren’t yet as persuasive as they might be. Chinese private fund managers investing abroad (as well as those public QDII funds which are not tightly geographically constrained by their prospectuses) have also been loading up on materials and resources firms that operate in the Pacific Rim. Given that neither of those categories of manager has any obvious political utility, a simpler explanation might be that they, like CIC, are attempting to exploit a perceived information advantage: well-grounded beliefs that China really is going to keep growing at the current pace (or faster) and that infrastructure investment is going to remain a higher priority for longer than most Western analysts believe. When CIC invests in ways that differ markedly from private Chinese fund managers (more correctly, in ways that both differ and aren’t clearly a consequence of size constraints), arguments for political utility might carry more weight.