The Contributions and Impact of Sovereign Wealth Funds
Meeting Proceedings
Kogod School of Business
American University
Washington, D.C.
October 9, 2014
CONTENTS
Meeting Planning Committee 2
Acronyms 2
Executive Summary 3
Presentation Summaries 4
Conclusions and Next Steps 8
Appendices
Appendix I: Meeting Agenda 10
Appendix II: Brief about Kogod School of Business 11
Appendix III: Copies of Speakers brief biographies 12
Appendix IV: List of Speakers 15
Appendix V: Remarks by Ghiyath Nakshbendi 16
Appendix VI: Remarks by Amb. Mohammed Al Kuwari 23
Appendix VII: Sovereign Wealth Fund: Evolution and Outlook 25
Appendix VIII: The Great Reallocation-Sovereign Wealth Fund-Annual Report 2013 49
Appendix IX: The Fundo Soberano De Angola-FSDEA 83
Appendix X: Italy’s Quest for Sovereign Fund Link-Ups 93
Appendix XI: Sovereign Wealth Funds: Aspects of Governance Structures and Investment 96
Management
Appendix XII: Write-up and Photo Slideshow from the Sovereign Wealth Funds Conference 130
Sponsors:
Embassy
of Bahrain
Embassy
of Qatar
Kogod School
of Business
American
University
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MEETING PLANNING COMMITTEE
Ghiyath Nakshbendi (Co-Chair)
Jeff Harris (Co-Chair)
International Business Department:
•
Frank DuBois
Budget:
•
Mindy Schuster
Marketing & Communications:
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Hadear Abdou
Laura Caruso
Lara Kline
Jackie Zajac
Admin. Services:
•
Rene Kauder
Conference Assistant:
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Charlotte Goodenow
Research Assistant:
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Faisel Irshad
ACRONYMS
SWFs
KSB
AU
IFSWF
KIA
SWFI
Sovereign Wealth Funds
Kogod School of Business
American University
International Forum of Sovereign Wealth Funds
Kuwait Investment Authority
Sovereign Wealth Fund Institute
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2!
EXECUTIVE SUMMARY
American University’s Kogod School of Business (KSB) convened a conference on the
Contributions and Impact of Sovereign Wealth Funds (SWFs) on October 9, 2014 at American
University (AU) in Washington, D.C. The purpose of the conference was to assess the
contributions and impact of Sovereign Wealth Funds on the world economies. The major theme
was the stabilizing role of SWFs in the world economies and twelve speakers presented papers
and remarks. The conference was supported by the Embassies of the State of Qatar and the
Kingdom of Bahrain to the United States of America, also, by Kogod School of Business and
American University.
Sovereign Wealth Funds are playing a more important role in the world economy than ever
before. The World Bank helped major SWFs to produce rules and regulations for the
management of these funds (Santiago Principles). The former World Bank president, Mr. Robert
B. Zoellick, argued that SWFs could help in addressing some of the world problems stemming
from the financial crisis by investing up to 1% of their assets in Africa and emerging economies.
The proposed international conference (”Conference”) is planned to address these issues and
assess the impact of these funds on the world economies in the next decades.
The speakers represented major institutions that deal with the issues under consideration.
Notably, Sovereign Investment Lab at Universita Bocconi, the Board of Governors of the
Federal Reserve System, The Brookings Institution, Council on Foreign Relations, US-Qatar
Business Council and the law firm of Squire Patton Boggs. That is in addition to researchers
from Georgetown and American Universities. The participants in this boutique conference
represented private equity corporations, major international banks, major investment companies,
think tanks and academic institutions.
SWFs, according to the International Monetary Fund, “are a special purpose investment fund or
arrangement, owned by the general government. Created by the general government for
macroeconomic purposes, SWFs hold, manage, or administer financial assets to achieve financial
objectives, and employ a set of investment strategies, which include investing in foreign
financial assets. SWFs are commonly established out of balance of payments surpluses, official
foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts
resulting from commodity exports.”
For obvious reason, SWFs were to be discussed by those who are involved in the operation of
these funds from owners to managers and other interested entities. Academics are not typically
engaged in the topic due to lack of sufficient data. Historically most owners, as part of
government concerns, keep SWF information very private. That was all changed more recently
with the formation of a voluntary association among some of the SWFs. Over the years,
ideologies were drafted and in 2007 were titled the Santiago Principles. Since then, SWFs have
been assessed based on the implementation of these principles. Most recently, a formal
secretariat for these SWFs has been formed, known as The International Forum of Sovereign
Wealth Funds (IFSWF).
The activities of SWFs are becoming more transparent due to changes in technology and the
media. Whenever a SWF acquires a position in an investment, the news will circulate and be
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published. In 2005, a private entity, the Sovereign Wealth Funds Institute (SWFI), was formed
to single-handedly take on the role of gathering information and publishing data related to the
activities of SWFs. This development, coupled with an increasing interest on the part of the
financial community to learn more about SWFs, created increased interest in the subject. There
is a need in academia to promote understanding of the SWFs in order to further cultivate interest
in research and above all, engage graduate and undergraduate students in learning about SWFs to
further generate employment possibilities.
PRESENTATION SUMMARIES
Opening Remarks
Dr. Ghiyath Nakshbendi, Kogod School of Business, International Business
Department, American University
The remarks focused on the following aspects:
•
Three objectives of this conference are:
1. To start a conversation in academia, including professors and students, about
SWFs and their importance in the world economy.
2. To assess the impact of these funds on capital markets, and
3. To learn about the latest changes in its operations.
•
The definition of SWF, according to the International Monetary Fund, is referred to as the
following: “SWFs are defined as a special purpose investment fund or arrangement,
owned by the general government. Created by the general government for
macroeconomic purposes, SWFs hold, manage, or administer financial assets to achieve
financial objectives, and employ a set of investment strategies, which include investing in
foreign financial assets. SWFs are commonly established out of the balance of payments
surpluses, official foreign currency operations, the proceeds of privatizations, fiscal
surpluses, and/or receipts resulting from commodity exports.”
The three major characteristics are:
1. Public ownership,
2. Long term horizon and above all,
3. Heterogeneous assets.
More countries are establishing SWFs, and there is a need to have excess cash resources,
as well as strategic planning.
The relationship between the SWF’s type and its purpose is essential.
The need to have guidelines to run the SWF should be altered to appease the current
administration.
Cited the role of Kuwait’s SWF (KIA), to providing for its citizen and country during the
invasion by Iraq in 1990.
Highlighted the importance of the strategic asset allocation and considering the fund as a
long term investor.
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While there is a need for external managers to cover certain regions, sectors, sub-sectors
and even the new modes of investment, at the end of the day, promoting the capabilities
of its own nationals should be one of the priorities of managing the SWF.
Going forward, we need to become more familiar with a very active organization, The
International Forum of Sovereign Wealth Funds (IFSWF). IFSWF is a voluntary group
of Sovereign Wealth Funds (SWFs), which will meet, exchange views on issues of
common interest, and facilitate an understanding of the Santiago Principles and SWF
activities. There are 24 members of the group ranging from Angola to the United States.
There are 24 Generally Accepted Principles and Practices (GAPP) of SWFs. These
principles focus on having a proper legal framework and a clear policy purpose,
consistent with the overall macroeconomic policies of the country. Many of these
principles emphasize the need for public disclosure and follow the international or
national standards of accounting and auditing. One of the issues is that dealings with
third parties should be based on economic and financial grounds.
The Sovereign Wealth Fund Institute, a private organization, listed 75 SWFs on its
website, with a total market value of $6.6 trillion (source).
More and more countries are establishing SWFs and joining the rank of nations that are
focusing on improving operations and participating in the world-wide management of
these resources.
Dr. Carol Bertaut, Chief of the Global Financial Flows section in the International
Finance Division of the Board of Governors of the Federal Reserve System
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There is no common definition of sovereign wealth funds.
Many SWFs are focused on stabilization.
In general, SWFs are more aggressively invested in areas like real estate.
Out of the $150 trillion in total world investment, $5-6 trillion is by SWFs, but there
is huge growth and they are becoming increasingly important.
Prior to mid-2000, not much attention was paid to SWFs.
There are questions concerning the lack of transparency, asset allocation, political
motivation and in general, there is not a lot of information available on SWFs.
Measures were taken by Ted Truman’s scoreboard.
The Santiago Principles have lead to more transparency.
Without transparency, there is more opportunity for corruption, fear for politically
motivated investment - especially for FDI and concern for recipient countries.
Most of SWFs have professional asset managers, and they are aware of their impact
SWFs should not be thought of as being source of “new capital.”
Keynote speaker #1
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Panel A: Sovereign
Wealth Funds
Structure, Operations,
and Challenges
Moderator: Prof. John Willoughby, College of Arts and Sciences, Economic
Department, American University
Dr. Celeste Cecilia Moles Lo Turco
Dr. Amadou Sy, Non-Resident Fellow, The Brookings Institution
Dr. Amin Mohseni-Cheraghlou, College of Arts and Sciences, Economic
Department, American University
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SWFs have been very active since the 2008 financial crisis.
Some put part of their portfolios in sustainable investment, such as refugees assistance,
Infrastructure, etc.
There is a lack of follow-up on some investments to follow-up on ethical issues and
guidelines.
There is a correlation between country governance and the transparency of its SWF.
Wealth of nations is not just reserves; it’s also human capital and infrastructure.
The Norwegian model is not applicable to all countries.
While China has 4% of the world SWFs investments, it attracted 6% of the funds.
Investments. Also, in China there is less interest in transparency because most of its
investment is domestic.
If funds are based on oil money, SWFs typically invest in liquid assets.
SWFs investments increase confidence and motivation for other funds to invest.
Director, Sovereign Investment Lab, Universita Bocconi, "The Great Reallocation: recent
Dr. Bernardo Bortolotto trends in global SWF investment"
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There is secrecy behind where SWFs are invested.
There is a deceleration of growth in emerging countries (2013) and a
slowdown in growth of foreign currency reserves.
There is a slowdown in investment activity along with a change in allocation
and a decrease in value.
There was a $50 billion in investment by SWFs in 2014.
There has been a steady increase of “safe” investment, such as real estate,
infrastructure, hotels, etc.
There is a bias towards developed markets.
State of Qatar was the top SWF investor this year with almost 30% of the
total investments.
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Keynote Speaker #2
Panel B: Sovereign
Wealth Funds Future
Outlook
His Excellency Patrick Theros, Ambassador of the State of Qatar
(Replaced H.E. Amb. Mohammad Al Kuwari in his emergency absence)
• Qatar Investment Authority (QIA) was officially designated in 2005 as a
SWF, which was followed by Qatar Petroleum International among others.
• The goal of Qatar is to reduce gas and oil dependency.
• The plan is to make investments that are non-political and non-partisan.
• There is a desire to invest in US infrastructure, technology and
communication.
• Qatar provides scholarship funds and employment quarantines to its citizens.
• Real estate is considered a safe investment.
• Building a skill set in Qatar is important because it is a financial hub.
• The U.S. will be a focus of Qatar investment in the future.
Moderator: Dr. Robert Kahn, Senior Fellow for International Economics, Council of
Foreign Relations
Amb. Patrick Theros, President and Executive Director, US-Qatar Business Council
Mr. Greogry Davis, Partner, Squire Patton Boggs
Mr. Wilmot Allen, Managing Partner, 1 World Enterprises
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What is the future of Sovereign Wealth Funds?
More deals will be made without advisors; more investments will be made in
developing countries and the Middle East. SWF will be more careful with its
investments, and will use strategic political objectives, as well as strategic
economic objectives. Some SWF portfolios will look into investments in
technology, while others will simply be interested in economic return.
There are many more business opportunities in the United States than in
Eastern Europe or China. There should be more long-term investments in the
U.S. The U.S is more experienced in dealing with developed countries.
There are a lot of changing landscapes in sub-Saharan Africa. This allows it
to be the perfect environment for investments. There is a lot of opportunity
for return on investment on the sub-national level by large firms. There are
also many opportunities for citizens to grow and develop and have a greater
participation in emerging markets as well as to participate in a growing
global economy. These opportunities will come about over the next 25-50
years.
Countries will often use economic tools to support geopolitical investing.
SWFs will look towards intangibles such as economic security and
governmental security in countries where communism has fallen. Many
Qatari investments have gone into unstable Middle Eastern countries. Saudi
Arabia misjudged Syria and put a lot of money into the Syrian government.
You can’t avoid having a political component to investing SWFs.
Political investments actually help to stabilize relationships between the
countries involved.
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Closing Remarks
There has always been a concern about state actors investing in the U.S.
There is a movement towards a world where it is harder for SWFs to make
large scale investments.
Geopolitical tensions arise when sovereign investors become concerned with
their reputations.
The best way to deal with investors is to always treat them like a private
investor and make sure that they are operating under the proper rules. There
is a strong likelihood that there will soon be a SWF international conference.
The Rule of Law is extremely important. When sanctions are imposed on a
country, it strikes fear in other investors in that country. Changing the rules
of the game creates unwanted side effects in the market. No one wants to
“put boots on the ground”, but going to economic war can be just as bad.
Stronger penalties imposed on countries will help self-policing. Political ties
can act as a buffer for cooperation between countries.
Sanctions against Russia creates uncertainty on future capital flow. In the
SWF context, significant tightening of capital flow is being seen as
successful.
Conflicts between state and non-state actors can influence economic
integration. States are not looking for non-state actors as allies.
Benchmarking and analytics are in high demand.
Dr. Jeff Harris, Kogod School of Business, Finance & Real Estate Department,
American University
[Oral remarks]
CONCLUSIONS AND NEXT STEPS:
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There is a need to learn more about SWFs and start a conversation about
SWFs in academia, and mostly to appreciate the importance of SWFs in the
world economy.
The basic premise of having a SWF is to act as a long term investor for the
benefit of the country.
The Santiago Principles paved the way for more transparency in the world of
SWFs. Also, it is worthwhile to follow the activities of some these major
funds through The International Forum of Sovereign Wealth Funds (IFSWF).
External managers are crucial to the success of the SWFs and they should
help out with promoting the field and sharing their knowledge with the
communities.
The Generally Accepted Principles and Practices (GAPP) of the SWFs
should be modified and updated to reflect the changes in this arena.
