The Design and Governance of Sovereign Wealth Funds
I’m taking off until January 4th. For those of you that are looking for something to read during the break, you’re in luck!
Rolando Avendano and Javier Santiso of the OECD just released a paper entitled, “Are Sovereign Wealth Funds’ Investments Politically Biased? A Comparison with Mutual Funds.” It’s a good paper; the authors show that they’ re not.
Also, you can review my top five SWF stories to remember from this year.
Thanks for reading in 2009 and we’ll see you in 2010!
2009 was a big year for SWFs. After shaking off the international political woes of 2007 and navigating a disastrous market in 2008, 2009 was a year for SWF growth, broadly defined. I actually managed to write almost 200 blog posts this year. With this in mind, I decided to go back through my archive and give you my ‘top five SWF stories to remember’ from 2009:
5) Cheaters: I’ve now come to accept that there are two communities of people who can cheat markets by taking advantage of SWFs. The first is front-runners. The second is the SWF sponsors. I admit that this wasn’t a huge story in 2009. But I think the anecdotal evidence from this year may foreshadow problems for the future. So, it’s in my top five stories to remember because I think it will be a topic we come back to in 2010 (…though I hope not…).
4) Santiago Principles: I’ve had many people tell me that the GAPP / Santiago Principles are too weak to do any good. I disagree. I think they were an important milestone in legitimizing these funds internationally. Put simply, this was a community building process that facilitated understanding, education and advocacy. This was desperately needed. (I should note that the GAPP actually came out in 2008; so I’m referring more to the ongoing international process, which is being taken forward by the new International Forum.)
3) SWF Cooperation: SWFs are increasingly making joint strategic investments, or coming together in joint funds, in order to better manage investment risks and maximize returns. This is a good thing.
2) New SWFs: For those that thought the global financial crisis would mark the end of SWFs, think again. 2009 was a banner year for these government owned special purpose vehicles. From Greenland to Angola to Papua New Guinea, I managed to count 14 funds at various stages of consideration or creation. Clearly, SWFs have never been more popular than they are now.
1) The CIC: After dropping the ball in 2007 and riding out 2008 in the penalty box, 2009 was the year of the China Investment Corporation. By some accounts, it spent $50 billion internationally this year. As I said recently, it was singing in the rain. Also, it is remarkable how many of my blog posts this year touched on this fund; it simply dominated my coverage.
Honorable Mentions: I thought about including the widespread restructurings that took place in 2009. From Alaska to Singapore, SWFs were re-evaluating their internal procedures; I thought that was a pretty big deal. I also nearly went for the Dubai World fiasco, but decided to leave it. It seems too early to know what the implications are from this fund’s woes.
Jamil Anderlini of the FT reports that the CIC will receive an injection of up to $200 billion in the coming months. This is confirmation of a development initially reported here in early November. While it’s gratifying to be right, I don’t want to give the impression of being too prescient; I just have reliable sources.
In any case, the CIC is looking very strong at the moment. I’ve already talked about how the GFC has played into its favor, clearing away many of the fund’s initial problems. Even still, the CIC is about to become a half a trillion dollar investment fund. To put this in perspective, with this capital injection, the CIC will be around $50 billion larger than Norway’s GPF-G. The latter is the largest stock owner in Europe and owns about 1 percent of global equities. So, the CIC is on its way to being a very significant player in global financial markets.
With this in mind, the CIC leadership has worked hard to contain geopolitical concerns associated with the fund’s dramatic rise. For example, Gao Xiqing recently made a point of saying that the CIC was not a strategic investor (even though the fund has been raising eyebrows with its recent wave of resource and energy investments).
The question I have is whether a half a trillion dollar investment vehicle sponsored by a communist country with a mandate to invest in global private markets will reignite protectionist fears. I don’t know the answer to that. But I can see how the words of the late, great Christopher George Latore Wallace might apply here: “…the more money we come across. The more problems we see.”
Daniel Drezner has a new article entitled, “Bad Debts: Assessing China’s Financial Influence in Great Power Politics.” It’s an interesting piece of scholarship, as it “appraises the ability of creditor states to convert their financial power into political power, drawing from the existing literature on economic statecraft.”
Spoiler alert: He finds that most of the financial threats are overblown, and there is more to geopolitics than financial influence.
It’s a good read; get it here.
Not too much attention has been paid to the National Social Security Fund (NSSF), especially when compared to the China Investment Corporation. The reason for this is simple: the fund was only permitted to invest 7 percent of its total assets in foreign markets. However, this is apparently changing, as the fund will increase its international portfolio to 20%. By allowing more investment overseas, the government is hoping to ease pressure on the Yuan.
It also makes sense from a portfolio management perspective: according to Zhang Haochuan of Z-Ben Advisors:
“NSSF’s investment now is concentrated in the domestic market…But China’s capital market is only about 10 percent of the global market, so investing up to 20 percent of assets in places like the U.S. and Europe is not too much.”
The fund currently has about $100 billion in assets and plans to have around $150 billion by October of next year. So, the NSSF will soon have a foreign portfolio in the $20-30 billion range, which is nothing to sneeze at! Moreover, the fund will be expanding its alternative allocations, which means this announcement should have implications for lots of different types of asset managers.
