Foreign Policy has just published a short article by Veljko Fotak and Bill Megginson in which the authors describe and explain the severity of the losses suffered by SWFs. As they note:
“…sovereign wealth funds lost a staggering $66.88 billion on their publicly disclosed investments and experienced a total return of negative 53.23 percent from the date the investments were made through March 27, 2009.”
The authors see more than just poor investment decisions at work:
“It’s not simply the managers’ fault. These are, after all, state-owned investment funds. As our data suggest, poor stock picking could have been the result of pressures that forced managers to invest in distressed industries and firms for political reasons.”
Referring to their data (in the recent Monitor report they contributed to), I also saw evidence for political influence over SWFs. If true, this would surely exaggerate the losses made by these SWFs.
I think it’s an interesting story…but I was actually surprised to see it in Foreign Policy, which is a magazine (and website) I read regularly. I think of FP as a provocateur, publishing articles that force the reader to reconsider firmly held beliefs and challenge conventional points of view. While this SWF article is interesting, it confirms what many in the west already hold to be a truth: SWFs are inherently political and this politicization creates inefficiencies (e.g. losses).
This got me thinking as to how I might write a short article on politicized SWF investment that was challenging and provocative. After a solid 30 seconds of reflection, I decided I would have written an article about how political influence can lead to SWF investment outperformance. And I think I’d have some evidence to back it up.
I’m thinking of a large SWF. This SWF has two distinct sides to its operations. On the one hand, it has its global investment activities, which represent its commercial investment operations. On the other hand, it has its domestic operations, which represent its investments in domestic and state-owned firms. In order to dampen western anxieties about political investing, this SWF keeps a strict “firewall” between the two sides of the fund. I’m of course referring to the China Investment Corporation:
“CIC maintains a strict operational firewall between its global investment activities and those of Central Huijin, which represents the State’s interest in domestic, state-owned financial institutions.”
In short, Central Huijin, a wholly owned CIC subsidiary, was set up to invest exclusively in domestic state-owned financial institutions on behalf of the state to enhance the value of state-owned financial assets and improve the governance of SOEs. While the objective over the long-term may be to make money, there are clear and obvious political undercurrents.
According to the conventional logic (highlighted in the FP article), the ‘commercial’ side of the CIC should have outperformed the ‘political’ side. So what happened? According to the CIC’s first annual report, the CIC’s global portfolio returned -2.1%. This is actually pretty darn good considering the massive declines in global stock markets (S&P 500 was down roughly 40% for the year). However, as Lou Jiwei notes in the report:
“Combined with Central Huijin’s excellent performance, CIC provided its shareholder with an overall return on registered capital of 6.8%.”
In other words, Central Huijin had an amazing year. Indeed, looking back to page 47 of the annual report, we see that the CIC is no longer a “$200 billion SWF,” it is a “$298 billion SWF.” This sudden growth is due to the domestic, politicized portfolio managed by Central Huijin.
If the FP wants provocation, here it is: The arm of the CIC representing the State’s interests outperformed the commercial arm in 2008. The very idea goes against conventional theories of governance and financial performance. Now I’m sure there are numerous points that are debatable about the above. We could also spend another 1000 words speculating as to why Huijin did so well. But that’s beside the point; this post was simply an attempt to get you thinking about these issues in a new way.