Archive for June, 2010

Neither Independent, Nor Commercial

Ashby Monk

I read quite a thought provoking article by Veljko Fotak and William Megginson on Project Syndicate this morning. Now, I have to admit, I was in a severe state of sleep deprivation when I read it, as I very recently became a new dad. But I just reread it, and I’m still intrigued.

The authors’ premise is simple: they claim SWFs are not as independent or as commercial as they would have you believe. In short, Fotak and Megginson seem to be making the case against certain aspects of SWFs’ own Santiago Principles:

“SWFs like to portray themselves as politically independent, commercially motivated investment vehicles. But the last couple of years have proved that, in a crisis, they are not immune from political pressures to re-focus their portfolio allocations towards domestic investments. This tendency at times of economic downturn suggests that SWFs are not the long-term, stable shareholders of foreign firms that they (and some commentators) claim themselves to be.”

I buy that. As I’ve argued time and time again, sponsoring governments do view their SWFs as ‘insurers-of-last-resort.’ But Fotak and Megginson seem to take that argument a step further, suggesting that this role extends to the SWFs’ investment decision-making and not just the governments’ access to the capital in the SWF. It’s a compelling argument given their empirical evidence.

What’s perhaps more interesting is the insight that this politically oriented investment may be driving the poor returns shared by some SWFs during the crisis.

“Incidentally, it is plausible that the cyclical behavior of the SWFs is responsible for the underperformance of their holdings. SWFs tend to invest in foreign markets more when times are good and security prices are more likely to be inflated, and to divest during market downturns, when divestment offer implies lower-than-fundamental-value security prices. Accordingly, the underperformance of SWF equity portfolios might be a consequence of unfortunate, but constrained, timing, rather than a result of poor stock picking.”

In other words, the SWFs have managed to create the opposite effect from traditional portfolio re-balancing. Still, one SWF has outperformed the market in 2008 and 2009: the CIC. That’s an important counter-factual…

SWFs as Market Saviors…Again

Ashby Monk

Dr. Alexander Mirtchev, who is the Independent Director of Kazakhstan’s SWF Samruk-Kazyna, argued over the weekend that SWFs could be saviors of the West and the global financial system:

“…SWFs are starting to look increasingly as the premier source of available financing for a cash-starved international financial system…SWFs could become increasingly accepted as investors in the US and Europe, as the spending capacity of Western governments remains constrained by the need to cut bulging budget deficits.”

I’m having a flashback to 2007. At that time, the financial crisis was picking up steam, and there was a widespread expectation that SWFs would step in and save cash-starved financial services firms. However, three years later, we know that was just a pipe dream. The crisis was simply too big and SWFs too small for them to ‘save the world’, as it were. More to the point, SWFs weren’t in the business of bailing out financial services firms. They were in the business of making profits. So, when the full extent of the financial crisis became apparent, SWFs retreated and left the West to sort itself out.

Anyway, let’s fast forward to 2010. Mirtchev is resurrecting the old argument about SWFs acting as market saviors:

“The Gulf SWFs can underwrite the autonomy of states by acting as an insurer of last resort – in other words, a buffer against global crises and cyclical development.”

It’s hard to know exactly what he is getting at here, because the article only gives us a series of quotations out of context. Nonetheless, I think he is arguing that SWFs could be ‘insurers of last resort’ for the global economy, writ large.

Now, I myself have argued (here) that SWFs can act as a “buffer against the risks to autonomy and sovereignty in a global economy.” But there is a fundamental difference in my argument from his: I see SWFs as insurers of last resort for the nation-state sponsor, while he seems to see them as potential saviors of the entire economic system during the upcoming period of fiscal austerity.

As I see it, the problem with the latter argument is simple: the profit motive. As we learned in 2007, SWFs aren’t in the business of bailing out foreign firms, industries or countries. They need to make returns so that they can fulfill their primary, domestic objectives. As I note in my paper,

“SWFs are conceived to be a desirable bulwark against the depredations occasioned by globalization—a means of protecting nation-state institutions and commitments from the economic and financial imperatives that drive the discounting of those institutions and commitments.”

And I stand by that analysis. In my opinion, SWFs exist to preserve the autonomy of the state that sponsors the SWF. But I don’t see SWFs acting as insurers of last resort for the foreign firms or countries in their portfolios.

In short, Mirtchev is right that SWFs will have plenty of opportunities for investment in Western markets desperate for capital. But if things get really bad, I’d expect SWFs to retreat (again) and go into capital preservation mode.

Weekend Reading

Ashby Monk

Vincent Gasparro just sent me a paper he published wich Michael S. Pagano in the Financial Analysts Journal entitled, “Sovereign Wealth Funds’ Impact on Debt and Equity Markets during the 2007–09 Financial Crisis.” Here’s a brief abstract:

“The authors found that news related to the financial crisis and sovereign wealth fund investments in U.S. and European firms not only affected returns on U.S. money market instruments and U.S. firms’ common stock but also created negative “spillover” effects on Canadian money markets and Canadian firms’ equity returns.”

It’s well worth a read. Get it here.

Have a good weekend!

Qatar’s Surprising Strategy

Ashby Monk

I admit it, I’m a ‘random walker’; my measly nest egg is parked in a variety of index funds and ETFs. I guess I just have a personal bias towards passive management over active management. Given this bias, you can imagine my ongoing astonishment over the Qatar Investment Authority’s investment philosophy.

This $70 billion SWF seems to have made ‘stock picking’ the cornerstone of its overall investment strategy. For example, the QIA has invested roughly $12 billion in Barclays and $10 billion in Volkswagen/Porsche alone. On top of that, it has a few billion in Sainsbury’s, a few billion in Harrods, and it is about to put nearly three billion into the AgBank IPO.