The Sovereign Wealth Fund Institute, a private organization, is a good source
of information and its activities should facilitate updating the data on SWFs.
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•
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•
•
•
•
•
•
•
•
More and more countries are establishing SWFs and joining the ranks of
nations that are focusing on improving operations and participating in the
world-wide management of these resources.
In general, SWF is more aggressively invested in areas like real estate. Out of
the $150 trillion in total world investment, $5-6 trillion is by SWFs, but there
is a huge growth and they are becoming increasingly important.
SWFs should not be thought of as being source of “new capital.”
SWFs investments increase confidence and motivation for other funds to
invest.
There is a deceleration of growth in emerging countries (2013) and a
slowdown in growth of foreign currency reserves. Also, there is a slowdown
in investment activity along with a change in allocation and decrease in
value.
A steady increase of “safe” investments, such as real estate, infrastructure,
hotels, etc.
There is a bias towards developed markets.
Qatar’s plan is to make investment which is non-political and non-partisan.
There is a desire to invest in US infrastructure, technology and
communication.
More deals will be made without advisors; more investments will be made in
developing countries and the Middle East. SWFs will be more careful with
investments, and will use strategic political and economic objectives. Some
SWF portfolios will look into investments in technology, while others will
simply be interested in economic return.
Political investments actually help to stabilize relationships between the
countries involved.
There has always been a concern about state actors investing in the U.S.
There is a movement towards a world where it is harder for SWFs to make
large-scale investments.
Geopolitical tensions arise when sovereign investors become concerned with
their reputations.
The best way to deal with investors is to always treat them like private
investors and make sure that they are operating under the proper rules. There
is a strong likelihood that there will soon be a SWF international conference.
It is very imperative to have a yearly conference dealing with the changes
that are taking place in the area of SWFs and to also activate the conversation
about SWFs in colleges and universities, especially among professors and
graduate students.
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Appendix IV- List of Speakers:
1. His Excellency Mohammad Al Kuwari, Ambassador of the State of Qatar (Keynote Speaker).
2. Mr. Wilmot Allen, Managing Partner, 1 World Enterprises .
3. Dr. Carol Bertaut, Chief of the Global Financial Flows section in the International
4. Finance Division of the Board of Governors of the Federal Reserve System (Keynote Speaker).
5. Dr. Bernardo Bortolotto, Director, Sovereign Investment Lab, Universita Bocconi (Keynote Speaker).
6. Dean Erran Carmel, Dean, Kogod School of Business, American University
7. Mr. Greogry Davis, Partner, Squire Patton Boggs
8. Dr. Jeff Harris, Kogod School of Business, Finance & Real Estate Department, American University
9. Dr. Robert Kahn, Senior Fellow for International Economics, Council of Foreign Relations (Moderator).
10. Dr. Amin Mohseni-Cheraghlou, College of Arts and Sciences, Economic Department, American University.
11. Dr. Ghiyath Nakshbendi, Kogod School of Business, International Business Department, American University.
12. Prof. John Willoughby, College of Arts and Sciences, Economic Department , American University (Moderator).
13. Dr. Amadou Sy, non-Resident Fellow, The Brookings Institution.
14. Amb. Patrick Theros, President and Executive Director, US-Qatar Business Council (Keynote Speaker)
15. Dr. Celeste Cecilia Moles Lo Turco
Appendix V: Remarks by Ghiyath Nakshbendi
Welcome to the conference
Ghiyath Nakshbendi
Good morning, I am Ghiyath Nakshbendi of the International Business Department at American
University’s Kogod School of Business.
Welcome to the 2014 Sovereign Wealth Funds
Conference. We are going to have an exciting day dealing with a very interesting and timely topic
and we are looking forward to a very productive discussion. Please note that our discussions and
presentations are off-the-record and no recording of the sessions will take place. We will have a
digital book of the proceedings that will include all the articles, remarks, and presentations of the
conference, in addition to an edited summary of the panel discussions. The proceedings will be
sent to you via email in addition to posting them on the conference website.
Now, I have the distinct pleasure of introducing our Dean.
Prior to stepping up to become dean, Dr. Carmel was a tech professor at the school for over 20
years. He studies the globalization of technology work: global teams, global sourcing, and the
emergence of technology industries around the world. He has written three books including the
influential 1999 book "Global Software Teams" and, in 2005, one of the first books on offshoring:
"Offshoring Information Technology.
Ladies and gentlemen, please join me in welcoming Dean Carmel.
(Dean Carmel presented his remarks)
General Welcome: Dr. Nakshbendi continue the welcoming remarks
Good morning
Excellences, ladies and gentlemen and colleagues. Thank you for attending The Sovereign Wealth
Conference. We are very happy to have you at American University and would like to give a
special welcome to our guests who have travelled from overseas. I hope the jetlag is improving!
The timing of this conference is very crucial on two fronts.
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First, it comes at the beginning of the annual meetings of the IMF and World Bank, where leaders
who make the financial and economic decisions that affect the world will gather over the following
few days.
Secondly, we are celebrating the 60th birthday of Kogod!
Please allow me to to recognize the attendance of our distinguished guests, H.E. Mohammad
Al-Kuwari, the Ambassador of the State of Qatar, H.E. Antoinr Chedid, the Ambassador of
Lebanon. Unfortunately, H.E. Mohammad Al-Kuwari, the Ambassador of the State of Qatar,
will not be with us due to being outside the country on urgent business and he asked me to share
his best wishes to you and the conference. Also, I would like to recognize, His Royal Highness,
Prince Abdulaziz Bin Talal Bin Abdulaziz Al Saud..
Also, I would also like to acknowledge the generous support of the Embassy of the Kingdom of
Bahrain, the Embassy of the State of Qatar and Kogod School of Business for making this
conference possible by sponsoring the breakfast, lunch and networking receptions. Many thanks
for your support.
Furthermore, I would like to express my deep appreciation to two of my dear colleagues from the
International Monetary Fund, Dr. Abdulla Al Hassan, for helping at the early stage of the
conference planning, and Dr. Michael Papaioannou, for his council throughout. Unfortunately, we
missed having them as speakers at the conference, as they are traveling on official business with
the IMF, helping to set up another SWF in Asia!
Today’s major theme is the assessment of the impact of sovereign wealth funds on the world
economy. We can identify three objectives of this conference. Firstly, to start a conversation in
academia, including professors and students, about SWFs and their importance in the world
economy. Secondly, to assess the impact of these funds on capital markets, and thirdly, to learn
about the latest changes in its operations.
2
When I got involved in the field of SWFs, and working for the oldest sovereign wealth fund in
the world, the Kuwait Investment Authority, my understanding of its objective was to administer
the General reserve Fund (GRE) of the government, and manage The Future Generations Fund
(FGF). For years, when I talked about my two decades of work with the Gulf Cooperation Council
Countries (GCC), I talked about The Future Generations Fund That was until 2008, when
Professor DuBois, the chair of my department at Kogod, called for a town hall gathering at the
school to assess and comment on the “financial meltdown” at that time. While preparing my
comments for the event, I came to learn about the new name, which were now called, Sovereign
Wealth Funds.
So what is a sovereign wealth fund?
According to the International Monetary Fund, “SWFs are defined as a special purpose investment
fund or arrangement, owned by the general government. Created by the general government for
macroeconomic purposes, SWFs hold, manage, or administer financial assets to achieve financial
objectives, and employ a set of investment strategies, which include investing in foreign financial
assets. SWFs are commonly established out of the balance of payments surpluses, official foreign
currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from
commodity exports”.
The three major characteristics are:
Public ownership,
long term horizon and above all
heterogeneous assets.
As you know, more countries are establishing SWFs, and while there is no magic formula, there
is a need to have excess cash resources, as well as strategic planning. Certain countries with
available resources took longer than others to establish their SWFs, and some established more
than one.
3
Certainly, the class or type of an SWF is related to its purpose. Is it for pension reserve?
Development? Fiscal stability? Or something else? For each of these objectives, you need different
strategies. The common denominator is having an investment return target.
From my experience, the need for clear rules and policies starting with where you get the funding,
to where to spend it, if at all, to the actual process of withdrawals, are very crucial for the proper
running and management of a SWF. A cautionary note: these guidelines cannot and should not be
altered with changes in the administration! There are redlines that must not be crossed and policy
should enforce them.
Some SWFs pay the citizens of the country a yearly cash payment (usually a certain percentage of
its yearly profits). Alaska is an example, its residents get paid a certain amount per year from its
Permanent Reserve Fund. So here is an open invitation to move to that state!
A very unique case in history is when Kuwait was invaded by Iraq in 1990. According to various
news accounts, the State of Kuwait funded its citizens’ expenses while away in other neighboring
countries, Europe and the U.S. Some figures show that almost 40% of its SWF was disbursed to
cover these expenses, along with the cost of its liberation.
Kuwaiti leadership was far-sighted when the Kuwait Investment Office was established in London
in 1953, almost 8 years before its independence. the late Amir Sheikh Jaber Al Ahmad Al Jaber
Al Sabah, was the one who pushed for the creation of the The Future Generations Fund (FGF)
when he was the Minister of Finance under the Amir Sheikh Abdullah Al Salem Al Sabah, the
father of Kuwait’s the independence. Also, the vision of establishing KIA in 1982 was carried out
by Abdultaif Al Hamad, the former minister of finance and currently the Chairman and Director
General of Arab Fund for Economic and Social Development.
In addition to the above, while there are alternatives as to where to set up the proposed funds, a
separate institution is preferable. The decision making process is much easier even though there
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will always be monitoring from the board of directors, the house of parliament, the ministry of
finance and the alike. I think the most important element in running a successful fund is the
strategic asset allocation which is assessed and modified from time to time, but not too often,
keeping in mind my initial description of these funds as long term investors.
I became more convinced over the years, that SWFs should and must be run, ultimately by its own
citizens. Yes, there is a need for external managers to cover certain regions, sectors, sub-sectors
and even the new modes of investment. But at the end of the day, promoting the capabilities of its
own nationals should be one of the priorities of managing the SWF.
Going forward, we need to become more familiar with a very active organization, The
International Forum of Sovereign Wealth Funds (IFSWF). IFSWF is a voluntary group of
Sovereign Wealth Funds (SWFs), which will meet, exchange views on issues of common
interest, and facilitate an understanding of the Santiago Principles and SWF activities.
There are 24 members of the group ranging from Angola to the United States.
Initially, the International Working Group of Sovereign Wealth Funds (IWG), which is a
voluntary association of the SWFs, met in Kuwait City on April 5-6, 2009 and later
established the IFSWF.
There are 24 Generally Accepted Principles and Practices (GAPP) of the SWFs. These
principles focus on having a proper legal framework and a clear policy purpose, consistent with
the overall macroeconomic policies of the country. Many of these principles emphasize the need
for public disclosure and follow the international or national standards of accounting and
auditing. One of the issues is that when dealing with third parties it should be based on
economic and financial grounds.
A few days ago, the Chair of the IFSWF was responding to some issue concerning the
management of the SWFs, and he pointed out that, “Long-term investment focused on genuine
economic value stabilises global financial markets, as adequately demonstrated by the recovery
from the global financial crisis. As stable and long-term sources of investment capital, our
member SWFs can invest counter-cyclically and so offer liquidity to markets when other sources
are unwilling or unable to provide it”
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In addition to the IFSWF, whose secretariat moved to London recently, the Sovereign Wealth
Fund Institute, a private organization, listed 75 SWF on its website, with a total market value of
$6.6 trillion(source). The Institute identifies the source of the fund for its list, from oil (Norway,
Saudi Arabia and Kuwait), oil and gas (Qatar) and non-commodity (China and Singapore). In
terms of regions, it listed Asia with 40% followed by the Middle East of 35% and Europe of 17%
More and more countries are establishing SWFs and joining the rank of nations that are focusing
on improving operations and participating in the world-wide management of these resources.
We are all looking forward to our keynote speaker, the two distinguished speakers and to our two
distinguished panels to have a very fruitful and constructive dialogue. Please note that we are
going to have a Q&A after each panel and you are welcome to ask questions using the
microphone provided.
Now I want to review with you the proposed program.
SWF
Conference:
Updated
Tentative
Agenda
8:30-9:00
9:00-9:10
Registration
Welcome
9:10-9:20
Opening Remarks
9:30-10:00
Keynote speaker #1
Panel A: Sovereign
Wealth Funds
Structure,
Operations, and
Challenges
10:00-11:00
Breakfast Available
Dean Erran Carmel, Kogod School of Business, American University
Dr. Ghiyath Nakshbendi, Kogod School of Business, International Business
Department, American University
Dr. Carol Bertaut, Chief of the Global Financial Flows section in the International
Finance Division of the Board of Governors of the Federal Reserve System.
Moderator: Prof. John Willoughby, College of Arts and Sciences, Economic
Department , American University
Dr. Celeste Cecilia Moles Lo Turco
Dr. Amadou Sy, non-Resident Fellow, The Brookings Institution.
Dr. Amin Mohseni-Cheraghlou, College of Arts and Sciences, Economic
Department, American University
6
11:00-11:30
11:35-12:15
12:20-12:50
1:00-2:00
2:15-3:00
3:00-3:10
3:10-3:15
3:30-4:00
Coffee/Networking
break
Dr. Bernardo
Bortolotto
keynote speaker #2
Lunch
Panel B: Sovereign
Wealth Funds
Future Outlook
Closing Remarks
Conference
Adjournment
Optional tour of
Kogod School of
Business Financial
Services &
Information
Technology Lab
Coffee/Networking break
Director, Sovereign Investment Lab, Universita Bocconi, "The Great Reallocation
trends in global SWF investment"
His Excellency Mohammad Al Kuwari, Ambassador of the State of Qatar
Moderator: Dr. Robert Kahn, Senior Fellow for International Economics,
Council of Foreign Relations
Amb. Patrick Theros, President and Executive Director, US-Qatar Business
Council
Mr. Greogry Davis, Partner, Squire Patton Boggs
Mr. Wilmot Allen, Managing Partner, 1 World Enterprises
Dr. Jeff Harris, Kogod School of Business, Finance & Real Estate Department,
American University
Dr. Ghiyath Nakshbendi, Kogod School of Business, International Business
Department, American University
Now, it is my pleasure to introduce my colleague and the co-chair of the conference, Dr. Jeff
Harris, who will introduce our next speaker. Dr. Harris is the Gary Cohn Goldman Sachs
Endowed Chair in Finance and Chair of the Finance and Real Estate Department at Kogod. He
has an extensive background in market microstructure and regulatory issues. Dr. Harris received
his B.A. in Physics and an MBA from the University of Iowa and a Ph.D. in Finance from The
Ohio State University.
