Ashby Monk
I’ve had the following question nagging at me for almost year now: If a sovereign wealth fund is financed by something other than sovereign wealth, should we still think of it as a sovereign wealth fund?
My interest in this topic stems from the fact that a growing number of SWFs are looking to the private sector for capital. And I’m not just talking about Mubadala or Mumtalakat – there are a bunch of SWFs that are going this route:
- I noted yesterday that Temasek was exploring ways to bring private investors into their operations through its new SeaTown venture.
- The GIC is also considering a $2 billion IPO of GIC Real Estate.
- Qatari Diar – a subsidiary of the Qatar Investment Authority – is looking to issue $3.5 billion in debt.
- Central Huijin, a subsidiary of the China Investment Corporation, is about to launch a big debt offering.
- And, finally, news came out this morning that Kazakhstan’s Samruk-Kazyna is looking to issue debt in the short term and potentially take the SWF public through an IPO in the long-run.
Clearly, raising cash from the private sector is increasingly popular among SWFs. So, back to my original question, should we still view these entities as SWFs if they are managing private money? I’m not so sure, and here’s why:
1) Liabilities: Back in 2007-08, those of us that were researching SWFs expended considerable effort trying to define the term ‘sovereign wealth fund‘. In addition, the SWFs themselves made an attempt at defining which funds were and were not within their community. In short, the common thread among SWFs was their liability profile — or rather their lack thereof — they have no liabilities (at least beyond the sponsoring government). In other words, if a SWF owes money to anybody, it owes it back to the government that set it up. Why is this important? Well, if a SWF issues debt to the private sector, its liability profile now includes non-governmental creditors.
2) Investment strategy. The liability profile of SWFs affords them a strategic advantage, as they have perhaps the longest time horizon among all institutional investors (although it is debatable whether all governments actually afford their SWFs this duration in practice). Now, if a SWF is taking in private money, then the investment strategy of the fund is going to have to shift, albeit slightly, towards investments that pay-off in a time-frame that meets private sector interests.
As such, the core characteristics of these funds are altered by accepting to manage private capital. This raises the question as to why they would want to do this. Again, I have some thoughts:
1) Cash poor. Undoubtedly, the rise in SWFs’ interest in private money is due to the fact that some SWFs found themselves over-committed during the financial crisis. In short, salvaging certain projects necessitated a turn to the private sector for additional financing.
2) Risk Seeking. Some SWFs have sought to use their solid credit rating – which they garnered on the back of their state sponsor’s rating – to issue cheap debt and then invest it in the market in riskier assets that generate higher returns. The economic principles that underpin this type of strategy are similar to those that underpin pension obligation bonds (POBs) in the United States. In my view, it’s overly risky behavior for governments.
3) International Legitimacy. If a SWF can attract private investors, then it is demonstrating to the world that it is purely commercial and financially oriented (because that’s all private investors care about). In turn, investment receiving countries will perceive them as non-threatening, which means that access to their markets will be assured.
4) Domestic Legitimacy. The big losses incurred by SWFs during the financial crisis caused plenty of problems at home for certain SWFs. One way to avoid this domestic criticism is to illustrate that private sector investors made similar investments, i.e. the SWF’s investment strategy is blessed by the private sector, which carries weight with domestic audiences.
5) A Myth. This final point is an acknowledgement on my part that many governments demand their SWFs make returns over short- to medium-term time horizons. Indeed, despite all the theory about SWFs being the longest-term investors in the world, I routinely find myself looking at counter examples that show how, in practice, these funds take the short-term view. As such, it is reasonable to say that some funds may not be giving up much by bringing private investors into their pool of capital.
In sum, I think we need to rethink the W in SWF. The evidence suggests that, over time, this may grow to include private as well as public capital.