This ‘strategic’ investment philosophy doesn’t quite jive with the QIA’s stated policy, which says that its mission is to “diversify” Qatar’s wealth. So, what gives? Why would the QIA — or any SWF for that matter — be in the business of making large bets on specific firms? Why would it be willing to gamble – it’s hard to call a $2.8 billion investment in the AgBank IPO anything other than a wager, in my opinion – with the country’s sovereign wealth?

The only justification that makes any sense – at least to my simple mind – would have to be extra-financial. By that I mean that the QIA may be investing for more than just investment returns; it is probably investing for the benefit of Qatar as a nation. For example, the investment in Volkswagen could be as much about forging a strategic partnership between Qatar and a world-renowned German car maker as it is about investment returns.

And, if you think about it, this is a pretty smart way to use a SWF. How else could this tiny island nation hope to be a ‘player’ in the global car industry? Clearly, making an eye-poppingly large investment in one of the premier firms is one way. After all, Qatar now has representation on the company board.

In this way, Qatar seems to be using its SWF to extend its ‘sovereignty’ extra-territorially. As Adam Dixon and I argue in a forthcoming paper, the actions of certain SWFs reflect a recognition on the part of nation-states, such as Qatar, that their economic and social wellbeing has become dependent on, or at least vulnerable to, the functioning of foreign markets and the behavior of foreign countries and firms. Through the SWF, nation-states can engage with these foreign entities extra-territorially, thereby minimizing any sovereign deficit that has arisen due to globalization. It’s actually a pretty interesting use for a SWF.

Colombia Creating New SWF

Ashby Monk

Colombia’s new Finance Minister Juan Carlos Echeverry — an economist with a PhD from New York University – wants a new sovereign wealth fund to help manage the country’s rapidly growing commodity revenues. Indeed, you may not be aware, but Colombia’s oil industry has actually been flourishing in the increasingly safe and secure operating environment created by Álvaro Uribe’s presidency:

“A few years ago, rebel groups bombed pipelines almost daily but the army now has a strong presence in many oil-producing areas.”

Accordingly, Colombia has become Latin America’s fourth largest crude producer. And the country has 1.36 billion barrels of proven crude oil reserves (as of 2010), which is the fifth-largest in South America. Moreover, oil consumption is a fraction (roughly 1/3) the country’s production, which means that Colombia is now a significant oil exporter (most of it going to the United States).

This presents the country with some of the classic problems faced by commodity rich countries, such as how to avoid Dutch Disease; how to prevent inflation (which ravaged the country in the 1990s); how to ensure the money is used for the benefit of all of the country’s citizens; how to prevent corruption and political mismanagement; and how to ensure inter-generational equity.

As Echeverry apparently understands, a well-governed SWF can be quite useful in managing these problems. But, all that being said, Colombia would be wise to retire some of its sovereign debt before focusing all of its attention (and resources) on a new SWF. Indeed, the chances of making the SWF’s returns high enough to justify not retiring debt are low (and the investment risks required to do so are high). Especially if the country has a high debt burden and high borrowing costs.

Is Aabar Going Long?

Ashby Monk

Aabar Investments has been a rising star within Abu Dhabi’s growing stable of government investment vehicles. Launched in 2005 under the name Aabar Petroleum, it has quickly become an important investment arm of the government. Indeed, Aabar has $10 billion under management and has made some remarkably high-profile investments, including 2 billion Euros for over 9 percent of Daimler. While Aabar is publicly traded, the International Petroleum Investment Company (IPIC) – yet another Abu Dhabi SWF – holds 71% of the company’s shares.

While I had pegged Aabar as similar in trajectory to Mubadala or Bahrain’s Mumtalakat – in that it was raising capital from the market and quite transparent – Chief Executive Mohamed Badawy al-Husseiny just announced that the company will be meeting on Thursday to discuss whether or not it should convert to a private joint stock company and cancel its stock listing on the Abu Dhabi Securities Exchange.

Why would Aabar take this unprecended step? To my knowledge, this type of conversion has never happened on the ADSE. To be clear, Aabar has not given any indication as to why it is considering this step, but that doesn’t stop us from making some guesses.

First, Aabar may be going private because it no longer needs the market for capital. After all, it has the backing of IPIC. Second, and perhaps more pressing, Aabar’s investment objectives — under pressure from IPIC — may be moving towards long-term, strategic plays, which would go against the public shareholders’ interest in dividends. According to one analyst:

“…going private made sense for Aabar because of the difference in interests between IPIC, which wants the company to use its cash to expand, and minority shareholders, who want Aabar to return some of its profits as dividends…Aabar has some longer term strategic goals that just don’t go well with a company that reports on a quarterly basis.”

While I’m never a fan of limiting transparency and disclosure — because I sincerely think there is a business case for transparency — I get it. Having a single, sovereign shareholder allows the fund to take an intergenerational time horizon on its investments.  It’ll be interesting to see what happens.

Renminbi Rambling

Ashby Monk

The PBOC surprised everybody with the announcement over the weekend that they would be moving towards a more flexible exchange rate. And, today, the Renminbi has already had its biggest single day increase in five years.

The PBOC statement was ‘carefully worded’, which is another way of saying that more information is needed. So I’ll resist the urge to make any big predictions about structural changes to the Chinese economy or, more significantly, the global economic imbalances.

Still, there is plenty of good analysis out there this morning – from those who see this as just a way to placate the G20 to those who see this as an important step in China’s maturation. Indeed, for the prediction starved reader, here’s one from The Economist:

“…by the end of 2011, you will be able to get 6.2 yuan for the dollar, compared with 6.83 now.”


About

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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