Thank you and please help me in welcoming Dr. Harris.
END of the remarks
10-09-2014
Appendix VI Remarks of H.E. Mohammad Al Kuwari
Remarks by H.E. Mohammad AL Kuwari-Ambassador of the State of Qatar to the United
States
7
At the Sovereign Wealth Funds 2014 Conference
Held on October 9, 2014 at American University, Washington, D.C.
Dr. Nakshbendi- Thank you for inviting me to the American University to speak at a forum
about something that has increasing relevance to the international financial system today.
The rise of sovereign wealth funds have been sudden and unexpected. The power equation
within the global economy, in this era of narrowing networks between nations and systems, are
shifting with far more fluidity than it did before.
I believe that this trend is no passing phenomenon. Rather, it has become a permanent fixture of
international financial relations.
New investors bring about a level of stabilizing force. They bring alongside them interesting,
alternative investment opportunities in emerging markets.
In this time of economic uncertainty, as the world begins to gradually recover from a major
downturn, the role of sovereign wealth funds have only become more important.
Qatar Investment Authority was founded by the state in 2005 not only to diversify the economy
but ultimately, to provide a coherent investment strategy for the country- at home and abroad.
Under the QIA, there are a number of vehicles which deals with a broad range of sectors like real
estate, technology, agriculture and sports.
The Fund has moved from the periphery to the center of global financial markets in a relatively
short amount of time, becoming increasingly more sophisticated and focused in a way that
supports the development of Qatar’s national economy.
Diversification remains a primary focus, as under Qatar’s National Vision, our goal is to reduce
our dependency on oil and gas revenues so that less than half of our GDP comes from
hydrocarbons by 2030. It is through the responsible deployment of the resources at hand that we
can build a knowledge-based economy and secure a successful future for new generations.
With more than $100 billion in assets with a global portfolio, our investments are entirely
nonpolitical and nonpartisan. We look towards alliances not only in the Arab world but in other
emerging economies. Our joint venture activities and investments set up $400 million in African
infrastructure, communication and energy sectors.
We worked with Vietnam’s State Capital Investment Corporation in 2008 to invest in
Vietnamese oil, port, infrastructure and property projects. We have partnerships and projects in
Europe, Asia and extensively in the United States- creating a wide network across industries like
financial services, healthcare, construction and real estate.
8
With this new central position, we understand that it comes with certain responsibilities. We
have put nearly $1 billion in humanitarian and government aid, going to over 100 countries.
These are projects to support education, women’s empowerment, sustainable development, and
increasing real opportunities for youth employment.
In the Arab world, Qatar has created a $100 million scholarship, given to students all over the
region to attend accredited universities with a guarantee of employment in Doha once they
graduate.
We are, as the trend is with the Arab sovereign wealth fund landscape, in a moment of profound
transformation. It is with strategic interests in mind that we are exploring investment
opportunities, in order to make Qatar the investment hub of the Middle East.
End of Remarks
9
Sovereign Wealth Funds:
Evolution and Outlook
Carol Bertaut
Division of International Finance
Board of Governors of the Federal Reserve System
American University Conference on
The Contributions and Impact of Sovereign Wealth Funds
October 9, 2014
The views expressed in this presentation are solely the responsibility of the author and should not be interpreted as
reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the
Federal Reserve System.
What are Sovereign Wealth Funds (SWFs)?
• No standard definition.
• IMF:
• Government-owned investment funds set up for a variety of macroeconomic
purposes.
• Commonly funded by the transfer of foreign exchange assets.
• Invested largely in foreign assets and for the long term.
• Examples:
• U.A.E. Abu Dhabi Investment Authority
• Norway Government Pension Fund
• China Investment Corporation
• But no commonly agreed upon set of funds to include.
10/9/2014
C. Bertaut Board of Governors
2
What are SWFs (cont’d)
• Some analysts exclude Saudi Arabian Monetary Authority (SAMA).
• Although capital largely generated from oil exports, SAMA also acts as Saudi Arabia’s central
bank.
• Difficult to differentiate SWF activities from central banking activities and standard FX reserves.
• Some include government pension funds such as California Public
Employees' Retirement System (CalPERS).
• Funded from employee and employer contributions, not foreign exchange assets.
• But government-run, and has similar long-term focus, and some assets invested internationally.
• And while many SWFs invest for the long run, some have an explicit
stabilization focus: to help buffer swings in government revenue owing to
changes in commodity prices.
• Chile Social and Economic Stabilization Fund
10/9/2014
C. Bertaut Board of Governors
3
Variability in source of capital for SWFs
• More than half of SWFs in terms of assets get funds from oil export
revenue.
• Capital source for most of the longest-standing SWFs
• Smaller number from other natural resources exports (copper,
diamonds, and other minerals).
• Increasingly also from international reserves (China SAFE Investment
Corporation, Government of Singapore Investment Corporation).
• If include public pension funds: also have contributions for employers
and employees.
10/9/2014
C. Bertaut Board of Governors
4
Geography of SWFs
• Red: oil funds
• Blue: non-oil funds
• Large concentration of
oil funds in MENA
• Large concentration of
non-oil funds in
eastern Asia
• United States is home
to several SWFs at the
State level
• Alaska Permanent
Fund
• Texas Permanent
School Fund
• New Mexico State
Investment Council
• Alabama, Louisiana,
North Dakota,
Wyoming
Source: Sovereign Wealth Fund Institute
10/9/2014
C. Bertaut Board of Governors
5
Considerable variability in how SWFs invest, in large part
reflecting the purpose of the fund
(but generally more aggressively managed than standard FX reserves)
Approximate share of portfolio invested in different asset categories, 2013
China
Government
Abu Dhabi Investment of Singapore
Norway
Investment Corp. Global Investment
Russia
Pension Fund Authority
Portfolio
Corp.
Reserve Fund
Publicly traded equity
62
46-70
40.4
48
0
Debt securities
Real Estate
Direct Investment, Private equity,
Commodities
Hedge funds and other managed
assets
37
1
15-30
5-10
17
36
7
70-100
8-23
28.2
9
5-10
11.8
0-10
2.6
Deposits and other short-term
10/9/2014
C. Bertaut Board of Governors
0-30
6
SWFs relatively small in terms of global investor universe
(but they are non-trivial players)
"Global Investor Universe"
$150 Trillion (estimate for 2012)
“Asset Owners”
Total public investment
$27 T
FX reserves
SWFs
Public pensions
11
5-6
10
Total private investment
$123 T
Selected private institutional investors
Insurance companies
Private pensions
Endowments/foundations
Corporate treasuries
other
60
24
20
0.5
15
60
"Asset allocators"
Investment companies
Alternative investors
(hedge funds, private equity firms)
10/9/2014
26
6
C. Bertaut Board of Governors
7
SWFs grew especially rapidly in years pre-crisis, even as
global market cap and cross-border financial assets were
also rapidly increasing
BIS debt securities statistics + equity market capitalization from Standard &
Poors Global Market Factbook
10/9/2014
Lane & Milesi-Ferretti “External Wealth of Nations” data set
C. Bertaut Board of Governors
8
Growth of SWFs and FX reserves relative to global market
capitalization
• As global market
cap doubled 20022007, SWF assets as
share of market cap
grew even faster.
• And combination of
SWF assets + FX
reserves grew even
more rapidly.
10/9/2014
C. Bertaut Board of Governors
9
Growth of SWFs and FX reserves relative to global crossborder financial assets
• Similar story if
expressed as
share of crossborder
financial
assets.
10/9/2014
C. Bertaut Board of Governors
10
Growth of SWFs and FX reserves relative to global GDP
• And even
more
pronounced
increases
relative to
global GDP.
10/9/2014
C. Bertaut Board of Governors
11
Concerns about SWFs
• Not much attention on SWFs prior to mid-2000s.
• But increased focus around mid-2000s, in part because of rapid
growth pre-crisis.
• Including projections SWFs could reach $12-$15 trillion by 2015!
• Concerns raised for recipients of SWF investments but also for host
countries:
• Lack of transparency and accountability
• Political/strategic motivations of SWF investments (more so than traditional
FX reserves)
• Implications for financial stability
• Concerns are inter-related.
10/9/2014
C. Bertaut Board of Governors
12
Lack of Transparency
• Many SWFs have traditionally operated with limited transparency.
• Difficult to get estimates of size of many SWFs prior to 2005.
• Many didn’t reveal asset allocations or even target allocations
• Concerns that investments are politically motivated more likely given lack of
transparency.
• Even for very large SWFs: still considerable range of degrees of
transparency:
• Norway Pension Fund publishes size and actual asset allocation
• Abu Dhabi Investment Authority does not publish size of fund or allocation
10/9/2014
C. Bertaut Board of Governors
13
Measures of transparency and accountability
• Ted Truman (Peterson Institute for International Economics, 2008) SWF
Scorecard:
• Metric to quantify governance practices, accountability, transparency, and
investment activities of SWFs.
• Assigns values for 33 elements and converts to an overall score ranging from low of 0
to high of 100.
• Santiago Principles:
• 24 voluntary guidelines of “best practices” for operations of SWFs, jointly agreed to
by IMF and International Working Group of Sovereign Wealth Funds in 2008.
• Considerable overlap between Principles and Truman scorecard measures but they
are not identical.
• SWFI also ranks funds using Linaburg-Maduell transparency index; also
overlaps with Truman scorecard but not as broad a focus.
10/9/2014
C. Bertaut Board of Governors
14
Truman SWF
scorecard
• 2007 score (horizontal)
2009/2010 score (vertical)
• Considerable range in
scores even in 2010
• Increased accountability:
many increased scores
since 2007
• Average score in 2007 is
about 41
• 56 in 2009/2010
• Some very noteworthy
increases in only 2-3 years
10/9/2014
C. Bertaut Board of Governors
15
Truman SWF
scorecard rating
vs. SWF size
• Truman found essentially
no relation between score,
size in 2007
• By 2010: weak positive
correlation between size,
score
• 7 largest funds all have
above-average scores
• Considerable range in
scores for smaller funds
• Some of the highest scores
• But also some of the lowest
10/9/2014
C. Bertaut Board of Governors
16
Concerns arising from limited
transparency/accountability
• For recipient countries, concerns seem largely related to potential for
strategic, politically motivated investments.
• For host countries:
• Without clear guidelines and financial disclosure, can be temptation to use
stockpile of wealth for current needs.
• May be at odds with reasons for establishment of fund
• Use for current domestic needs can have macroeconomic effects
• Potential for mismanagement /corruption.
• Potential consequences are as important for economic well-being of small
countries with small SWFs as for countries with more sizable SWFs.
• Implications for economic well-being and stability are also important for a
country’s neighbors.
10/9/2014
C. Bertaut Board of Governors
17
Lack of transparency not limited to SWF investments
• Global FX reserves are not fully disclosed: IMF COFER data show that
of $11.9 trillion in current reserves reported to IMF, only $6.2 trillion
is reported by currency.
• Not all countries participate in IMF SDDS Reserves Template (China
does not participate).
• Lack of transparency is also not limited to public sector investors or
market participants.
• Hedge funds and similar types of managed accounts are active participants in
global financial markets and typically operate with limited transparency.
• Bearing in mind that many SWFs themselves invest in hedge funds and private
equity.
10/9/2014
C. Bertaut Board of Governors
18
Concerns about politically motivated, strategic
investments
• Concern for recipient countries.
• Bigger issue than for standard FX reserves which tend to be invested
in liquid, safe investment assets (i.e. U.S. Treasuries).
• Attention especially if in the form of FDI.
• Controlling interest
• Potential for acquisition of “sensitive” industries
• Investments are much larger in publicly traded equity.
• Activist shareholders? How to treat voting shares.
• Motivations may be viewed as political, even if not undertaken with
that intent.
10/9/2014
C. Bertaut Board of Governors
19
Implications of SWF activities for financial stability
• Many individual SWFs are large enough that actions could cause
market disturbances.
• Actions can be especially pronounced in shallower markets.
• May be more of a concern for EMEs as recipients of SWF investments.
• But most SWFs have professional asset managers who are aware of
potential to move markets and would be expected to move cautiously
in portfolio rebalancing.
• Limited empirical evidence available suggests that SWFs actions may have
market effects similar to those of other large investors.
• Market participants generally interpret SWF actions as those of informed,
sophisticated investors.
10/9/2014
C. Bertaut Board of Governors
20
SWFs and Financial Stability (cont’d)
• During global financial crisis, several SWFs took well-publicized stakes
in U.S. and European financial institutions.
• SWFs were in a position to provide beneficial capital injections at a time when
much needed.
• But could be some concerns about foreign government controlled
entities taking stakes in domestic banks even if below 10 percent: are
banks “special”?
• Because of deposit insurance, access to central bank lending facilities and
payments systems.
10/9/2014
C. Bertaut Board of Governors
21
Financial stability concerns aren’t limited to SWFs either
• Even concerns with standard FX allocations:
• Concentration of reserves in Treasuries.
• Potential effects on U.S. Treasury yields should a major holder decide to divest.
• Potential for financial stability concerns even from actions of standard investment
vehicles and asset managers.
• Announcement late September that Bill Gross was leaving Pimco.
• Reports of widespread redemptions from Total Return Fund raised potential for financial
stability concerns.
• Many assets known to be held by the Total Return Fund tumbled as traders anticipated that investors
would pull money out of the fund.
• Financial Times noted that U.S. regulators were looking into whether fund redemptions could pose risk.
• More generally: U.S. Financial Stability Oversight Council has stressed that large
asset management groups are interconnected in complex ways.
• Potential for exacerbating stress in volatile market conditions.
10/9/2014
C. Bertaut Board of Governors
22
Responsibilities for recipient countries of SWF
investments
• Concerns over potential for increasing financial protectionism in
recipient countries, hampering free flow of capital.
• In addition to principles for SWF conduct, OECD agreed to principles
for recipient countries in 2008.
• Recipient countries should not erect protectionist barriers to foreign
investment, portfolio or direct investment.
