Guest Blog: Rachel Ziemba

Are Sovereign Funds Back? A Roundup

Rachel Ziemba

It certainly seems so—at least in terms of new purchases. At least two of the conditions that contributed to SWF’s rapid rise in 2007 and early 2008— a rally of equities and alternative assets, as well as the growth in foreign exchange reserves—have resumed, to some extent. Yet future growth might be more muted—the third condition – large oil surpluses – no longer exists.

The revival of equity and commodity prices has contributed to the rise of sovereign funds’ assets under management, allowing them on average to make back half of the paper losses sustained in the 2008/09 price correction. Equity-heavy SWF portfolios have reflated along with the market. At current oil prices, most oil funds are again receiving some new capital, albeit much less than inflows of 2007 and 2008. Most also face new domestic competition.

My estimates suggest that the foreign assets under management by the 10 or so largest sovereign funds rose to an estimated US$1.7 trillion by the end of September 2009. Excluded from this total are domestic holdings of funds like China’s CIC, Singapore’s GIC and several of the Abu Dhabi funds. This total reflects an increase of almost US$300 billion in assets from the end 2008/early 2009 lows, but remains well below the highs of mid 2008. It also assumes the funds’ returns roughly tracked established benchmarks—an assumption that may not provide a totally accurate picture given the changes in asset allocation and management strategy since the crisis. (A past working paper with Brad Setser has more methodological details.)

New Actors?

Yet, differences among funds have widened. The richest countries, either in terms of unused reserves (China) or lower domestic spending needs (Abu Dhabi, Norway, Qatar), are the most active. Those funds and countries that are the most leveraged (Dubai, Russia) are facing challenges. The need for liquidity and offsetting revenue shortfalls has contributed to withdrawals from some funds (Russia, Saudi Arabia). Yet domestically focused investors such as state holding companies or resource companies seem to have gotten a bigger piece of a smaller pie.

Yet, much of the new sovereign wealth activity stems from China. After almost a year of no new foreign investments, the CIC seems to have received the go-signal beginning in July. It has subsequently launched an advisory board, allocated billions of dollars to a number of asset managers and made a handful of investments (for instance, it purchased a stake in the Canadian mining company Teck Resources, several Asian resource companies, the Kazakh oil and gas company Kazmunaigaz and is eyeing U.S. property). The investments have spanned a number of sectors, but resources have dominated—mirroring a generalized stampede of Chinese government investors into in resources this year.

New Sectors:

It’s always difficult to assess the exact portfolios of sovereign funds, as many purchases (or divestments) are not publicly reported. However, there is some evidence that sovereign funds are rebalancing away from the financial sector.

In the boom years many sovereign funds over-weighted financials. Singapore’s Temasek was a case in point—financials accounted for a whopping 40% of its portfolio in early 2008 but fell to 33% a year later. Financial stakes were likewise attractive to other funds, even if the allocation was lower. Previous RGE research suggests that the bulk of identifiable purchases by GCC sovereign wealth funds in 2007 and 2008 were in financial institutions. This “overweight” reflected several trends including the outperformance of financial institutions relative to other sectors, as well as opportunities to buy into global players at what seemed like cheap prices. Similarly, domestic financial sector holdings may have encouraged funds to buy what they knew.

Several funds that provided capital to cash-strapped global financial firms have sold their stakes—in many cases at a profit. These moves, however, are likely to shift most financials to neutral weight rather than underweight. Even Temasek’s 33% is a large allocation to the financial sector. Most sovereign funds increased their exposure to domestic financial institutions in 2008/2009 as part of their effort to support domestic banks so adding foreign exposure might not be the smartest idea.

Some funds could end up overweighting some other sectors, most notably commodities. In terms of optimal asset allocation on a national basis, this is a bigger concern for oil funds. Investing in resources would be like doubling down for an oil, gas or resource rich nation. Doing so might increase the volatility of returns even as doing so could facilitate an increase in the national government’s (or national oil company’s) market share.

Responding to Losses:

Most sovereign funds—like most investors—have been reassessing their investment strategies as they process the volatile market moves of the past year and ask how their risk models went awry. Some funds have replaced key managers (Norway) or reshuffled/combined operations (Dubai World). Clearly as with private asset managers, strategy and hedging shifts are likely. Of course this is a rather opaque area so details are fuzzy.

The other more significant asset management shift—to more domestic holdings—has been ongoing for some years. This shift could potentially reduce investor independence and further blur the ultimate investment goals of some SWFs.

With the emergence of new goals come new responsibilities. The jury is still out on the effectiveness of the Santiago Principles, a voluntary code of governance principles that aim to increase transparency. In part, the need for capital changes the concerns of target countries. International scrutiny has in some cases heightened domestic pressures. Many countries—particularly those that are more democratic—are under great pressure not to squander national wealth and to use it as seed capital to support growth.

Slower Growth Ahead?

Absent a transfer from China’s central bank to the CIC, the investment pace of “sovereign wealth funds” may slow given the reduction in new capital. Such a transfer should not be ruled out, especially as the CIC is one of several outward investment vehicles being promoted by China. However, other countries might be wary of allocating more funds to equities. Russia’s spending needs mean it will spend all of its reserve fund over the next year—its value has already almost halved to US$76 billion since January—and prior plans to invest the wealth fund in equities seem off the table for now. Other funds might take the lesson that a reserve is more useful than a number of high profile investments.

Oil funds have roughly maintained their share of about 75% of total sovereign wealth fund assets under management. They are also receiving new funds, yet new capital transfer levels are well below 2007 levels in most cases. Norway’s fund is perhaps an exception, as Norway’s spending has climbed more slowly than that of oil exporters in the Gulf and elsewhere. Aside from Kuwait, which continues to show a reluctance to spend, even the GCC funds are now saving less. Production cuts and higher spending have eroded the surpluses of the UAE, Qatar, and especially Saudi Arabia.

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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