At the very least, I imagine we’re going to start hearing a lot more about the NSSF…
1Malaysia Development Fund Bhd (1MDB) appears to be ramping up its activities. According to Anita Gabriel, who has an interesting article in The Star, the fund has already allocated roughly $1 billion and has tentative plans to work with “two other giant foreign entities from China and Abu Dhabi.” (…I think I can guess what entities she might be talking about…)
It’s interesting to see this fund moving forward, as things got a bit confusing earlier in the year when the federal government decided to take over what was originally a state-sponsored SWF. (Anybody remember the short-lived Terengganu Investment Authority?) Anyway, the transition is apparently over, and things are taking shape.
In fact, Gabriel has put together a very interesting graphic that depicts the new fund’s mandate. It’s worth studying.
Natsuko Waki has a nice article in Forbes this morning. She looks at how some SWFs are still shy about strategic investing after the global financial crisis, while others (i.e. the CIC) have had their problems swept away by the GFC and are now operating at full throttle (see here for more details). What I found interesting about the article was a quote she managed to get from an advisor to Asian SWFs:
“In practice, the notion that SWFs are more patient than private investors does not really hold water. SWFs often face the same horizon as other market players, and are subject to the same exigencies — they need to maximise return for their shareholders…and governments can be even less patient than private investors. SWFs pursue industrial goals of the government that can be quite pressing. They are operating under very tight schedules.”
This is quite a different description of SWF investment behavior than we are used to seeing. This seems to suggest that SWFs have a clear and well-articulated short-term mandate. While the responsibility is to the government, it is supposedly driving investment behavior in the same way as an external liability would do for a private investor.
It’s an interesting point, but I’m not sure it holds water outside of a crisis environment. To be sure, SWFs around the world have been called on by their sponsors to bail-out industries, but that’s what these funds are there for (e.g. self-insurance). Moreover, to say that governments are even less patient than private investors is hard to swallow, especially when the economy is doing well.
SWFs are apparently interested in doing their part for a cleaner, more sustainable world. The China Daily reports that China has entered into a cooperative arrangement with the Kazakstan’s sovereign wealth fund, Samruk Kazyna, on a wind-power cooperation program, which will be followed by some cooperative projects in the field of renewable energy. The announcement of the deal is well-timed: coming during the COP15 negotiations, it will build on some of the other environmental work SWFs are doing.
I’ve argued that SWFs should be getting involved in clean-tech and renewables, which offer commodity sourced SWFs, such as the Kazakh fund, a good hedge against technological advances that might reduce our dependence on hydrocarbons (and cut off their funding). Moreover, since Kazakhstan apparently has money to burn on projects that have no financial objectives, why not burn it on things that have social and environmental benefits (which is better than having it siphoned off due to corruption)?
I waxed poetic last week about how the rise of SWFs may end up ameliorating international relations through new cooperative arrangements between countries. This latest announcement is yet another example of how a long-term institution with deep pockets can be a positive influence in an increasingly globalized world. Do SWFs represent ‘a new hope‘?
This weekend’s homework assignment is short, but I think it’s worth doing. As seems to happen often, The Economist has its finger on the pulse:
“The banking crisis was a baptism of fire. Most SWFs are still keen on strategic investments but only in healthy firms where there is a clearer national interest.”
Have a nice weekend.
When I look back over my original grant application to study SWFs, I’m struck by the fact that, in late 2006, I was preoccupied by the potential negatives that a rise of SWFs could engender for the global political-economy. That’s not to say the application didn’t mention any potential positives, it did, but it was contrived to highlight possible geopolitical tensions. I hadn’t given much thought to the idea that SWFs could become mechanisms to facilitate inter-state cooperation or augment international relations.
However, as the perception of a ‘SWF threat’ dissipates in the West, I’m starting to consider a more euphoric interpretation of the rise of SWFs; one that focuses on the new opportunities these institutions offer countries to work together. For example, what will inter-state SWF cooperation on investment projects do for inter-state relations? Also, if disparate countries are linked together in a supra-national SWF, will this give the countries involved a common sense of purpose and an incentive to be civil (and peaceful)? At the very least, it would provide countries with a desire to keep markets stable, lest they lose the capital they put in the fund.
Anyway, this notion crystallized for me this morning after seeing a spate of announcements on the topic of SWF cooperation. First, the Future Fund is working with the Canada Pension Plan on a huge infrastructure deal. Also, Korea has signaled its willingness to enter into joint projects with other SWFs, specifically citing the CIC (which for its part has already raised the notion of a supra-national SWF). Finally, Mercosur announced that the countries of Argentina, Brazil, Paraguay and Uruguay are considering setting up a supra-SWF so as to ensure that a weakening dollar does not destabilize markets. (More here, here, and here).
Provided we get the governance right in these arrangements, the above, it seems to me, is an indication of the good that may come from this new institution. So maybe it’s time to start thinking about the positive effects SWF cooperation can have on international relations, rather than rehearsing the arguments about SWFs as threats. Just a thought…