• Recipient countries should ensure predictable investment frameworks.
• Recipient countries should not discriminate among investors.
• Additional restrictions on foreign investors should only be considered for legitimate
national security concerns.
10/9/2014
C. Bertaut Board of Governors
23
Concluding remarks
• More transparency desired but not just for SWFs.
• Efforts to require differential disclosure for SWFs or restrict activities
of SWFs can have opposite results if drives more activity via less
transparent intermediaries such as hedge funds, private equity
located in offshore financial centers.
• Shouldn’t think of SWFs as being source of “new capital” for global
financial markets.
• Their sources of revenue are already part of the international flow of capital.
10/9/2014
C. Bertaut Board of Governors
24
Sovereign Investment Lab
contact info
phone +39.02 58365306
centro.baffi@unibocconi.it
www.centrobaffi.unibocconi.it /sil
With the support of
Università Commerciale
Luigi Bocconi
BAFFI
Center on International Markets,
Money and Regulation
The Great Reallocation
Sovereign Wealth Fund
Annual Report 2013
Contents
3
From the Editor
7
The Sovereign Investment Landscape
13 SWF Investment in 2013
Bernardo Bortolotti, Veljko Fotak, Laura Pellizzola
13 Activity
15 Sectors
23 Geography
35 Funds
36 The Great Reallocation
39 Articles
39 Sovereign Shareholder Activism: How SWFs Can Engage in Corporate Governance
Paul Rose
43 Sovereign Wealth Fund Investment Performance: Some Stylized Strategic Asset Allocation Results
Michael Papaioannou, Bayasgalan Rentsendorj
49 Long Term For Real: SWF's Growing Investments in Infrastructure
Massimiliano Castelli
55 Spotlights on research
61 Appendix
61 Methodology
From the Editor
Some call it the rise of the fiduciary state. From a long-term perspective, the boundaries between states and markets have changed considerably in the past decades.
After the massive wave of nationalizations and public investments of the post-war
period, governments of all stripes experienced the poor quality of products and services provided and the abysmal financial and operating performance of state-owned
enterprises. With their reputation as managers severely dented, governments
launched a global wave of state sell-offs, and privatization became a legitimate tool
of statecraft around the world. But while the rollback of the economic activity of
the state continued apace particularly in developed economies, an opposing trend
started to surface, and gained momentum with the turn of the century: the massive
accumulation of assets by sovereign wealth funds (SWFs) and other state-sponsored
vehicles, growing in size to exceed the $4 trillion mark in 2013.
The key innovation that explains the apparent contradiction between resurging state
capitalism and privatization is that the recent government acquisitions of equity
have been conducted mostly by state entities acting as investors rather than owners,
buying non-controlling stakes primarily in foreign companies in order to generate
long-term financial return rather than to manage these businesses. Under this new
regime, sovereign investors are typically minority shareholders, with limited power
to exert political interference in the target companies. Furthermore, by investing
abroad, they deliberately locate financial interest beyond the scope of their sovereign authority or supervisory power.
But can governments ever act as objective, commercially driven long-term global
investors, managing their nation’s wealth as investment fiduciaries? Only time will
tell, but for the time being we observe that SWFs are gaining ground, growing faster
than any other type of asset owners, and graduating as highly respected players of
the global financial industry.
Against this background, we are glad to present our annual report on SWF investment in 2013. The reader will find here the usual high quality data which made the
3
THE GREAT REALLOCATION
From the Editor
Sovereign Investment Lab a rather unique source for independent, reliable information on global SWF transactions. Additionally, this issue boasts contributions from
international experts such as Paul Rose, Michael Papaioannou, Bayasgalan
Rentsendorj, and Massimiliano Castelli covering the corporate governance challenges of SWFs, their strategic asset allocation, and the role they can play in boosting infrastructure investment.
• Banks vs real estate too close to call. By deals, financial services still received
more publicly reported investments from SWFs than any other sector: 47 deals
worth $11 billion. But their share by value continues declining in favour of real
estate and hotels tourism facilities, reporting 22 deals worth $10 billion and 16
deals worth $6 billion, respectively.
• Crawling down the energy value chain. SWF displayed strong interest in the
energy sector, the associated processing industries, including infrastructure.
During 2013, the combined expenditure in those sectors was $5.2 billion.
• Developed markets targets of choice. The share of SWF investment in OECD targets is steadily increasing, reaching a share of 65 percent by value, the highest since
the outbreak of the financial crisis. Europe attracts most activity of value (33 deals
accounting for $18.4 billion ), North America resumes in earnest from last year
low with 29 deals worth $8.2 billion). For the first time in the SWF history, France
surpasses the United Kingdom by deal value with $7.7 billion of investment.
• BRICs rebalancing. BRICs share of investments shrunk to 21 percent ($10.7 billion), with China being the biggest loser. In 2013, foreign SWF investment in
China is down to $620 million from the $4.6 billion raised the previous year.
Russia and India were the main beneficiaries of the reallocation, with $5.4 and
$2.8 billion, respectively. Indirect exposure to emerging market growth via established multinational firms as targets is also toning down.
• The rise of co-investment alliances. Cooperation amongst like-minded investors
is increasing and taking the form of joint-ventures and co-investments among
SWFs, but also partnerships involving private investors. 53 SWF deals worth
$16.9 billion involved investment alliances, and 84 percent by value with private
partners.
Emerging markets have enjoyed breath-taking growth over the past two decades by
closing the productivity gap with the more developed economies. But, as the gap
narrowed, growth rates have declined – and the slowdown of China and India has
led to lower commodity prices. At the same time, the shale revolution in North
American energy markets has put downward pressure – and future uncertainty – on
the oil and natural gas prices that have underpinned much of SWF growth. This is
why in 2013 not only have we observed SWF lower aggregate investments, but allocations have changed. The same slowdown that led to declining fund accumulations
in developing countries has also led to the same markets being less appealing investment targets. We call this process the Great Reallocation, with implications across
geographies and sectors. The biggest beneficiaries of this reallocation have been
developed economies, primarily Europe, the United States, and Australia. Within
this region, SWF selectively slowed down investment in manufacturers indirectly
exposed to emerging market growth, and focused on real estate especially commercial properties in Europe, and safe assets as infrastructure. SWFs are quite unpredictable but we tend to foresee this trend consolidating in 2014.
2013 has been a crucial year for SWFs. The main facts can be summarized as follows.
• Investment slowing down. In 2013, we observed 19 SWFs completing 175 deals
with a total publicly reported value of $50.1 billion, a 35 percent decrease in the
number of transactions, and a 15 percent decrease in total deal value relative to
2012.
4
Bernardo Bortolotti
Director, SIL
5
The Sovereign Investment Landscape
There is no consensus, in either the academic or
practitioner literature, on exactly what constitutes
a sovereign wealth fund (SWF). While SWFs are a
heterogeneous group, most of the larger and more
established SWFs evolved from funds set up by
governments whose revenue streams were dependent on the value of one underlying commodity and
thus wished to diversify investments with the goal
of stabilizing revenues. Accordingly, most SWFs
have been established in countries that are rich in
natural resources, with oil-related SWFs being the
most common and most important. These include
the funds sponsored by Arab Gulf countries,
Russia and the ex-Soviet republics, Malaysia,
Brunei and Norway. A newer set of funds has
The SIL definition of SWF
According to our definition, SWFs have an independent corporate identity (they are not managed
by a central bank or finance ministry) and invest for
commercial return over the long term. Unlike central-bank, stabilisation, or public pension funds,
SWFs have no explicit liabilities—i.e., their assets
are not routinely called on for stabilisation or pension contributions—so they can have a greater tolerance for risk and illiquid assets to generate superior returns. As such, these funds have a strategic
asset allocation that incorporates a wide range of
assets that can include any of the following: equities, bonds, private equity, real estate, hedge funds,
exchange-traded funds, futures contracts, commodities, etc. These investments may be made
through asset managers or directly, in domestic
assets or international markets.1
SWFs are just one type
of state-sponsored investment
vehicle and several countries
are launching new funds
recently been established in response to discovery
of major new resource endowments – particularly
natural gas, but also oil, coal, diamonds, copper,
and other minerals. The other important group of
SWFs includes those that have been financed out of
accumulated foreign currency reserves resulting
from persistent and large net exports, especially
A “Sovereign Wealth Fund” is an investment vehicle
that is:
1 Owned directly by a sovereign government
2 Managed independently of other state financial
and political institutions
3 Does not have predominant explicit current pension obligations
4 Invests in a diverse set of financial asset classes in
pursuit of commercial returns
5 Has made a significant proportion of its publicly
reported investments internationally
1
All SWFs with equity portfolios, and many with only fixed-income portfolios,
employ asset managers. However, the funds that invest a significant proportion
of their portfolios directly often do so through a series of wholly owned subsidiaries
that often are registered in low-tax environments such as Mauritius or the
Cayman Islands.
7
THE GREAT REALLOCATION
The Sovereign Investment Landscape
Table 1: Sovereign Wealth Funds, Assets Under Management, 2013
Table 2: New Sovereign Investment Funds Launched or Proposed Since January 2008
Country
Fund Name
Inception
Year
of Funds
Norway
Government Pension Fund – Global £
1990
Commodity (Oil & Gas)
840.80
China
China Investment Corporation **
2007
Trade Surplus
575.20
UAE-Abu Dhabi
Abu Dhabi Investment Authority
1976
Commodity (Oil & Gas)
773.00
Kuwait
Kuwait Investment Authority †
1953
Commodity (Oil & Gas)
410.00
†
Source
(US$BN)
Singapore
Government of Singapore Investment Corporation
1981
Trade Surplus
285.00
Russia
National Wealth Fund and Reserve Fund ϭ
2006
Commodity (Oil & Gas)
174.60
Singapore
Temasek Holdings
1974
Trade Surplus
173.30
China
National Social Security Fund
2000
Trade Surplus
Qatar
Qatar Investment Authority †
2005
Commodity (Oil & Gas)
Australia
Australian Future Fund µ
2006
Non-Commodity
87.60
UAE - Dubai
Investment Corporation of Dubai
2006
Commodity (Oil & Gas)
70.00
Libya
Libyan Investment Authority †
2006
Commodity (Oil & Gas)
60.00
UAE-Dubai
International Petroleum Investment Company
1984
Commodity (Oil & Gas)
UAE-Abu Dhabi
Mubadala Development Company PJSC ¥
2002
Commodity (Oil & Gas)
Kazakhstan
Kazakhstan National Fund †
2000
Commodity (Oil & Gas)
68.90
§
**
†
Ɛ
†
Date fund
AUM
Country
Rationale for Fund, funding source, and discussion
Status, as of April 3, 2014
October
The Fundo Soberano de Angola (FSDEA) was launched with $5 billion
Became operational October
2012
of seed capital from Angola’s oil revenues to stabilize impact of commodity
2012 with $5 bn initial capital.
price volatility, invest in domestic infrastructure, and invest internationally.
In July 2013, the president’s son
proposed
officially
Angola
named the fund’s first head.
Brazil
June
Brazil announced plans to establish a new Fundo Soberano do Brasil
Fund launched July 2008 with
2008
(FSB) soon after Petrobras proved massive new offshore “pre-salt” oil
$6.1 bn initial capital. Now has
141.40
reserves. Purpose to reduce inflationary impact of government spending,
$11.6 bn.
115.00
minimize real appreciation, and support Brazilian firms’ foreign investment.
Ultimately hope to achieve funding of $200-300 bn from oil revenues.
Chile
April
Government announced plans to invest up to $5.9 bn from Chile’s two
Apparently established, but
2008
existing stabilization and wealth funds in publicly listed international stocks
little news reported on actual
63.46
and bonds. Modeled after Norway’s SWF, purpose was to diversify Chilean
investments.
55.50
state assets globally.
France
October
President Sarkozy proposed setting up a new Strategic Investment Fund
Launched in October 2008, with
Republic of Korea
Korea Investment Corporation
2005
Government-Linked Firms
56.62
to protect French companies from acquisition by foreign “predators”.
€6 bn initial capital; currently has
Malaysia
Khazanah Nasional Berhard ϭ
1993
Government-Linked Firms
31.70
New fund to be operated and 51% owned by Caisse des Dépôts et
about €20 bn in total capital.
Brunei
Brunei Investment Agency
1983
Commodity (Oil & Gas)
40.00
Consignations and authorized to make loans and direct equity investments
Azerbaijan
State Oil Fund of Azerbaijan
1999
Commodity (Oil & Gas)
35.89
in French companies threatened by foreign competition or acquisition,
Ireland
National Pension Reserve Fund µ
2001
Non-Commodity
19.90
which it has done.
New Zealand
New Zealand Superannuation Fund
2001
Non-Commodity
20.20
East Timor
Timor-Leste Petroleum Fund ¥
2005
Commodity (Oil & Gas)
14.56
UAE - Dubai
Istithmar World
2003
Government-Linked Firms
Bahrain
Mumtalakat Holding Company
2006
UAE
Emirates Investment Authority *
2007
UAE-Abu Dhabi
Abu Dhabi Investment Council
Oman
State General Reserve Fund
UAE-Ras Al Khaimah
Ras Al Khaimah Investment Authority *
Vietnam
**
†
ϭ
2008
Ghana
January
Finance Minister proposed setting up a SWF to channel surplus oil
First Fund board meeting
2010
revenues expected to begin accruing in 2011. Parliament passed the
held March 2012. Initial funding
11.50
law in March 2011 formally establishing two funds: the Ghana Heritage
of $69.2 mn, but no investments
Government-Linked Firms
10.90
Fund and the Ghana Stabilization Fund with a minimum of 30% of state’s
announced yet. First report
Commodity (Oil & Gas)
10.00
projected oil revenues to be allocated.
in May 2012 noted areas
2007
Commodity (Oil & Gas)
10.00
1980
Commodity (Oil & Gas)
8.20
2005
Commodity (Oil)
2.00
State Capital Investment Corporation *
2005
Government-Linked Firms
0.60
of a SWF, based on Norway’s model, to be funded by oil revenues.
Kiribati
Revenue Equalization Reserve Fund *
1956
Commodity (Phosphates)
0.50
To date, no commercial quantities of oil have been produced.
