In our preview of the January 2020 print edition, we look into how sovereign wealth funds could benefit the wider investment community
by Dominic Dudley
The world’s biggest rainy-day fund, Norway’s Government Pension Fund Global, holds US$1.1tn in assets, or around 1.4% of all listed companies globally. Halfway around the world, the Bhutan Economic Stabilization Fund has assets of just US$1.5m – no more than a rounding error for the Norwegians.
The two funds have little in common other than being sovereign wealth funds (SWFs) – state-owned investment vehicles that are a growing presence in capital markets. It is a diverse sector, and not just in terms of the size of individual funds – their aims, initial sources of funding and what they invest in can all vary widely. But one thing that seems unarguable is the collective impact of SWFs on the investment sector globally. According to one estimate by research firm Preqin, SWFs are now comparable in scale to the entire alternative assets sector.
“SWFs are an ever-increasing influence on the global economy, with growth in terms of numbers, size and investment sophistication,” says Tarek Shoukri, global director for private equity and sovereign funds at PwC.
The growth of SWFs
Some SWFs are set up to save money for future generations, others are designed to protect a country from volatility, others to assist with economic diversification. Whatever the motivation, governments are hopping on the bandwagon. The Official Monetary and Financial Institutions Forum (OMFIF) estimates there are 85–90 SWFs with assets of around US$8.6tn – a figure which grew by US$632bn between 2018 and 2019.
The oldest examples date back to the mid-19th century; one was the Texas Permanent School Fund, created by the state legislature for the benefit of public schools. Among the newest is the New South Wales (NSW) Generations Fund, launched in 2018.
More are set to join their ranks, as governments recognise the benefit of developing a rainy-day fund for the future. In all, more than 50 countries have at least one SWF, with governments often attracted to them because of their flexibility.
“A lot of countries are setting up sovereign funds to take advantage of the fact that such vehicles can have flexible rules around what kind of assets they can invest in,” says Danae Kyriakopoulou, chief economist and director of research at the OMFIF. “Central banks cannot invest reserves in ways that are centred around making a return, whereas for sovereign funds in many countries, their whole purpose is to increase wealth.”
How SWFs work
Some are run as stand-alone institutions, others are managed by central banks or other state-owned bodies. Their degree of independence varies widely and some have been manipulated for nefarious purposes a little too easily.
In Norway’s case the Stortinget, the Norwegian parliament, set out the formal framework for its SWF in the Government Pension Fund Act of 2005. The country’s Ministry of Finance has overall responsibility for the fund, but it is the executive board of Norges Bank (the country’s central bank) that manages it.
ADIA was set up by the Abu Dhabi government in 1976 as an independent institution. It says it carries out its investment activities without reference to its government. However, there remains a close link between the two sides: the government provides ADIA with funds to invest and in turn ADIA is required to hand funds back to the government on request.
There is now a trend for SWFs to expand into more asset classes and make more co-investments. One example of this was in October 2016, when Saudi Arabia’s PIF announced it was partnering with Japan’s SoftBank Group to set up the SoftBank Vision Fund.
According to the International Forum of Sovereign Wealth Funds (IFSWF), in 2018 some 211 investments were made by SWFs acting as part of consortiums; more than double the 92 deals completed as solo investors. The number of co-investments has been steadily increasing, from 133 deals in 2015, to 143 in 2016 and 206 in 2017.
Calls for transparency
Many funds are quiet about their operations, as is made clear by the Linaburg-Maduell Transparency Index. This rates funds on criteria such as the availability of audited annual reports, details of their holdings and their ownership structure. The performance varies widely: Singapore’s Temasek Holdings and Ireland’s National Pensions Reserve Fund score a maximum ten points; Brunei Investment Agency and Algeria’s Revenue Regulation Fund score just one.
However, there have been moves towards greater openness. In 2008, several large funds signed the Santiago Principles for governance and transparency, which are maintained and promoted by the IFSWF.
SWFs are now taking their role as market participants more seriously. The size of some means they can hoover up liquidity and squeeze out smaller investors, but they can be a positive influence too. In the wake of the global financial crisis, SWFs were among the few investors able to inject capital at scale where it was needed. As one review of the sector remarked in 2008, “SWFs quickly turned into the white knights of Wall Street”. More recent research, published in the Human Resource Management Journal in 2018, looked at the impact that Norway’s Government Pension Fund Global had on its portfolio companies. It finds that the fund helped those businesses avoid making mass redundancies following the 2008 crisis.
Going forward, the impact SWFs have on the market may hinge on the extent to which they decide to become more active shareholders. “There are different approaches. You either use your shareholder power to have a positive influence or you divest entirely, and, in certain sectors, a lot of funds have chosen to divest,” says Danae. But she adds that funds have the potential to make a positive difference in some sectors. “Given their long-term investment horizon, sovereign funds have the opportunity to act as very positive forces in terms of advancing sustainable asset classes, helping to generate more green growth projects. We are not there yet, but there is potential.”
The full version of this article will appear in the January 2020 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.
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