A lot of strange and secretive investment groups have crept into the investment scene of late. Among the (relative) newcomers are: private equity, hedge funds and, not far behind, Sovereign Wealth Funds.
While these funds haven’t generated quite as many column inches as hedge funds, they are in fact a much bigger financial force.
Including their many offshoots — pension reserve funds and official foreign reserve exchanges — International Financial Services London (IFSL) estimates that Sovereign Wealth Funds (SWFs) control assets worth collectively 14.3 trillion dollars!
Even looking simply at ‘traditional’ SWFs — big state-controlled national investment funds — assets under management tops $3.3 trillion... $0.7 trillion more than the whole hedge fund industry.
The most common type of SWF is funded by state assets, usually commodities (oil and gas) exports, which alludes to their geographic prevalence.
The United Arab Emirates boasts the largest SWF, the Abu Dhabi Investment Authority on $875 billion, followed by Norway’s Government Pension Fund on $380 billion.
The Middle East and Asia holds the lion’s share of the funds. Governmental wealth is not so prevalent in western nations, with the UK, US and the Eurozone barely registering on the world SWF map.
A foreign force this powerful probably merits the scrutiny, but maybe not the suspicion, that it seems to garner.
At the end of the day, these state-controlled vehicles have the same objectives as most pension funds:
- They tend to invest for the long-term, a stark contrast to entire categories of the hedge fund world;
- Management typically remains passive, unlike the activist ‘hedgie’ groups that have inspired many share price disruptions (I’m looking at you Mr Hohn!);
- And, they tend not to make politically influenced investment decisions...
That last point might be out of date.
SWFs, over the past 12 months, have been making "atypical and opportunistic" moves, according to think tank Monitor Group, by buying up stakes in investment banks.
Not least in Barclays, who are being courted by Singaporean fund Temasek and the China Development Bank.
The Subprime Clearance Sale
SWFs tend to invest locally. Investing in Asian and emerging markets was commonly regarded as ‘their thing.’ When this was the case, scrutiny was at a minimum... now that they are venturing abroad everything’s changing.
Merrill Lynch; UBS, Morgan Stanley, Citigroup, Blackstone Group, Bear Stearns (RIP)... and the list goes on.
These are the institutions that have gratefully received multi-billion dollar investments from sovereign wealth funds in the last 12 months alone.
Now Barclays, which has already sold a 5% stake to SWFs, is gearing up to sell another 6% or £4 billion of shares to the Singaporean and Chinese funds.
For Barclays and Co., SWFs have acted as a great fail-safe mechanism in these times of panic.
The shaky state of the banks’ capital bases following months of write-downs and write-offs forced all but a lucky few into the arms of the oil money.
It has been very convenient for firms that could have suffered embarrassingly undersubscribed share sales to a market looking for excuses to short the sector.
But, investment banks are uber-important cogs of the international money machine. With these buys, SWFs have a significant influence over the world of finance. And this is what has so annoyed western policy makers.
Fear of the Unknown
Most Sovereign Wealth Funds are notoriously secretive.
They are not legally required to publish their size, their strategies or their holdings. The financial regulatory community has a natural uneasiness with big anonymous forces that can materially impact on the markets they are there to protect.
They’re not the only ones.
In the US, which has been the largest recent receiver of petrodollars, 55% of respondents thought investments by foreign governments harmed US national security, according to a poll by Public Strategies.
Alas, no big answers have emerged from the big questions regarding wealth fund regulation.
It is very similar to the debate with hedge funds. And, it will probably result in the same outcome.
When hedge funds shot to prominence in the 2003 — 2007 bull-run for equities, the FSA was found wanting to define or regulate the mysterious industry.
Little was known about their ‘black box’ operations and how they made their money... and this only fuelled market suspicion.
The problem is that regulating hedge funds is a bit like herding cats... try as you might there it’s impossible to establish a coordinated activity.
This is because a hedge fund can be whatever it wants.
There are dozens of different types of fund that pursue hundreds of different strategies across every asset class going. To impose a catch-all bit of legislation would stifle some parts of the industry and complete overlook others.
The only response is to introduce rulings that are so flexible and accommodating that they may as well have not been introduced in the first place.
This is the conclusion, I assume, the FSA came to and explains why self-regulation, via the Hedge Fund Working Group was introduced.
SWFs are equally diverse. These are groups that have different objectives and fall under the standards of different home nations... my guess is that a similar course of self-regulation will take shape.
How Do SWFs Affect Me?
Never mind the political considerations!
Are wealth funds good stock pickers? With all their money, SWFs have access to the greatest minds and the most comprehensive data in the world. They are perceivably the ‘smart money’ in the market. And by following the ‘smart money,’ in and out of positions — or coat-tail investing — we should be able to make a lot for ourselves.
Unfortuntately, based on recent results (which are not a reliable indicator of future returns), SWFs are bad stock pickers.
Assets under management in the industry did grow by 18% in 2007, but this isn’t the result of clever stock picking, but a result of increases in foreign reserves and rising revenue from oil exports.
By backing the banks, SWFs have lost big; Bear Stearns, Merrill Lynch and UBS proving particularly badly timed investments.
Barclays, which had already lost Temasek and China Development Bank 40% of their investment, is not much better. Nonetheless, the SWFs can see beyond the short- or medium-term, and we should be thankful that they can.
Had they not collectively stepped in when they did, who knows how much worse this financial crisis could have been?
So, in the short term, we can argue they’ve had a positive impact in helping to stem the decline of the banking sector... the third biggest group in the FTSE 350.
OK, their recent investments haven’t been great... but SWFs are still big, influential buyers.
What impact do they have on the companies they invest in? According to an academic study by Price Business School, a big investment by a SWF boosts the share price by 1%.
1%. Whoopee.
And that’s just the initial response, "Investments by SWFs have a negative impact on management incentives and lead to deteriorating firm performance. In support, we document abnormal returns equal to negative 6.63% for firms whose shares have been acquired by SWFs in the 120 days following the acquisition."
In other words, the purchases have practically no impact in the short-term and actually invoke a sizeable decline in the 4 months that follow!
That’s awful.
It seems that we have all been focusing on the wrong side of the equation.
The political argument against sovereign wealth funds is overblown paranoia. They have, typically, noble intentions of holding investments for the long-term, not influencing the corporate management and increasing shareholder return.
The problem is, on the investment argument, they don’t appear to be very good at it.
The only benefit that we private investors get from watching sovereign wealth funds is as a contrarian indicator. If they start piling into any of your holdings, start worrying!
Theo Casey
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