São Tomé & Principe
National Oil Account *
2004
Commodity (Oil & Gas)
< 0.01
Oman
Oman Investment Fund
2006
Commodity (Oil & Gas)
Unknown
UAE - Dubai
Dubai International Financial Center
2002
Government-Linked Firms
Unknown
Total OIL & GAS
2,751.91
and large fiscal deficit, but pressure continued to build. In April 2012
TOTAL TRADE SURPLUS
1,174.90
government officially proposed setting up a new SWF, with $10 bn
ϭ
*
**
*
*
TOTAL OTHER
TOTAL AUM
£
**
ϭ
§
µ
†
Ɛ
¥
*
AUM as of December 22, 2013
AUM as of the end of 2012
AUM as of January 2014
AUM as of March 2013
AUM as of the end of 2013
Estimate by SWF Institute as of March 17, 2014
AUM as of June 2013
AUM as of September 2013
Sovereign Investment Lab estimate of assets under management (AUM).
of concern.
Greenland 2008
India
After a US Geological Survey in 2008 estimated that 31 bn barrels of oil
Fund established but thus
lies off Greenland’s coast, Greenland’s parliament approved creation
far unfunded.
April
A government-appointed panel of experts recommended setting up a
2008
SWF to earn a higher return on India’s $300 bn foreign reserves. India’s
and apparently not yet formally
central bank long opposed this, since country has a very low savings rate
approved by Parliament.
Fund still pending
initial capital to be provided from disinvestment proceeds, to help acquire
239.52
4,166.33
overseas energy assets and raw materials.
Iran
2010
A new National Development Fund was set up by the Ahmadinejad
Currently has reported value
government in 2010 to help break country’s economic isolation and to
of about $35 bn, but no major
benefit future generations. Mandated to invest at least 20% internationally,
investments announced yet.
the rest locally.
SWFs website, SWF Institute Website and Sovereign Investment Lab estimates
8
9
The Sovereign Investment Landscape
THE GREAT REALLOCATION
Israel
January
After two enormous natural gas fields were proven off Israel’s coastline,
SWF bill proposed by
Saudi
January
The vice governor of Saudi Arabian Monetary Authority (SAMA) announced
Apparently established,
2012
the government proposes a new SWF to be funded from the state’s future
government in October 2012;
Arabia
2008
that Saudi Arabia’s Finance Ministry was considering launching a SWF,
but no major investments
gas revenues. The fund will invest in education and health and will help
Parliament approved bill and
with about $6 bn initial capitalization, that would mostly make equity
yet announced.
develop Israel’s high-tech export industries. Though initial capitalization
SWF survived court challenge
to be $10 bn, plans call for the fund to reach $80 bn by 2040.
in 2013. No actual revenues
investments. The fund was apparently established in March 2009.
Scotland
or investments yet.
Italy
Japan
November
Setting up a Scottish SWF on the lines of Norway’s model has long been
Proposed, but actual establishment
2012
a proposal of the Scottish National Party (SNP), using oil revenues
would only occur if SNP wins
July
Italy launched the Fondo Strategico Italiano with a seed investment
First investments in May 2012 of
from the UK sector of North Sea fields. Listed as an objective if SNP wins
the independence election
2011
of €1 bn from state entities Cassa Depositi e Prestiti and Fintecna. Fund’s
€200 mn for 46% stake in Reti
election to make Scotland independent from UK.
in September 2014.
purpose to acquire minority interests in promising Italian companies,
TLC-Metroweb and of €150 mn
Sierra
April
The Finance Minister, Samura Kamara, announced plans to set up a SWF
Planned but not yet
and plans are to achieve €4 bn in total funding.
for 90% stake in Kedrion.
Leone
2012
financed through “windfall mining revenues” and proceeds from oil sales
established or funded.
April
A panel set up by ruling Liberal Democratic Party proposed legislation to
Still under consideration but
2008
set up SWF. In September 2011, ruling Democratic Party of Japan again
no official legislation submitted
proposed setting up a $5 bn SWF using some of Japan’s huge foreign
to Diet.
that could flow by 2015.
Slovenia
July
Government submitted to Parliament draft legislation to set up a SWF
2012
as a “bad bank” to take over €10 bn worth of bad loans from the nation’s
exchange reserves in order to weaken the yen, earn higher returns on
banks. The opposition successfully forced a referendum on the bad
forex reserves, and cushion fiscal impact of country’s aging population.
Lebanon
Liberia
Maldives
bank/SWF plan, which is pending.
August
Lebanon’s Parliament approved a long-delayed Energy law establishing
No gas proceeds have been
South
November
2010
procedures for developing large offshore natural gas deposits
realized and so fund remains
Africa
2010
and authorizing a new SWF if and when state revenues begin to accrue.
embryonic.
September
A new SWF was proposed by country’s finance minister after African Petroleum
Still in planning stage.
a report commissioned by the ruling African National Congress called
by the government.
2012
Corporation announced it had found significant offshore oil reserves.
November
The newly-elected president, Mohamed Nasheed, proposed that Maldives
Unclear whether SWF ever
2008
divert a portion of its tourist revenues to set up a SWF as insurance
actually set up; no investments
against climate change and rising seas. President later claimed
have been made.
April
Government announced plans to use proceeds from mining vast
Apparently still
2012
newly-discovered mineral deposits to set up SWF with an initial $600 mn
in planning stage.
November
Newly-appointed finance minister Ngozi Okonjo-Iweala announced plans
First Fund board meeting held in
2011
to set up SWF to better manage part of country’s large — but historically
September 2012, and first
mismanaged — oil revenues. Fund actually established in September
investment ($200 mn) made in
2012 with $1 bn initial capitalization and $100 mn per month revenue
September 2013. Issued $1 bn
inflow. Fund unsuccessfully challenged in court by nation’s powerful state
Eurobond in 2013 and committed
governors.
$550 mn to boosting electricity
supply in February 2014.
Panama
June
Cabinet Council approved a plan for the Savings Fund of Panama,
2012
a sovereign wealth and stabilization fund, to be funded through Panama
Pending.
Canal revenues in excess of 3.5% of GDP. Bill submitted to Congress
calling for fund to begin in 2015, and eventually reach $6 bn funding.
Papua
February
Prime Minister Peter O’Neill announced that one new liquefied natural gas
Fund set up, awaiting initial
New
2012
(LNG) project would ultimately contribute over $30 bn (ten times the coun-
capital injection planned
try’s GNP) to a new SWF. The SWF bill was quickly approved unanimously
for 2014.
Guinea
by PNG’s Parliament in February 2012. The LNG project should begin its
first exports, and contributions to SWF in 2014.
Russia
Under consideration, but no
reserves, reduce the value of the rand, and promote economic
formal plans for a SWF
development. The proposal was not adopted, but in February 2012
have been submitted
that could raise $5.3 bn per year.
Tanzania
September
Government proposed setting up a SWF to manage revenues from large,
Planned but not yet formally
2012
newly discovered offshore natural gas deposits.
approved or funded.
In a 15,000 word document, government proposed setting up a SWF to
Planned but not yet approved.
Zimbabwe November
capitalization.
Nigeria
The government proposed setting up a SWF to help manage forex
for a SWF to be set up and funded with a new tax on the mining industry
that the fund was established.
Mongolia
Planned but not yet approved.
September
Russian finance minister Anton Siluanov announced plans for the new
Two SWFs (the Russia Reserve
2012
Federal Financial Agency (FFA) to begin operating in 2013. The new SWF
Fund and National Welfare Fund)
will invest excess oil revenues broadly in international and domestic assets,
are already operating. FFA to
including equities for the first time. The $150 bn of assets in the two exi-
begin 2013.
2013
be funded through various fiscal savings and new bond issues. Legislation
officially tabled by government in January 2014.
Source: Megginson, W.L., and V. Fotak, “The rise of the fiduciary state: a survey of SWF research”, SIL Working Paper, 2014.
the funds based in Singapore, Korea, China, and
other East-Asian exporters.
Because definitions vary and because few funds have
disclosed key organizational details, heterogeneous
funds are often grouped into the SWF category, even
though there are significant differences between
funds with respect to organizational structure,
investment objectives, and degree of transparency.
Against this background of complexity, the
Sovereign Investment Lab uses the definition of
SWF described in the box to identify precisely the
funds addressed in the body of this report and listed
in Table 1 above.
funds. Even if none of these organizations meets
today all the criteria for inclusion in the SIL list of
SWFs, we think that it is interesting to follow these
developments, as some of these new born sovereign
investment funds (SIF) may graduate in the future
as fully-fledged SWFs, and enter in our radar
screens.
The landscape of sovereign investment has
changed, as we report in Table 2, in the last years
as many countries have launched or proposed new
sting funds will be transferred to the FFA.
10
11
SWF Investment in 2013
Bernardo Bortolotti SIL, Università Bocconi, and Università di Torino
Veljko Fotak SIL, Università Bocconi, and University at Buffalo
Laura Pellizzola SIL, Università Bocconi, and Fondazione Eni Enrico Mattei
Activity
In 2013, we observed 19 SWFs completing 175
equity investments with a total publicly reported
value of $50.1 billion. This represents a 35 percent
decrease in the number of transactions we reported
in 2012 and a 14 percent decrease in investment
value. This sharp decline in activity can be easily
explained by two main factors: increasing future
uncertainty and a slowdown in the accumulation of
funds in SWF portfolios.
In 2013, investments
slowed down due to lower growth
in emerging markets
and the shale gas revolution
In May, investors awoke to the realization that
Fed’s extraordinary monetary stimulus through
“quantitative easing” could not last forever, and
repercussions were felt worldwide. The expectation of tapering, which finally materialized in
December 2013, caused a sharp jump in yields and
a surge in volatility in bond markets, provoking
substantial anxiety and fear, at least for the shortterm, across asset classes and sectors. While markets were overall volatile, equities performed well:
with the US in recovery mode and the widespread
corporate share buy-backs, which in the US in
2013 totalled the stellar amount of $458 billion,
the S&P500 more than doubled since 2009. After
this strong run, equities in major markets started
to look expensive, discouraging investments from
emerging markets. This trend was compounded by
an obvious desire, following the past turbulent
years, to provide increased portfolio diversification
away from a policy of heavy investments in US dollars and markets.
shale gas and tight oil revolution in the US has started to produce real effects, turning the country into a
net exporter of gas and, according to some estimates, virtually self-sufficient in energy by 2030. As
recently discussed in an open letter by Saudi billionaire Prince Alwaleed bin Talal, North American
shale gas production is an inevitable threat to oilexporting countries, affecting the accumulation of
financial sovereign wealth. Second, global growth
has shrunk considerably due to a process that The
Economist deemed “The Great Deceleration,”
meaning that booming emerging economies are no
longer making up for weakness in rich countries.
Take China as an example, a country still accounting for one third of global growth, but whose lowcost manufacturing advantage is weakening due to
higher wages and currency appreciation. This
process took its tolls on Chinese exports, which
slowed down considerably in 2013. A more competitive supply of energy and lower growth in emerging
markets have a direct implication on SWF investments, as lower commodity revenues or trade surplus flows into central bank coffers in the form of
foreign reserves translate into slower fund accumulation in SWF portfolios.
While these trends may have affected global
investors of all stripes, two important factors had
deeper implications for the SWF industry. First, the
Relative to 2012, we report a sizable uptick in the
average deal value, reaching $286.1 billion this
year. However, taken from a long-term perspective,
13
SWF Investment in 2013
THE GREAT REALLOCATION
Figure 1: Direct SWF Investments since 2000
Figure 2: Direct SWF Investment: Average Deal Size since 2000
Number
Value (US$BN)
800.0
300
270
700.0
250
250
400.0
111.7
93
100
50
0
27
20
1.8
2000
0.5
2001
1.3
2002
1.8
2003
226.4
58.4
50.1
25.2
11.5
286.1
82.6
47.6
5.7
330.4
273.6
300.0
88.2
77.7
53
38
33
92
558.2
158
137
150
566.9
500.0
175
173
645.6
600.0
210
200
Average Deal Size (US$MN)
216.3
200.0
100.0
66.3
106.8
24.4
38.8
46.2
2002
2003
123.4
0.0
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2000
2001
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
the general trend confirms a decline in deal value
reflecting deep organizational changes in the
industry. An increasing number of SWFs is rethinking the traditional model based on external forprofit asset managers and questioning the value
proposition it offers against agency costs and management fees. As a result, these organizations are
becoming more active in the direct management of
their portfolios through the creation of internal
teams. In this direction, several SWFs have also
recently opened satellite offices in international
financial centres as a strategy to acquire highly specialized skills from established pools of human
capital and to activate local network effects
enabling deal flows. Enhanced internal capacity
enabled the direct execution of a larger number of
operations, and more deals of smaller size appear
on our radar screen. However, structural and orga-
diversification will continue being a driving force,
but sectors and geographies where these organizations tend to have a competitive advantage as
investors will skew operations in favour of larger
deals and high price tags.
14
nizational changes take time. Consider that SWF
are very large organizations by assets with very
limited staff. The combined personnel of the three
largest funds (Norges Bank Investment
Management, which manages the wealth of the
Norwegian Government Pension Fund Global,
China Investment Corporation, and Abu Dhabi
Investment Authority) is about 3,000 people with
total assets under management exceeding $2 trillion, as compared to the 20,000 staff of an institutional investor such as Fidelity, managing $1.5 trillion. The internal capabilities for internal execution will increase, but still the legacy of SWF as relatively understaffed organization will matter for
these developments. We thus expect that deal size
will tend to decrease on average, but will remain
significantly higher than typical private sector
transactions in the foreseeable future. Indeed,
Sectors
In 2013, as usual, financial services received more
publicly reported investments from SWFs than any
other sector: 47 deals worth $11.0 billion, 22 percent of total investment. At the peak of the financial crisis, the financial sector attracted the lion’s
share of sovereign investments and stellar amounts
in the form of capital injections in distressed banks
in both developed and emerging economies. More
recently, SWFs have diversified their portfolios better by reducing overall exposure to banks in their
new investments.
Also, we should note that, while SWF investments in
the financial industry in the 2008-2011 years were
focused on domestic rescues and recapitalizations of
struggling Western financial institutions, in 2013
SWFs allocated their investments abroad primarily
to banks in emerging economies. In other words,
while SWFs are still in part aiding with domestic
recovery, about half of their financial-sector investments are aimed at gaining exposure to the sector’s
recovery – and are thus more likely to be cross-border investments.
