New group of investors stamp their authority
Asian funds are ranked high for their level of transparency
By William R Thomson
Sovereign wealth funds (SWFs) are large pools of state owned or controlled capital invested internationally. The first SWF created was the Kuwait Investment Authority in 1958 designed to invest the surplus foreign exchange reserves of the kingdom to create an income stream to support the population when the oil revenues ran out. Its net assets today are over US$230 billion. Other oil producing countries in the Middle East and elsewhere followed by creating such multi-generational funds as their foreign exchange reserves swelled far beyond their current investment capacity or needs. The largest one is the Abu Dhabi fund with assets in excess of US$450 billion. Singapore was the first Asian country to create overseas investment funds with the establishment of GSIC and Temasek in the 1970s.
Whilst a few such funds based on oil or commodity earnings have existed for several decades, it was the explosion of the foreign exchange reserves of the Asian export tigers that led to their wide-spread creation in the decade after 2000 and the naming of this class of fund as a Sovereign Wealth Fund. These swollen reserves were the direct result of their policy decisions to self-insure against a repeat of the 1997 Asian crisis which forced three countries to turn to the IMF for assistance and follow its diktats, something that was deeply distressing and politically destabilising. With reserves far beyond their current needs they determined to achieve better investment returns through these specialised investment vehicles.
The weakness of the US dollar since 2000, as a result of its deficit financing and loose monetary policy whilst waging two major wars, has further increased the need of Asian developing countries to diversify their investments by asset class in order to stand a reasonable chance of producing a real return over time. This need has increased as a result of the global financial crisis since 2008.
Park (ref 1) shows that developing Asia’s reserves grew from 13% of GDP in 1990 to over 40% of Asian GDP in 2008; they are still higher today. During the same period the reserves of developing Asia (excluding Japan) has grown in the same time from 22% global reserves to over 50%, with China being the largest with reserves presently estimated in excess of US$2,500 billion.
The list of Asian SWFs is shown in Table 1. In addition, India is actively considering the establishment of a fund with an initial capitalisation of US$10 billion. Thailand has also mulled the question from time to time but does not presently have any active plans to start one. In addition to the SWFs shown, many countries have established pension funds that invest a portion of their funds internationally. The key difference is that pension funds tend to be more domestically focussed and more restrictive than SWFs in their choice of asset classes for their international investment. SWFs can be opportunistic with a greater proportion of their funds as was shown during the crisis.
SWFs became a political issue in the developed world before the financial crisis because of a lack of transparency on their holdings and investment policies and, to a degree, xenophobia about having strategic assets being controlled by foreigners. The US was most guilty of this, constructing strategic in the broadest manner, and being happy to purchase real assets from the exporting countries but throwing roadblocks against domestic investment by them (especially China and the Middle East) other than US Treasury paper. Dubai Ports was the classic example of this paranoia in action.
To deflect criticism and protect their investments the SWFs, with the assistance of the IMF, the World Bank and the OECD, developed a set of investment standards known as the Santiago Principles. This has led to a scoreboard of Generally Accepted Principles and Practices of SWFs to be overseen by the International Forum on SWFs. The objective of the exercise is to develop high quality best practices for SWFs with an emphasis on full transparency and good corporate governance of their investment practices. The gradual adoption of these Principles by many SWFs together with their usefulness when many funds came to the rescue of major corporations - such as Morgan Stanley, Citibank and Barclays - at the height of the crisis has diffused the criticism of them in the US.
The gold standard of transparency is accorded to the Norwegian Global Pension Fund with about US$400 billion in AUM. Truman (ref. 2) ranks SWFs and pensions funds on a scale of 1 to 100 according to the extent they are following the Santiago Principles. As shown in Table 2, Norway has a score of 96 whilst the Asian SWFs vary from a high of 80 or more for Temasek and the Timor Leste Petroleum Fund down to 28 for the Brunei Investment Agency. Truman categorises a score of 80 or above as excellent and below 30 as unsatisfactory. This group consists mainly of Middle Eastern and African funds.
Total global assets controlled by all SWFs are variously estimated in excess of US$3 trillion with Asian SWFs amounting to almost US$1 trillion.
China and Singapore have had the most visibility in their investment activities as well as the bulk of Asian SWF assets and CIC has been more active as it has filled its portfolio.
The CIC’s portfolio distribution in June 2010 was as follows:
Listed equities: 25%
Special situations: 18.9%
Fixed Income: 18%
Hedge Funds: 9.4%
Inflation Protected 8.8%
Cash: 7%
Private equity: 7%
Other Assets: 4.3%
CIC aims to have a broad investment horizon that is global in nature. In the past year it has stepped up its investments in energy and other natural resources, including in the global power company AES Systems, Chesapeake, the Russian Nobel Oil company and Teck Resources of Canada. Latin America and emerging markets in general are reportedly receiving enhanced focus. In the past year, CIC also took a 40% share in CITIC Capital, the investment management arm of CITIC and its first investment in a Chinese asset management company. Going forward, it is aiming to manage its investments in developed markets in-house as it steadily builds its capacity.
A further capital injection from the Government has been requested which would expand CIC’s reach in global markets.
The imbalances in the global economy remain severe with much of the developed world in a period of very sub-par growth as a result of their need to rebuild the health of their financial systems. This is a process that could be extended, much as happened in Japan after its bubble burst in 1990.
One of the probable responses by the US is to attempt to force an adjustment in the terms of trade with Asia by depreciating its currency further through a new round of quantitative easing. This will only increase short-term tensions with a China that wants to maintain its export competiveness and does not want to lose on its US Treasury investments. However, for the medium term through 2015 China wishes to increase domestic consumption from 35 to 45% GDP. This would ease its current account surplus and possibly mean that CIC’s net assets would have to grow organically rather than through fresh injections from the government.
SWFs, in general, should remain important sources of liquidity for global markets. They should grow organically but further injections from governments will depend on the extent that these global imbalances and record commodity prices are maintained.
References:
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Asia’s Sovereign Wealth Funds and Reform of the Global Reserve System D. Park and A. Rosanov Asian Development Bank April 2010 http://aric.adb.org/grs/papers/Park.pdf
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Sovereign Wealth Funds: Threat or salvation? Edwin Truman Peterson Institute for International Economics Sept 2010