Guest Blog: Latin Sovereign Wealth Funds

Javier Santiso

Sovereign wealth funds are more fashionable than ever. There are around 50 at present, and another 15 countries are considering getting one. From Algeria to India, South Africa, Japan and Israel, candidates to adopt an instrument of this sort are proliferating. In Latin America, some countries – Chile, Trinidad and Tobago and Venezuela – already have theirs. Brazil joined them in 2010, with reserves of over $250 billion, and at the end of that year Peru, Colombia, Panama and Bolivia initiated debates to create one.

All these countries now have abundant reserves and face the challenge – the Andean countries in particular – of managing the raw materials boom. Their investments and exports are still highly concentrated within these low-intensity areas for added value and jobs. Hence their desire to make better use of this abundance to take a leap forward production-wise and diversify their economies, an issue that remains pending. Sovereign wealth funds may be strategic vehicles to this end, as long as the institution is nurtured by providing it with first-rate professionals and processes.

This is precisely what was masterfully achieved by Chile. In the middle of the last decade it created two sovereign wealth funds with stringent rules and top-level human and institutional capital. The outcome is that this Latin country has become a worldwide reference, on a par with Norway, in matters of sovereign wealth funds. In the case of Chile, the funds are set in the context of a strict fiscal responsibility law, adopted in 2006, which requires 0.5% of the GDP of the surplus of the previous year to be allocated to the first fund (pension reserve fund); the next 0.5% of the GDP of the surplus to capitalise the Central Bank, and whatever surplus is generated above that amount, to the second sovereign wealth fund (Economic and Social Stabilisation Fund).

Several lessons can be learnt from this successful Latin experience. The first is that this sort of instrument is inseparable from a serious fiscal policy. The second is that very rigorous regulatory and institutional frameworks are needed, especially when we are talking about emerging countries. And lastly, it is equally essential to provide the institution with the right human capital. In the Chilean case, both in the previous government and the present one, we are talking of professionals and economists of great value, starting with the two finance ministers who supervised (Andrés Velasco) and supervise (Felipe Larraín) the funds, together with those directly in charge of them in the previous government (Eric Parrado) and the current one (Ignacio Briones), all of them with a PhD in Economics, a long academic career and ample professional experience.

However, the Chilean funds are not strategic funds, i.e., aimed at encouraging business development and diversification. Some emerging countries such as the Emirates, Singapore and Malaysia created strategic funds with the clear aim of contributing to business development and production diversification. One might imagine Chile equipping itself with a (third) sovereign wealth fund for this purpose. The beauty of the Chilean scheme is that it potentially offers the right structure of incentives to do so: the present three successive layers for fiscal surplus allocations could be joined by a fourth for a strategic fund. This would only be activated if the first three items are fulfilled. Therefore it would only be activated above a significant level of fiscal surplus. The strategic fund could then operate as a fund of funds, pushing production diversity towards technology sectors or even mining industry suppliers, for example.

In fact it is remarkable that, although it is the world’s leading producer and exporter of copper, Chile has no world-scale multinational supplying that industry with vehicles, diggers or explosives. They are all foreign: Caterpillar and Joy Global are listed in New York, Komatsu in Tokyo, Atlas Copco and Sandvik in Stockholm, Boart Longyear, Leighton and Orica are Australian, the Weir Group is Scottish and Hatch is Canadian. They are all large-scale creators of high value added jobs. Coldelco, the world’s biggest producer of copper, employs just under 20,000 people – a great deal fewer than the Swedish multinationals Sandvik (44,000 employees) and Atlas Copco (30,000 employees). Its income is seven times lower than that of Caterpillar, which also employs almost five times more people than the Chilean multinational.

Latin America does not lack natural resources, and it is undoubtedly a blessing. However, except for Mexico and Brazil, which possess a wide range of industrial activities, there has been little product diversification. On average, more than 50% of the region’s exports are still linked to raw materials, and over $150 billion of investments are expected in these industries in the next five years. Having raw materials is not a curse; it all depends what you do with them, as shown by the cases of highly raw material dependent and highly developed economies such as Norway, Australia and Canada. In the end, the question we must ask a country that has lithium, for instance (as do Chile, Argentina and Bolivia), is the following one. Where do you want to be in the value added chain: in the market of lithium as a raw material, estimated to be worth a little over $1 billion? Or the lithium battery market, estimated at a little over $25 billion? Or even the electric car market, which will use lithium batteries and is estimated to be worth $200 billion?

Part of the answer to this question may lie in the creation of strategic funds. The experience of other countries, particularly in the Arabian Peninsula and Southeast Asia, can serve as a model in this regard.

In the Emirates, the Mubadala fund, for example, is Abu Dhabi’s strategic vehicle for diversifying the oil economy. This institution, set up in 2005, is endowed with some $10 billion and owns Masdar, a city that aspires to be the Silicon Valley of renewable energies. It made investments and strategic agreements with multinationals such as General Electric (it owns 0.7% of the US giant), which created R&D centres in the Masdar complex. Mubadala and GE fostered a joint investment fund now endowed with $2 billion. In this way the Emirates seek to position themselves as an aerospace hub, and to this end they reached an association agreement with the European multinational EADS (Airbus), in which another Arab sovereign wealth fund, Dubai International Capital, owns over 3% of the capital. Mubadala was also involved in strategic agreements with multinationals such as the French Veolia Water and, at the end of 2010, the Spanish technology company Indra. Furthermore, in 2010 it undertook an aggressive diversification strategy aimed at emerging markets, reaching agreements with the Malaysian sovereign wealth fund ($7 billion) and a Russian private venture capital fund ($100 million).

Likewise, Malaysia offers an interesting examples of successful strategic sovereign wealth funds. Khazanah, the Malaysian sovereign wealth fund, manages around $30 billion. It made strategic investments in 50 companies, including the world-leading telecommunications group Axiata (with 45% of the total) and the car manufacturer Proton (in which it owns 42% of the capital), today the biggest in Southeast Asia. It has interests in airports, airlines, hospitals and banks all over the country, where 90% of its portfolio is concentrated. It also started up an international expansion process in line with the industrial strategy of the country to position it as a regional healthcare hub. In this way in 2010 it took over Parkway Holdings, the main private hospital operator in Asia, for a record sum of nearly $3,5 billion. On the strength of these successes, at the end of 2009 Malaysia equipped itself with a second sovereign wealth fund, 1Malaysia Development Berhad, thus multiplying the cooperation agreements with the Qatar sovereign fund (by creating a $5 billion co-investment vehicle) and the oil company PetroSaudi International (to invest $2,5 billion).

These examples illustrate to what extent sovereign wealth funds can be strategic actors for the diversification and development of an economy. In the case of Latin America, Brazil has, through the BNDES, effectively operated with an instrument of this sort, producing giants such as Vale and Petrobras in raw material industries, but also in cutting-edge industries such as the case of Embraer in aviation. Today countries like Peru and Colombia, heavily dependent on raw materials, are adding their voices to the debate about whether or not to create sovereign wealth funds. They could look to Chile to design strategies, but also further afield, to the Emirates, Singapore and Malaysia, and think of a scheme that would also enable them to set up a strategic fund, something that Chile itself could consider too.

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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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