At any rate, SWFs’ appetite for big international
banks did not vanish completely in 2013. Indeed, one
of the most significant deals of the year is the $1 billion investment in Bank of America by the Qatar
Investment Authority (QIA), an example of the fund’s
15
SWF Investment in 2013
THE GREAT REALLOCATION
strategy to acquire minority stakes in major global
companies. The position, while significant in absolute
size, represents a stake below 1 percent and did thus
not require regulatory disclosure. Accordingly, while
QIA disclosed the investment in the fall of 2013,
shares were likely accumulated over the previous two
years on the open market. The rationale of the investment appears to be a desire to profit from the US
recovery. Yet, we know little about QIA’s stakes in US
firms and it is possible that the SWF is holding other,
undisclosed, investments below the five percent
reporting threshold. In the past, QIA has gained
exposure to Western financial institutions through a
stake in Credit Suisse, acquired in 2008, and three
capital injections into Barclays in the same year. QIA
currently holds also interests in the financial sector in
Greece, after investments in the now merged Alpha
Bank and Eurobank.
With this notable exception, in 2013 SWFs shied
away from the financial industry of developed
economies, focusing instead on emerging markets.
Probably one of the most interesting deals of the
year is the joint acquisition of Russia’s secondlargest bank VTB by a consortium of sovereign
wealth funds, including Qatar Holding, Azerbaijan’s
state oil fund SOFAZ, and Norges Bank Investment
Management, each investing about $500m. This
$3.3 billion secondary offering – a privatization
diluting the Russian Government’s ownership stake
from 75.5 percent to 60.93 percent - has strengthened considerably VTB Bank’s capital ratio, being
also a direct result of the Russian Government’s
stated policy of seeking to privatize a number of key
state entities over the next several years.
Interestingly, this deal represents a case of sovereign
16
involvement on the two sides of the market, as seller and buyer, an outcome that we will be observing
frequently in future privatization waves. Amongst
cross-border deals in the financial sector, we should
also note the acquisition by the Government of
Singapore Investment Corporation (GIC) of 5.6 percent of the Bank of Philippines Island marking the
enduring relevance of the fund as a key regional
player in South Asia.
Figure 3: Number of Direct SWF Investments by Target Sector, 2006 - 2013
270
280
Banking, Insurance, Trading
250
Real Estate
240
210
Petroleum & Natural Gas
200
173
160
175
158
Chemicals
137
Precious Metals, Non-Metallic,
and Industrial Metal Mining
Infrastructure & Utilities
120
Reporting on China Investment Corporation (CIC)
activism in the domestic banking industry in 2012,
we concluded that with slowing GDP growth and
shrinking bank profits due to bad loans, the most
recent round of capital infusions was not going to be
the last. Indeed, our prediction was correct. In 2013,
CIC has relied heavily on its domestic arm, Central
Huijin, to strengthen all “Big Four” state-owned
banks also as a strategy to prop up the domestic
equity markets for “A shares”. The fund invested
$439 million in nine capital injections involving the
Industrial and Commercial Bank of China (ICBC),
the Bank of China, the Agricultural Bank of China,
and the China Construction Bank (CCB). Temasek,
the second largest fund from Singapore, followed in
this wake by buying a minority stake in ICBC in two
tranches worth $273 million. Temasek, by amassing
stakes worth almost $18 billion in Big Four, is the
biggest foreign investor in Chinese banks, and is
continuing to build on the portfolio rather than
shrinking it. Such an overexposure to the Chinese
banks may be risky: if growth in China continues to
slow down, the financial sector will be the first
affected, and this might seriously dent the portfolio.
It must be noted, however, that Chinese banks, facing deteriorating conditions at home, are accelerat-
Transportation
92
Aircraft, Autos, Ships & Trains
80
Retail
Communications
40
Restaurants, Hotels, Motels
Other
0
2006
2007
2008
2009
2010
2011
2012
2013
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
ing global expansion as demand for offshore financial services surges along with the growing presence
of Chinese companies in overseas markets. In 2013,
CCB, has acquired 72 percent of capital of Banco
Industrial e Comercial, a primary commercial bank
in Brasil, and also participated with a $100 million
ticket to the consortium involving SWFs for above
mentioned privatization of the Russian VTB.
Construction Bank, which added operations in
countries including Dubai and Japan this year, now
has 17 subsidiaries with assets of about $120 billion
in 15 nations. Geographical diversification of activities by Chinese banks has become an important
trend to follow and could have strong consequences
for the SWFs who have invested in them.
Since the financial crisis, real estate had an
increasing role on SWF investment portfolios.
During 2012, SWFs went on a spending binge and
so reporting a scaling back in 2013 is hardly surprising. With 22 publicly reported deals worth
$10 billion, real estate still represents 20 per cent
of total investment value, quite in line with the
total amount raised in the financial industry – and
those numbers do not include the substantial
investments in hotels that we analyse and discuss
separately. Indeed, over the last decade, appetite
for brick-and-mortar assets has increased, and
nowadays together with alternative investments
and private equity real estate represents a significant and increasing share of SWF portfolios.
Several explanations can be set forth to understand this trend, such as the demand for safe,
“inflation-free” assets, but also the cheap prices
that can still be fetched in the housing markets of
developed economies.
17
THE GREAT REALLOCATION
SWF Investment in 2013
Figure 4: Value of Direct SWF Investments by Target Sector, 2006 - 2013
but more recently its allocation has changed to
include a 5 percent of assets in real estate. In 2013,
the fund landed in the US after tapping European
property markets, and started to add on its global
portfolios properties worth $1.7 billion, including
the entire block of the iconic Time Square Tower
from Boston Properties, the assets of a joint venture
with the US pension fund TIAA-CREF, and a portfolio of 11 UK distribution properties from the real
estate firm LondonMetric through a joint venture
with Prologis (U.S. Logistic Venture – USLV)
120
111.7
Banking, Insurance, Trading
Real Estate
100
88.2
Petroleum & Natural Gas
82.6
77.7
80
Transportation
Chemicals
58.4
60
50.1
47.6
Precious Metals, Non-Metallic,
and Industrial Metal Mining
Infrastructure & Utilities
Aircraft, Autos, Ships & Trains
40
25.2
Retail
Communications
20
Restaurants, Hotels, Motels
Other
0
2006
2007
2008
2009
2010
2011
2012
2013
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
While in line with these broad trends shaping portfolio reallocation, we highlight a few noteworthy
features in 2013 activity in real estate: a high concentration of very large deals in the United Kingdom
and US and the absence of development projects in
emerging economies. The BRICs (Brazil, Russia,
India, and China) are slowing down in both
absolute and relative terms: according to IMF estimates, they accounted for two-thirds of world GDP
growth in 2008, for half of it in 2011, and for about
40% in 2013. Naturally, this translates into lower
investment flows towards development and infrastructure projects in the developing world.
Interestingly, sovereign investment in real estate last
year is dominated by four SWFs. GIC alone spent
$3.58 billion in the sector and executed one of the
biggest European property deals since the financial
18
crisis, the $2.8 billion acquisition of Broadgate
Estates, a large office and retail complex at the heart
of the City of London, purchased from US private
equity firm Blackstone. In partnership with ADIA,
the Singaporean fund also contributed $400 million
to a $1.3 billion purchase of Time Warner’s headquarters in the Time Warner Center. Indeed, ADIA
has been very active in the French property market
last year, by completing the acquisition of Docks
Lyonnais portfolio – which includes 6-8 Boulevard
Haussmann in Paris, Le Capitole in Nanterre and
Antony Parc in the south of Paris - from UBS Wealth
Management fund, for $916 million, and the acquisition of a large property in 90 Boulevard Pasteur.
The Norwegian Government Pension Fund Global
(GPFG) is not immune to this trend. Its portfolio has
been traditionally focused on equities and bonds,
Finally, the Kuwait Investment Authority (KIA) surpassed the $1 billion mark of property investment in
London and New York. KIA completed its acquisition of Bank of America’s European headquarters
from the private equity group Evans Randall. The
sale of London’s 5 Canada Square marks one of the
most valuable office transactions in London since
the start of the global financial downturn and highlights the increasing interest from Middle Eastern
sovereign wealth funds in prime office space in
London. In U.S., the Atlanta-based subsidiary of
KIA acquired Washington’s 1200 19th St. NW for
about $294 million, or roughly $871 per square
foot, one of the highest prices for an investment sale
in downtown D.C. Finally, KIA joined also forces
with real estate developer Related Companies and
Oxford properties to invest in the $15 billion
Hudson Yards project in Manhattan.
In 2013, deal flow in hotels and tourism facilities
has been particularly impressive, yielding $6 billion
in 16 acquisitions, following a very similar pattern
of real estate deals. SWFs displayed a strong preference for assets of established brands in developed
The boom in real estate
continues a pace with a shift from
development projects to existing
brick-and-mortar assets
markets, and the usual handful of funds was
involved. QIA confirmed its appetite for trophyassets and luxury brands by acquiring via its specialized subsidiary Constellations Hotels Holding nothing less than the InterContinental flagship hotels in
London and New York, l’Hotel du Louvre in Paris,
and the Four Seasons Hotel in Florence. In a separate £100m deal it also acquired the freehold from
the Crown Estate, the property company that controls the assets of the Crown in the United Kingdom.
Indeed, QIA is building a global top-end hotel portfolio, and this year’s $2.4 billion purchases mark
another landmark in the process.
However, the single largest deal of the year in the
hotel sector was completed by GIC, acquiring three
luxury resorts managed by the Waldorf Astoria
Hotels & Resorts brand of Hilton Worldwide, among
which the Grand Wailea Resort in Maui, Hawaii for
$1.5 billion. After winning a tough bidding with
other investors including other SWFs, Abu Dhabi
Investment Authority (ADIA) bought for $991 million 42 Marriott-branded hotels from Britain’s Royal
Bank of Scotland featuring landmark hotels in the
United Kingdom’s capital, including the County Hall
hotel and the renowned London Regent’s Park.
Finally, the acquisition of the historical Hotel Eden in
Rome by the Dorchester Group, the luxury hotel
19
THE GREAT REALLOCATION
SWF Investment in 2013
Figure 5: Direct SWF Investments by Sectors in Domestic and Foreign Markets, 2013
terminal MMX Porto Sudeste, an iron ore port
owned by (former) billionaire Eike Batista. The deal
represented the latest effort to stave off the collapse
of his once high-flying Grupo EBX conglomerate,
thanks to a $996 million cash infusion that takes
debt off his hands and secures new investment for
the completion of the port.
0.2%
Banking, Insurance, Trading
1.4% 3.7%
3.1%
3.4%
8.2%
3.2%
3.5%
Real Estate
16.4%
Restaurants, Hotels, Motels
4.6%
Transportation
4.5%
53.6%
Petroleum & Natural Gas
Chemicals
6.4%
23.5%
27.2%
Retail
Personal & Business Services
6.9%
Communications
Infrastructure & Utilities
8.2%
4.5%
4%
Coal
13.5%
0.1%
Domestic
$7.7 billion
Foreign
$42.4 billion
Construction
& Construction Materials
Other
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
operator of Brunei Investment Authority, is certainly
worth mentioning.
Infrastructure assets look attractive to SWFs because
of their strong correlation with economic growth,
inflation protection and relative high levels of earnings certainty. This is the reason why funds continue
to seek opportunities to increase exposure to high
quality infrastructure around the world. In the last
decade, however, deal flow in the sector was not particularly impressive, which is a reflection of a scarcity of available projects. In the aftermath of the crisis,
funding for projects increasingly dried up, and countries started to suffer from infrastructure bottlenecks
undermining their potential to grow. In 2013, global
SWFs entered the scene, investing a total of $4 billion of direct equity investment on infrastructure
projects with a high exposure to a country’s export20
ing capabilities: airports and ports. Australia, due to
its impressive resilience throughout the crisis, was
one of the main beneficiaries of this stream of investments. As to domestic deals, the Australian Future
Fund acquired the assets of the country’s largest listed infrastructure fund (AIX) for $2.1 billion, including stakes in airports in Perth, Melbourne and
Queensland. As to international deals, ADIA took
part in the consortium including Australian superannuation funds winning the 99-year lease contract
from the New South Wales government for the operation of Sydney’s Port Botany and the Illawarra’s
Port Kembla with a consideration of $1 billion. Once
again, we are observing SWFs taking part in privatizations, and this deal will certainly not be the last.
Outside Australia, but in a similar vein, Mubadala
from Abu Dhabi acquired joint control with Dutch
energy firm Trafigura Beheer of the port and iron ore
Recent SWF investment in energy consolidates the
“crawling down the value chain” effect that we
reported last year. After having invested significantly in the last years in the primary provision of commodities, in 2013 SWFs focused on integrated oil
and gas and energy infrastructure with total investments of $5.2 billion. This progressive strategy of
downstream expansion along the value chain can
have multiple purposes. At a more general level,
energy is a good proxy for the needs of transforming economies and growing middle-class population, typical investment themes by SWFs. For
resource rich countries, however, it is also a result of
the desire to acquire increasing control over the
entire value chain of the supply of energy, allowing
higher profit margins through integration.
This argument validly applies to the most recent
deals by QIA in the sector. The fund raised its stake
in Total, the French oil and gas operator, to 4.8 per
cent thanks to the acquisition of an additional stake
worth $2.1 billion. QIA further teamed up with
other local players such as Qatar Electricity and
Water Co. and Qatar Petroleum International to
create Nebras Power, a $1 billion multi-utility that
will invest in power generation, water desalination,
and cooling and heating projects in countries with
as much as 8 percent growth in electricity demand a
Luxury hotels and tourism
facilities in Western markets
are targets of choice
year, mainly in the Middle East and East Asia. While
being classified as a domestic investment, the project
is strongly exposed to external drivers of growth.
