If oil stays in the 60s -- and if China isn’t willing to buy Agencies, let alone riskier assets -- sovereign funds are not going to be the kind of force in the global economy that many forecast earlier this year. The investment banks are now busy revising their forecasts for the growth of sovereign funds down.
Nonetheless, sovereign funds are not going to disappear entirely, so understanding their various investment strategies remains important. In my view, the common argument sovereign funds are inherently passive, long-term investors interested mostly in financial returns oversimplifies.
For a recent example of this argument -- one that happened to catch my attention -- consider a recent column from Bloomberg’s Michael Sesit:
These funds represent the excess reserves of countries with large current-account surpluses and/or major oil exporters. They are overwhelmingly invested outside their domestic markets and so far have been managed passively, without political bias, to achieve enhanced returns.
No doubt some sovereign funds are invested passively and without political bias. Norway’s fund certainly invests passively, and its "political bias" is very transparent. The Abu Dhabi Investment Authority, Singapore’s GIC and the Kuwait Investment Authority all seem to focus primarily on managing a passive external portfolio -- though in all three cases a lack of transparency makes it hard to know for sure. The KIA is certainly under pressure to do more to support Kuwait’s own market. The scale of the GIC’s investments in the financial sector also at least raises the question of whether the GIC’s strategic is evolving to include taking strategic states that might help to support Signapore’s own ambitions as a financial hub.
But many other funds invest both at home and abroad. Any many aren’t just passive investors either.
Singapore’s Temasek, for example, originally had some similarities to France’s proposed sovereign fund: it managed the Signapore’s strategic stakes in its large domestic firms. And it clearly takes large strategic stakes when it invests abroad.
Many new funds also invest at domestically as well as external stakes. The CIC is still a work in progress. But it certainly has large stakes in a sector that China considers strategic (i.e. the state banks) as well as a foreign portfolio. It recently took a significant stake in the Agricultural Bank of China as part of that bank’s recapitalization. In that sense it doesn’t seem all that different from the French fund Sesit criticizes.* The CIC’s external investment strategy isn’t clear from the investments it has made to date, as most of its portfolio apparently remains in cash. But so far it hasn’t shied away from doing big "deals" that involve taking significant stakes in key companies. It hasn’t limited itself to investing in passive index funds.
Some of the new Gulf funds also seem rather keen on doing strategic investments -- and in blurring the line between foreign and domestic investment.
For example, the Qatar Investment Authority owns Qatar National Bank, and it recently took large stakes in Qatar’s other banks as part of their recapitalization. Its real estate arm Qatari Diar is active in Qatar as well as abroad. And it clearly isn’t adverse to large strategic stakes; just look at its current investment in Barclays. Or for that matter, just look at its website.
Most of Abu Dhabi’s new funds also seem rather more keen on taking strategic stakes that ADIA. Mubadala is an obvious example. Part of its mandate is to make strategic investments that help develop and diversify Abu Dhabi’s economy. Look on its web site: it describes itself as a business development firm as well as an investment firm and its mandate as economic diversification as well as financial return. Some of Abu Dhabi’s large state-owned firms are increasingly taking large stakes abroad as well -- leading some to consider them mini-sovereign funds.
And then there is Russia’s sovereign fund. It might initially have been designed as a vehicle for making passive investments abroad. But it looks more and more like it will be used to pay off the external debts of key Russian companies, and thus keep them out of the hands of their foreign creditors. It certainly has been given permission to invest in the local stock market to help offset sales by foreign investors.
In a lot of ways it seems -- at least to me -- that if anything the trend in the sovereign investing world is away from the passive diversified style of some of the older more-established funds and toward the deal-making style of some of the new funds.
Here I may be focusing too much on Abu Dhabi and Qatar. Then again, if oil prices stay low and a host of emerging economies remain cut off from international capital markets, Abu Dhabi and Qatar may be among the few countries that still have the cash flow needed to be adding assets to their funds.
Setting China aside of course.
China could create a much bigger CIC quite easily. All it needs to do is hand the management of more of its current stockpile of reserves over to the CIC. That though seems unlikely to happen in the near term, if for no other reason than the fact that the CIC still hasn’t invested most of its initial allocation.
I suspect that the reduced pace of growth of key sovereign funds over the next year will reduce the attention that they receive. But if the debate on sovereign funds continues, it would be nice to debate sovereign funds as they are -- in their full diversity -- rather than focus on a model that only applies to some funds. France’s proposed new fund no doubt reflects France’s own penchant for state capitalism. But most of countries that have large sovereign funds that invest abroad also have something of a penchant for "state capitalism." Their domestic economies look a lot more like the Anglo-Saxon stereotype of the state-guided French economy than the French economy itself.
There are concerns that come even with sovereign funds that have passive investment strategies. For example, even passively managed sovereign funds can emerge from policies -- like excessive intervention in the foreign exchange market -- that inhibit needed adjustments in the global economy.
But much of the concern about sovereign funds arises because governments that invest strategically at home seem interested, on occasion, in taking strategic stakes abroad.
* There is one difference: China often has used foreign exchange reserves to help recapitalize its domestic banks. This though is a reflection of the fact that China has a lot reserves. It is perfectly possible to recapitalize domestic banks without having any foreign exchange reserves. Just ask Hank Paulson.