First appearing around the midpoint of last century, sovereign wealth funds (SWFs) have long occupied a significant space in financial markets. However it’s only in recent years that these rainy-day funds have come into their own.
Speaking at the 68th CFA Institute Annual Conference in May, the former CIO of the Korea Investment Corporation (South Korea’s SWF) Scott Kalb offered up some choice statistics on what he called an “active and powerful” opportunity. First was that at the end of 2014 the world’s 74 highest ranking SWFs held a colossal $7.7trn in assets, $3.3tn greater than in 2010 and significantly more than the $500bn held in 1990, according to the IMF. Next, Kalb remarked that 53 SWFs had been established since 2000, 40 since 2005, and concluded with studies to show that SWFs and sovereign pension funds averaged at over $100bn under management.
“Sovereign wealth funds represent a large and growing pool of savings. An increasing number of these funds are owned by natural resource–exporting countries and have a variety of objectives, including intergenerational equity and macroeconomic stabilisation”, according to a World Bank working paper on long-term development finance. “Traditionally, these funds have invested in external assets, especially securities traded in major markets. But the persistent infrastructure financing gap in developing countries has motivated some governments to encourage their sovereign wealth funds to invest domestically.”
The points here are proof, if ever it were needed, that SWFs have become a fixture of modern day financial markets, and on a day when asset managers are fighting for quick returns, SWFs could alter, perhaps fundamentally, the way in which institutional capital is managed.
Assets held by 74 highest ranking SWFs, 2014
New SWFs established since 2000
Much attention has been paid recently to the rate at which assets are gaining, though the ambition for any SWF is not simply to stockpile funds, but secure a future for generations ahead, and it’s in emerging Asia, Africa and the Middle East that this focus can best be seen. Where major resource discoveries can often bring both volatility and corruption for host nations, a well-balanced SWF can keep a lid on wayward ambitions and protect wealth far into the future. Faced with a much-changed landscape from that of 10, five or even one year ago, institutional investors are evolving in what ways they can to generate meaningful returns, though often to little avail.
The intergenerational focus of SWFs, meanwhile, makes them a very different proposition to that of their privately owned counterparts, yet these government-run alternatives are more closely aligned with traditional asset managers today than they perhaps ever have been.
Studies show that SWFs are dabbling, increasingly so, in opportunistic investments, if only to keep tabs on the latest changes to capital markets, and alternative investments account for a larger share of the pie. Developing nations, particularly those rich in natural resources, are finding also that SWFs can serve as a key source of funding in low price environments and lay the foundations for sustainable development. Add to that a growing tendency to keep investments local, and “the secretive and exclusive subset of the institutional investor community”, as labelled by Preqin, has undergone a quite extraordinary transformation.
Norway out in front
“One day the oil will run out, but the return on the fund will continue to benefit the Norwegian population”, according to Norges Bank Investment Management, whose job it is to manage Norway’s Government Pension Fund Global (GPFG).
Currently the world’s largest SWF, the fund has proven itself a precious financial buffer in times of economic hardship, best seen at the beginning of the year when assets peaked and oil prices fell through the floor. At the same time, the total number of assets under management tipped the NOK5.1trn ($675.88bn) mark, equivalent to over NOK1m in local currency for every member of the population, amounting to a significant – albeit essentially meaningless – milestone for the savings pot. Fast-forward to the end of 2014, with the fund sitting at $893bn (see Fig. 1), it’s little surprise that new entrants to the subset often cite the GPFG as an example of how best to manage state-owned assets.
Another important development arrived recently when the country allowed those working at the fund to invest in real estate, rather than equities and fixed income only. Marking a paradigm shift, not just for the GPFG but the wider SWF community, over two percent of the fund’s investments fall on real estate currently, with the percentage primed to reach five in the near future.
“It’s a global trend, the shift toward real assets that provide investors with diversification, inflation hedging, asset backing and more operational effort than some bargained for”, according to PwC’s The Real Estate Equation. “Real estate attracts a significant proportion of global capital raising the challenge of bridging global demand with local supply and micro environments with macroeconomics. Sovereign wealth funds certainly face this challenge.”
In essence, what the focus on real assets brings is a far greater emphasis on local investment. SWFs, historically speaking, have invested overseas to hedge against home-grown crises, though their role in supporting domestic development means that they’ve tended recently to champion subjects closer to home. True, domestic objectives can sometimes diverge from the greater goal of capital preservation, but improvements on home soil often go some way towards mitigating long-term risks and cementing a stable base on which future generations can build.
Closely in keeping with this focus on local investment and real assets is one on infrastructure, for which their long-term investment horizons are well suited. “Potentially competitive returns in developing economies and the sharp reductions in traditional sources of long-term financing after the financial crisis have contributed to fuel a growing interest among national authorities in permitting, and even encouraging, the national SWF to invest domestically, in particular to finance long-term infrastructure investments”, reads a World Bank report on the constraints of infrastructure financing. “Such pressure is inevitable, considering the fact that many countries with substantial savings, several of them recent resource-exporters, also have urgent needs. A number of existing SWFs now invest a portion of their portfolios domestically and more are being created to play this role.”
Preqin estimates show that 60 percent of SWFs allocated capital to infrastructure projects in 2014 (see Fig. 2), far greater than the 16 percent in 2011, as participating countries look inwards when arriving at how they might distribute capital. “Alternative assets have emerged as an increasingly important portion of the portfolios of many sovereign wealth fund investors over recent years, as these investors seek to diversify their portfolios and acquire assets that can generate yield and help them meet their long-term objectives”, according to the data and research firm.
The case in point can best be seen in resource rich nations, where fast-growing mining sectors require also that host nations improve their infrastructural competencies. In Abu Dhabi, some $30bn has been allocated to infrastructure, and both Angola and Nigeria have done much the same, albeit to a lesser degree, with $5bn and $1bn respectively. Occupied not so much with the pursuit of liquidity, long-term returns such as those on infrastructure have been made to appear all the more attractive in light of the financial crisis and recent oil price shock.
Any decisions made by SWFs in this instance are in keeping more so with development finance institutions than they are say hedge funds, and sustainable economic development not liquidity takes precedent in the here and now. Going back to before the financial crisis hit, SWFs were met with a note of caution. However, the part played by these government-run investment vehicles in the aftermath, both in developed and developing nations, means that these government-run investment vehicles are received more positively.
“It is difficult and unwise to generalise about the (financial) performance of SWFs and my expertise is with respect to transparency and accountability where the trend is toward improvement by many funds”, says Edwin Truman, economist and nonresident senior fellow of the Peterson Institute for International Economics.
It’s worth noting also that not all funds have been resilient recently. Truman points to Russian funds, which have been raided for political purposes, and oil-based funds, which are suffering reduced inflows. “But some funds have I think swum against the tide of general market caution”, he says.
Though blighted still by criticisms of inadequate governance and poor transparency, what’s certain is that SWFs have carved out a niche in global financial markets since the crisis. And in a period when past funding models of a more traditional sort are failing, SWFs and their long-investment horizons mean they’re well endowed to thrive in the present climate. With transparency and accountability much improved on years past, the new inward facing nature of SWFs means that they have fast become an important part of sustainable economic development.