The rest of energy investment in 2013 came from
Singapore. Temasek doubled the size of its portfolio in
energy by purchasing a $1.3 billion share in Repsol,
the Spanish oil and gas operator, raising its stake to
6.3 per cent, and by completing the acquisition of
Sembcorp Utilities, the Dutch-based global energy and
global operator. The other SWF from Singapore, GIC,
formed a consortium with Snam, the Italian gas transport and storage operator, and EDF, the French electricity giant, for the acquisition of Transport et
Infrastructures Gaz France (TIGF), Total’s gas transport and storage business in the South-West of France,
a strategic platform for the interconnection of the
European gas markets. This deal, the largest of the
year in the utilities sector, follows in the wake of a
process of unbundling and vertical de-integration by
oil and gas companies, which is taking place in Europe
with the aim to streamline activities and strengthen
financial positions. Finally, GIC invested a sizable
amount in Aegea Saneamento e Participações, managing a wide portfolio of water and sewage concessions
in Brazil. This acquisition could be the first of many
Brazilian deals to come for GIC, which has just
opened an office in São Paulo to ramp up its investment in Latin America, which remains an attractive
21
THE GREAT REALLOCATION
SWF Investment in 2013
Figure 6: SWF Investments in OECD and Non-OECD Markets, 2006 - 2013
Figure 7: Direct SWF Investments by Target Country in 2012 and 2013
77.7
111.7
88.2
47.6
82.6
58.4
14.71
14
50.1
OECD
11.82
12
29.3%
80.00%
40.2%
34.0%
50.2%
50.0%
47.6%
41.0%
34.6%
70.00%
8
2013
10.11
10
9.38
7.97
7.70
60.00%
6.61
6
0.33
1.60
0.26
2008
2009
2010
2011
2012
2013
Sp
ai
n
In
di
a
Q
at
ar
In
do
ne
si
a
2007
Au
st
ra
lia
2006
Fr
an
ce
U
SA
0
1.13
0.93
0.10
0
10.00%
1.50 1.50 1.37
0.78 1.05 0.66
0.21
O
th
er
s
20.00%
2.31
1.65
1.19
K
or
ea
2
2.98
2.84 2.64
2.12
So
ut
h
52.4%
3.64
G
er
m
an
y
50.0%
65.4%
Ze
al
an
d
49.8%
59.0%
C
hi
na
66.0%
N
ew
59.8%
30.00%
4.02
4
Br
az
il
70.7%
5.37
Ita
ly
50.00%
40.00%
2012
Non-OECD
R
us
si
a
90.00%
25.2
U
K
100.00%
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
region despite macroeconomic turbulence and bleak
growth prospect, at least in the short run.
ling stake from the real estate investment division of
Deutsche Bank’s Asset Management division via its
specialized Luxemburg-based operating arm Divine
Investment, outbidding the French competitor
Galeries Lafayette. QIA also increased its stake in
Tiffany & Co. to 11.3 percent, with the acquisition
of an additional 3.2 million shares of the retailer.
After Harrods, LVMH, Porsche, and some of
Europe’s leading luxury hotels, the extent of Qatar’s
Investment Authority involvement in the luxury
industry this year has become even more impressive,
perhaps not surprising given that Qatar is, by some
metrics, the richest country in the world.
Companies in the chemical sector did not enter the
radar screen of SWFs since the large-scale acquisitions reported in 2009. 2013 marks a definite
upward trend of investment in the sector, primarily
thanks to the acquisition of the world largest
potash producer, the Russian Uralkali, by CIC. This
$2.1 billion deal, the third largest by value in 2013,
involved the exchange into equity of bonds issued
by a special purpose vehicle owned by Russian oligarch Suleiman Kerimov. The move paves the way
for Mr. Kerimov’s exit as shareholder to quell an
ugly dispute with Belarus that has landed Uralkali’s
chief executive in a Belarusian prison and prompted Belarus to issue a warrant for Mr. Kerimov’s
arrest. The arrest of the CEO on abuse of power
22
charges followed Uralkali’s departure from a trading partnership with Belarus’ state-run potash
miner that effectively ended an informal global
pricing cartel and threw the market for the fertilizer additive into turmoil. Chinese investors should
contribute to stabilize company and markets. At a
more general level, as economic development and
urbanization continues, China’s demand for agricultural products (including fertilizers) will keep on
growing. Agriculture is a relatively stable investment, but more importantly, it provides China with
resources that it needs in the long term.
Finally, QIA confirmed its interest in “trophy
assets”, as its investment in luxury brands and
retailers continues unabated. QIA’s subsidiary Qatar
Holding took full control of French department
store Printemps. Qatar Holding bought a control-
Geography
If one takes a broad view on SWF investment flows
over the last years by target regions, the strong pref-
erence given to developed markets sticks out. On
average, OECD economies account for the majority
of deal values. Interestingly, this share has been
steadily increasing since 2010, reaching 65 percent
of total investment in 2013 ($32.7 billion), the highest value since the financial crisis. The share of
BRICS, conversely, shrunk to 21 percent ($10.7 billion), while frontier markets (i.e. economies with
thin capitalization and illiquid markets but endowed
with a potential to graduate as fully fledged emerging economies) lagged behind. One could interpret
this decline of interest by SWFs in emerging markets
as an initial effect of the so called Great
Deceleration, whereby the investment in BRICs does
not look any longer impressive as compared to the
prospect and stability of mature economies and to
the low prices that can fetched in these markets.
Indeed, with the Eurozone stabilizing thanks to ECB
23
THE GREAT REALLOCATION
SWF Investment in 2013
Teaming up: the rise of alliances
among like-minded investors
Recent joint ventures involving SWFs
Joint Venture Name
Over the past year, SWFs have displayed an
increasing desire and ability to team up and find
opportunities for co-investments with other SWFs
or other financial investors and through joint-ventures. This trend is related to SWFs moving away
from expensive – and not always effective – external fund management and towards more internal
portfolio management. As SWFs attempt to manage a larger portion of their funds in-house, collaboration is a way to leverage limited humanresources, to learn from their investment partners,
and to spread risks. The rationale is very simple:
sharing information, generating economies of scale,
leverage up control power while maintaining portfolio diversification.
Alliances amongst SWF have typically taken the
form of direct equity co-investments in the same
target, epitomized by high mark acquisition of Total
and Xstrata by the pooled resources of QIA, CIC,
and GIC. Another high-profile co-investment is the
acquisition in 2013 by GIC, ADIA, KIA, and the
GPFG of an undisclosed share of Royal Mail, the
renowned postal operator of the United Kingdom,
with a combined deal value of $340 million. In particular, GIC emerged as the second biggest private
investor in Royal Mail with a 4.1 percent stake in
the newly privatised delivery company. SWF coinvestment in privatizations included also the
acquisition of Russia’s second-largest bank VTB by
a consortium including Qatar Holding, Azerbaijan’s
state oil fund SOFAZ, and Norges Bank Investment
Management, each investing approximately
$500m.
A trend surfacing in 2012 and consolidating in 2013
is the emergence of private equity funds as jointventures amongst SWFs and other sovereign
investors. Last year we reported the launch of the
IQ Made in Italy joint-venture between Fondo
Strategico Italiano, the private equity investment
arm of Italian Cassa Depositi e Prestiti, and Qatar
Holding, the subsidiary of QIA. This model has been
institutionalized by the Russian Development
24
Investment Fund (RDIF). By statute, in every transaction it enters into, RDIF is mandated to co-invest
with an international investor qualified by size. In
2013, RDIF successfully established bilateral
investment platforms with SWFs such as Mubadala
from Abu Dhabi, the Korea Investment Corporation,
CIC, and the Fondo Strategico Italiano, and deals
started to flow. The Russia-China venture invested
in the Russian Forest Products Group and in the
Moscow Exchange. In a similar vein, this year also
witnessed the investments in Indian operators
National Commodity and Derivative Exchange and
the Bangalore based ING Vysya Bank by the Oman
India Joint Investment Fund. This special purpose
vehicle between Oman’s SWF and the State Bank
of India was launched in 2011with an initial corpus
of $100 million for promoting joint investment in
projects in India but the investment partnership
between India and Oman is reflected through operation of hundreds of joint ventures which are valued
at $7.5 billion.
Year
Astrea I
2006
Temasek sponsored Astrea I in 2006 with a diversified and balanced portfolio of selected
Temasek interests in high quality private equity funds. Astrea I was intended as the first
(Partnership of Temasek)
of a series of private equity co-investment platforms.
Oman Brunei
2009
Oman Brunei Investment Co. is a private equity fund jointly capitalised by Ministry
of Finance, Government of Oman (@ 50%) and the Brunei Investment Agency (@ 50%)
Investment Company
with a capital of US$ 100 million. The fund company has been created to promote social,
financial and economic benefits to Oman, GCC and Brunei. The fund shall undertake
investments in Infrastructure, Utilities, Metals, Education, Service, Healthcare,
Manufacturing and add value to its investee companies over the investment horizon.
Oman India Joint
2011
Oman India Joint Investment Fund is a private equity fund sponsored by Oman’s sovereign
wealth fund State General Reserve Fund and India’s largest lender State Bank of India.
Investment Fund (OIJIF)
It was created with an initial corpus of US$100 million.
Russia-China
2012
The Russia-China Investment Fund (RCIF) is a $2-4 billion private equity fund, established
jointly by the Russian Direct Investment Fund (RDIF) and China Investment Corp (CIC),
Investment Fund (RCIF)
aims to generate strong returns from equity investments in projects that take advantage
of the increasingly robust economic relationship between Russia and China.
Russian-Korean
2013
The Russian Direct Investment Fund and the Korea Investment Corporation agreed
to form the Russian-Korean Investment Platform. The investment platform will focus
Investment Platform
on cross-border investments which fulfill Russian- Korean strategic interests.
RDIF-Mubadala
2013
RDIF-Mubadala Co-Investment Fund is a $2 billion co-investment fund to pursue
opportunities in Russia. The fund will predominantly focus on long-term investment
Co-Investment Fund
In context of rising alliances, a very interesting trend
to follow is the increased cooperation between
SWFs and other private, like-minded investors in
deal making. In a rather bold move, the Qatar
Investment Authority has invested $3 billion in the
launch of Doha Global Investment Company, a new
business half-owned by the country’s sovereign
wealth fund and half by the private sector, giving
Qatari institutions and individuals the chance to
invest around the world alongside the state. The
vehicle was slated for listing on the Qatar
Exchange, which seeks to rival Dubai as a financial
hub, but the IPO has been postponed officially due
to lacking regulatory approvals. Indeed, the public
listing of the company might require the disclosure
of information about sponsoring entities, and the
Qatar Investment Authority – a rather conservative
organization – might be reluctant to fully open its
books. However, the QIA move is a step further: the
SWF not only acts as a co-investor and partner, but
is here the largest investor and catalyst for a large
number of private-sector co-investors.
Description
of Inception
opportunities across a range of industry sectors, acting as a catalyst for direct investment
in Russia. The announcement is aligned with Mubadala’s plans to establish a strong
presence in key international markets. Mubadala and RDIF are each committing $1 billion.
The majority of Mubadala's commitment will be deployed in opportunities that will be
evaluated on a deal-by-deal basis while some of the capital will be invested as
an automatic co-investment into RDIF deals.
Unnamed Assets Fund
2013
A unnamed dedicated assets fund created by a Consortium constituted by Snam,
the Italian gas transport and storage operator (45%), GIC, the Singaporean
(Partnership of GIC)
sovereign fund (35%) and EDF (20%, through its dedicated assets for the dismantling
of nuclear plants)
NSW Ports
2013
Led by Industry Funds Management, the consortium includes AustralianSuper, Cbus,
HESTA, HOSTPLUS and Tawreed Investments Limited, a wholly owned subsidiary
(Partnership of ADIA)
of the Abu Dhabi Investment Authority. NSW Ports is committed to the long term
sustainable development of the ports for the benefit of the shareholders.
JV Norwegian Government
2013
Real Estate Joint Venture
Pension Fund Global
and Boston Properties
25
THE GREAT REALLOCATION
JV Norwegian Government
2013
In February 2013, TIAA-CREF and Norwegian Government Pension Fund Global
announce $1.2 Billion Real Estate Joint Venture. TIAA-CREF, a leading financial services
Pension Fund Global
provider, enters into a joint venture with Norges Bank Investment Management (NBIM),
and TIAA-CREF
manager of the Norwegian Government Pension Fund Global, to invest in high-quality
office properties in Boston, New York and Washington. TIAA-CREF owns a 50.1 percent
share and will manage the joint venture. NBIM holds the remaining 49.9 percent share.
The joint venture is invested in several prime office properties measuring 1.9 million
square feet and valued at $1.2 billion (approximately 6.6 billion kroner). TIAA-CREF
and NBIM plan to co-invest in additional high-quality office properties in Boston,
New York and Washington.
Astrea II
2014
Astrea II is a co-investment vehicle with broadly diversified holdings in 36 private equity
funds. Temasek is the single largest investor in Astrea II at 38%. Astrea II is the latest
(Partnership of Temasek)
of Temasek's continuing efforts to develop co-investment platforms where diversified
portfolios of assets can be made available to a broader base of investors, including
retail investors in the long term.
Direct SWF Co-investments by Type of Partnership, 2013
Sovereign Investors
16,0%
Sovereign Investors
28,3%
Private Partners
71,7%
Private Partners
84,0%
Value: US$16.9 billion
Number of Deals: 53
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
26
SWF Investment in 2013
THE GREAT REALLOCATION
Figure 8: Value of Direct SWF Investments by Target Region, 2006 - 2013
120
111.7
Figure 9: Foreign SWF Investments in Europe, 2013
0.20
Europe
Eurozone
Asia-Pacific
100
88.2
North America
82.6
77.7
80
UK
6.61
Serbia
MENA
Non-Pacific Asia
58.4
60
20
0
2008
2009
2010
2011
2012
2013
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
announcements and the US in sustained recovery
mode, in 2013 SWFs pushed heavily investments in
Western markets, where they found suitable targets
by size and well-functioning institutions to protect
their returns.
At a closer look, the regional breakdown reveals
some new interesting trends. While European targets still attract most SWF activity (33 deals
accounting for $18.4 billion, 37 percent of total
value), the Asian-Pacific region is down to 18 percent ($9.1 billion), half of what it raised in 2012.
Investments in the United States resumed in earnest,
up from the tiny 5 percent of deal value reported last
year to 16 percent ($8.3 billion). But the real surprise of 2013 is the Non Pacific Asia, boasting 18
percent of total investment ($8.9 billion) thanks to
revamping interest in Russia, India and Turkey. The
28
Spain
1.50
Italy
0.78
Germany
Sub-Saharan Africa
25.2
2007
1.65
11.63
40
2006
France
Latin America
50.1
47.6
7.70
analysis by target region thus allows us to qualify
more precisely the effects of the macroeconomic
adjustments reported before: within BRICs, China
was the country mainly affected by the reallocation.
