Funding the Future

Funding the Future

Not so long ago sovereign wealth funds (SWFs) were viewed with a good deal of mistrust. Today, while not without challenges, they are considered potential saviors for a rattled global economy. What changed?

Better communication between fund managers, the investor community, and governments. Many funds have embraced the Santiago principles — the code of best practices developed by the IMF and the International Forum of Sovereign Wealth Funds that address legal issues and transparency, which has led to greater comfort on the part of countries in which SWFs have investments. Also, we have seen very prominent funds apply very professional standards to their investments, allaying fears that their governments are guiding the funds.

The crisis of 2007–08 was also quite influential. Major financial institutions, banks, and insurance companies badly needed recapitalization, and they began to seek out SWFs, which were often the only funds willing to contemplate such investments. While the funds have lost money to date as large, long-term investors, they are no longer unappreciated as a natural source of capital for large institutions.

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Can SWFs play the same role with the Eurozone crisis?

If you are a reserve fund, as SWFs are, government debt is a very attractive investment because it’s safe. But the Eurozone crisis makes these investments less liquid and less safe, and SWFs have been holding a lot of Eurozone debt. Many SWFs are outside the Eurozone, and it’s a big and natural clientele: they have a very long investment horizon and are naturally placed to absorb these shocks. So if you want insurers for global capital markets, that’s a very natural place to be — although those investments don’t look great in the short run, and the fund managers have begun to understand that they should not invest quite so much in government debt.

The book reflects the proceedings of a conference held last year, Sovereign Wealth Funds and Other Long-Term Investors: A New Form of Capitalism, a joint effort between the Commitee on Global Thought at Columbia and the Sovereign Wealth Fund Research Initiative of University Paris Dauphine. What does “a new form of capitalism” mean?

Capitalism has been associated with capital and financial markets where the primary sources of capital have been private rather than public. New players — they are few but large — are public entities with different time horizons, capabilities, and objectives. The Norwegian fund’s objective, for example, is wealth preservation for future generations of Norwegian citizens. Its managers have to ask: what risks is a typical Norwegian in a future generation exposed to? How do you hedge against those risks? How do we invest to maximize wealth in the long-term? That’s the financial dimension.

There is also the social dimension: to the extent that the representative Norwegian citizen is concerned with, for example, climate change, that concern must be also taken into account in the funds’ investment choices.

I use Norway as an example because among critics of SWFs, who would be afraid of Norway? Yet the objectives of the Government Investment Corporation (GIC), the Chinese fund, like Norway’s, include socially responsible investing and avoiding armaments and tobacco. I would not say it is consistent across funds — and we don’t know the composition of many SWF portfolios — but even if we look at just a handful of funds, the total assets under management are enormous. If a large fund shies away from stocks it views as socially irresponsible, that has an effect.

SWFs are known for passive investing and what some have characterized as “excessive prudence.” Is this attributable to the double standards and regulatory hurdles that the funds face?

Some of it is. If a fund wants to conduct long-term investment and potentially increase risk, it must have staffing, which remains quite small [at most SWFs], though they are growing larger quickly. That is probably as important an obstacle as regulatory challenges. Consider one older example involving GIC: when GIC took a position in Morgan Stanley, they took up to 6 percent of equity. It was nonvoting and it was only on that basis that they could take a stake. Who else would agree to take 6 percent stake in an investment bank without having voting power or board representation?

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