15 August 2011
Sovereign wealth funds’ investments are based not on politics but sound economic factors, say Dale Gabbert and Olivier s’Jacob
Sovereign wealth funds (SWFs) are not a new phenomenon. The first SWF was established more than 50 years ago, but they attract more interest now than ever. This is both because of their sheer scale - the Gulf-based SWFs alone are thought to control assets equivalent to those of the entire hedge fund industry - and a number of high-profile transactions in recent years.
Detractors often incorrectly assume that SWFs are a homogeneous group of investors. Although an SWF is, in generic terms, an investment vehicle with authority to invest the assets of a nation, such institutions range from central banks to state-owned companies and include stabilisation funds, savings funds and state pension funds.
Although the typical SWF might be thought to hail from an oil-rich nation, according to the Sovereign Wealth Fund Institute’s rankings, only four of the top 10 SWFs by assets under management are funded through oil reserves.
Not only is each SWF funded differently but they have differing strategies. For example, some invest predominantly in their own region or in a single asset class, while others operate like global investment houses. Although some are not afraid of taking active stakes in overseas businesses, most are relatively passive investors, especially in relation to their private equity investments.
The increased prominence of SWFs as players in the global economy occurred just as the downturn hit the financial markets. Some cannily used this opportunity to acquire assets at knock-down prices, as they were able to make acquisitions without taking out debt finance.
SWFs have been a source of stability in the global economy in the past few years, as they have been able to provide much-needed funding to businesses while the banking and private equity industries have been on the ropes. Indeed, since May 2007, SWFs have acquired interests in excess of $60bn (£36.7bn) in large global banks, potentially saving them from collapse.
Although these are obviously high-impact transactions it is important to bear in mind that SWFs still form a relatively small proportion of the global investment industry.
Critics often cite SWFs’ perceived lack of transparency and the fear that their investment activity may be politically motivated. In practice, it is hard to find examples of this and, where a SWF’s investment approach is informed by political considerations, these tend to be non-contentious motivations such as boosting local infrastructure or jobs.
In addition, most SWFs are relatively passive, not seeking board representation or management control. They take a long-term approach to investment based on economic factors rather than seeking strategic advantage. Having proper systems and controls is something they take seriously.
It is clear that their decision-making process is thorough and involves experienced professionals acting in ways little different to those of typical investment banks or fund managers. Why would SWFs go to these lengths if their investments were simply part of a wider political agenda?
Although the governing bodies of many SWFs include politicians they are usually there in a supervisory capacity, guiding issues such as overall policy and risk tolerance, and rarely getting involved in individual investment decisions. A 2008 IMF report failed to find clear evidence that SWF investments were motivated by narrow political objectives.
Trend towards transparency
Unease with SWFs springs from a number of sources, not least a lack of understanding. In part this is because they did not position themselves for the press attention they have received in recent years. As non-commercial players in a commercially driven market they have had to play catch-up in positioning themselves in the eyes of the investment community and the media.
That process is now underway and SWFs are beginning to show their credentials as responsible investors, cooperating with the IMF to carve out a voluntary code under what are known as the Santiago Principles. As well as this communal effort there is a trend towards transparency on an individual basis. The Abu Dhabi Investment Authority published its first annual review in 2010 and a significant number of other SWFs now do likewise.
This, coupled with the widespread adoption of the Santiago Principles, is sure to encourage a more frank and open dialogue, and remove some of the unhelpful mystique surrounding these investors.
In the meantime, detractors should not overlook the positives of SWF investment and respect the right of all nations to invest their resources and seek to secure financial stability for future generations.
Dale Gabbert and Oliver s’Jacob are partners at Reed Smith