Lumping global SWF activity by region misses a
qualifying feature in the geography of sovereign
investment such as its international profile captured
by the distinction between domestic and foreign
deals, which in turn hinges upon their investment
strategy and ultimately their mission. Some funds
(such as Mubadala, Temasek, etc.) have a strong
domestic focus and a broad mandate to support the
national economy. Other funds (such as QIA, KIA,
etc.), due to the limited absorption capacity of their
national economies, invest internationally a larger
share of surplus, seeking better returns and diversification opportunities.
Value
(US$BN)
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
The SIL definition of a “sovereign wealth fund”
hinges upon a significant share of investment to be
carried out abroad by the funds, even if all our
funds (with the notable exception of Norway’s
GPFG) are free to invest at home especially if the
national economy requires support, as it often
happened throughout this prolonged crisis. That
the overwhelming majority of direct equity investments by our funds took place abroad is thus
hardly surprising. Nevertheless, the stability of
this share in the last years is quite striking: in
2013, the share of foreign deals by value is 85 percent, remaining virtually unchanged relative to
previous year. As long as some pro-cyclicality can
be traced in the international patterns of SWF
activity, this recent trend can be interpreted as an
additional sign of stabilization and recovery of the
investing countries.
As usual, the largest share of cross-border investment landed in Europe, with a twist. For the first
time since the inception of our series, the United
Kingdom does not lead the ranking by annual deal
value. In 2013, the prize is carried off to France, in
the context of an overall rebalancing in favour of
the Eurozone. True, London still attracts the largest
deal flow by operations, but the total price tag for
French targets acquired by SWF is one billion larger
than the British, with a total of $11.6 billion raised
in the Eurozone. Furthermore, in 2013 SWFs started to worry about the growth prospect of emerging
economies and therefore limited the indirect exposure to those markets via investment in European
manufacturers with a large market shares abroad.
This rebalancing is clearly visible in the sector allocation of SWF investment in 2013: the combined
value invested in European non tradable sectors
29
SWF Investment in 2013
THE GREAT REALLOCATION
Western companies have been
targets of choice while
investments in BRICs slowed
down especially in China
(primarily real estate) is $10 billion, 55 percent of
the total European investments, against the 36 percent reported last year.
France jumped in top position thanks to the trophy
brick-and-mortar assets purchases by ADIA and
QIA along with stakes acquired in top energy players by GIC and again QIA. London, the usual magnet of SWF investments in real estate, completed five
large scale operations (including a real estate development project involving the Norway’s GPFG)
worth in total $5.4 billion, 81 percent of total SWF
inflow in the country.
Singapore’s SWFs Temasek and GIC account for the
rest, acquiring a stake of around 10 percent in
Markit, the fast-growing UK financial data company, and Rothesay Life, a large pension insurer. Spain
implemented some structural reforms aimed at
increasing competitiveness, and in terms of attraction of foreign capital, those are starting to pay out.
SWF investment in Spanish companies increased significantly in 2013, thanks to two large investments:
the 5 percent stake acquired by Temasek in the oil
group Repsol makes the Singapore investor the
company’s fourth-largest shareholder; and the
investment in the railroad construction company
Construcciones y Auxiliar de Ferrocarriles by the
30
Norwegian GPFG. For Spain, a confidence vote by
highly respected SWFs is certainly a valuable political dividend. Italy, a country finally on the radar
screen of foreign institutional investors, gained the
attention of SWFs, as they invested $1.5 billion in
five sizable deals. Those included the Qatar
Investment Authority acquiring a 40% stake in the
Milan financial district Porta Nuova and thus
boosting one of the most ambitious real estate development projects in the country, and the bail-out of
Piaggio Aero by Abu Dhabi Mubadala, an acquisition recently cleared by Italian government enjoying
a “golden share” in the company.
In 2013, the other most attractive regions in terms
of cross-border investment flows have been NonPacific Asia and North America, each reporting a
total deal value more than $8 billion, 17 percent of
the total foreign investment. The leap forward of
Non Pacific Asia has been quite spectacular thanks
primarily to the keen interest on Russian targets,
which raised alone $5.4 billion. SWF investment in
Russia in 2013 has some key features: heavily
skewed in favor of the financial and chemical sectors, typically executed in partnership with the local
sovereign investor or with other SWFs, and strongly
affected by Chinese acquisitions. Indeed, CIC, primarily via its subsidiary Chengdong Investment
Corporation, was the key player investor in all
major deals. India sticks out as the other country of
choice in the region, with 17 operations worth $2.8
billion. The Oman Investment Fund via its JV with
the State Bank of India and Temasek have been the
most active funds and broadly diversified investments across sectors, aiming to mitigate risks of a
country growing recently at a slower pace.
Figure 10: Investment Flows from Middle East & North Africa SWFs 2013
MENA to Non-Pacific Asia
13 deals, $3.8bn
MENA to Europe
19 deals, $10.5bn
MENA to North America
10 deals, $2.4bn
MENA to Pacific Asia
6 deals, $2.2bn
Within MENA
12 deals, $3.8bn
MENA to Latin America
1 deal, $0.5bn
MENA to Sub-Saharan Africa
2 deals, $0.0bn
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
In the last years, SWFs shied away from the United
States, with their fingers burnt from the big bailout
of Wall Street banks. However, in 2013 they came
back strong, investing $8.2 billion in 29 US targets.
At a closer look, with the only exception of QIA
investment on Bank of America, SWF shied away
from finance and invested with a vengeance in one
sector, real estate. Indeed, 2013 was the record year
for American brick-and-mortar, with 14 deals worth
$4.8 billion executed mainly by Norway’s GPFG
and GIC. With the sole exception of IT company
BMC Software acquired by GIC, in 2013 global
SWFs did not execute a single significant deal with
US manufacturers as targets.
As we noticed above, the geographical reallocation
within BRICs primarily affected China. Indeed, within the Asia Pacific Region, 2013 witnessed a significant shift of market shares from China in favor of
another developed country such as Australia and
amongst emerging economies such as Indonesia.
Chinese data are particularly impressive. Foreign
31
THE GREAT REALLOCATION
SWF Investment in 2013
Figure 11: Investment Flows from Asia-Pacific SWFs 2013
SWF investment flows accounted for 26 per cent
while South-North for 66 per cent.
Asia-Pacific to Non-Pacific Asia
16 deals, $4.1bn
Asia-Pacific to Europe
10 deals, $7.2bn
Asia-Pacific to North America
18 deals, $4.0bn
Asia-Pacific to MENA
0 deals, $0.0bn
Asia-Pacific to Latin America
4 deals, $0.9bn
Within Asia-Pacific
52 deals, $6.9bn
Asia-Pacific to Sub-Saharan Africa
3 deal, $0.2bn
Foreign investments represent a qualifying, and for
some alarming, feature of SWFs activity.
Nonetheless, sovereign investment is also deployed
within the national borders to support long-term
economic development or the domestic economy
when the outlook deteriorates. We already noticed
that 2013 the share domestic investments remained
in the same range of the previous year, with SWFs
purchasing domestic assets worth $7.7 billion in 33
deals. The bigger spender was QIA, due to the sizable investment in the Doha Investment
Corporation, followed by Australian Future Fund
and New Zealand Superannuation Fund, heavily
engaged in upgrading infrastructure. The most
active organization by number of deals is the usual
suspect, CIC’s Central Huijin, propping up with 12
equity investments in local big banks and financial
institutions.
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
SWF investment in the country primarily from
Singapore totaled $620 million, a figure dwarfed by
the 4.6 billion raised in 2012. Conversely, Australia
was the most successful economy of the region in
attracting SWFs and the country of choice of ADIA,
pouring $1.9 billion in tourist and infrastructure
assets. Finally, activity in Indonesia is also noteworthy, where CIC invested heavily in coal industries, in
quest of cheap energy for its manufacturers.
At a more aggregate level, an important dimension
of the geography of cross-border investment by
32
SWFs is the share of activity in neighbouring countries and region, within a logic of South-South
trade and financial integration between emerging
countries, as opposed to the share occurring at
great distance across hemispheres. In 2013, SouthSouth foreign SWF investment flows (i.e. within
MENA, Africa, Asia-Pacific and Latin America)
accounted for a total value of $6.9 billion in 47
transactions, while South-North for $31.9 billion
in 86 deals. These values represent respectively the
16 per cent and the 75 per cent of the SWF foreign
investments in 2013. In 2012, South-South foreign
Funds
After the spectacular records of last year, one could
hardly figure out that QIA’s could gain further
prominence as direct equity investor amongst SWF.
Yet in 2013 QIA not only leads the ranking by deal
value, but it has also increased its share of total
investment from 26 percent to 30 percent, thanks to
26 acquisitions worth $14.9 billion.
Momentum changes occurred in Qatar in 2013. In
July, the Emir Hamad Al Thani left the throne to
his and Sheikha Moza’s 33-year-old son Sheikh
Tamim. Ahmad Al-Sayed, who headed Qatar
Holding LLC, was promoted QIA chief executive
officer, replacing Sheikh Hamad bin Jassim alThani (HBJ), who set the style and tone of Qatar’s
investment drive the former emir’s 18-year reign.
Commentators worried that HBJ’s departure could
mean a slowdown in the pace of external investment. However, deals continued to flow regularly
also in the third and fourth quarter, with the usual
penchant for trophy assets – often, real estate icons
– and established brands across sectors. For the
time being, we conclude that the changeover in
power meant more continuity than disruption.
Furthermore, by clarifying the lines between political leaders and the state’s sovereign wealth fund,
recent changes could modernize the fund and arm’s
length management might be beneficial to its image
as a more professional institution.
Singaporean funds have been extremely active
investors in 2013. As in 2012, Temasek and GIC
lead the ranking by number of deals with 60 acquisitions, one third of total volume. GIC, the largest
fund by assets, confirms its role of top spender
with a total direct equity investment of $9.4 billion. The geographical and sector diversification of
both funds is impressive, and confirming their reputation of truly global investors with distinctive
missions: Temasek a strategic investor with larger
stakes, GIC a fund aiming at global portfolio
diversification.
ADIA and CIC are the other big spenders in 2013,
each reporting direct equity investment above the
$5 billion, 10 percent of the total. ADIA displayed
its usual appetite for safe assets, primarily real
estate and infrastructure, in developed economies,
33
THE GREAT REALLOCATION
SWF Investment in 2013
Table 3: Direct SWF Investments of over $1 billion, 2013
Figure 12: Value of Direct Investments
by Top Spending SWFs, 2013
Fund
Target
Target
Name
Country
Doha Global Investment
Qatar
Banking, Insurance, Trading
3.00
Investment Corporation (GIC)
Broadgate Estates Ltd
UK
Real Estate
2.78
China Investment Corporation (CIC)
OAO Uralkaliy
Russia
Chemicals
2.14
Qatar Investment Authority (QIA)
Total SA
France
Petroleum & Natural Gas
2.14
4.31
Future Fund
Australian Infrastructure Fund (AIX) Australian Infrastructure Assets
Australia
Transportation
2.08
5.17
France Printemps SA
France
Retail
2.08
Qatar Investment Authority (QIA)
Sector
Deal Size Country
(Value US$ Billion)
50.00
Government of Singapore
Qatar Investment Authority (QIA)
40.00
5.27
BMC Software Inc
USA
Personal & Business Services
1.68
Investment Corporation (GIC)
Grand Wailea Resort Hotel
USA
Restaurants, Hotels, Motels
1.50
Temasek Holdings Pte Ltd
Repsol SA
Spain
Petroleum & Natural Gas
1.35
China Investment Corporation (CIC)
Bumi Resources Tbk
Indonesia
Coal
1.30
Qatar Investment Authority (QIA)
Bharti Airtel Ltd
India
Communications
1.26
Qatar Investment Authority (QIA)
Louvre Hotels
France
Restaurants, Hotels, Motels
1.10
Investment Corporation (GIC)
TIGF
France
Infrastructure & Utilities
1.09
Qatar Investment Authority (QIA)
Porta Nuova Srl
Italy
Real Estate
1.05
Qatar Investment Authority (QIA)
Bank of America Corporation
USA
Banking, Insurance, Trading
1.00
Government of Singapore
20.00
Mubadala Development
9.40
Other
Kuwait Investment Authority (KIA)
New Zealand Superannuation
Fund
Mubadala Development
Company PJSC
Future Fund
Government Pension Fund Global
Temasek Holdings Pte Ltd
10.00
14.90
Government of Singapore
Company PJSC
3.14
30.00
Government of Singapore
Investment Corporation (GIC)
1.92
1.01
1.03
1.84
2.08
China Investment Corporation
(CIC)
Abu Dhabi Investment Authority
(ADIA)
Government of Singapore
Investment Corporation (GIC)
Qatar Investment Authority (QIA)
0.00
Publicly available data for direct SWF equity & real estate deals, joint ventures
RDIF-Mubadala Co-Investment Fund
Russia
Banking, Insurance, Trading
1.00
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
and capital injections. Source: Sovereign Investment Lab, Università Bocconi
while CIC, under tighter budget constraint, pulled
back investments even further, focusing on the
domestic financial sector and foreign targets producing commodities to fuel cheaply its decelerating
economy.
Interestingly, in 2013 a new entry in the top ten list
by number of deals is the Oman Investment Fund,
which balanced investments at home with sizable
34
QIA is the usual
top spender and Singaporean
funds are the most active
deals in India in order to strengthen commercial ties
with the neighbouring country. By keeping the value
of its assets strictly undisclosed, uncertainty remains
over the effective firepower of this organization.
Finally, we report interesting news from down
under. Australia’s Future Fund and the New
Zealand Superannuation Fund have entered our top
ten list by deal value, with a respectable $3 billion
of domestic direct equity investment primarily in
infrastructure to strengthen their potential to grow.
The Great Reallocation
Emerging markets have enjoyed breath-taking
growth over the past two decades by closing the
productivity gap with the more developed
economies. But, as the gap has narrowed, growth
rates have declined – and the slowdown of China
and India has led to lower commodity prices. At the
same time, the shale revolution in North American
energy markets has put downward pressure – and
future uncertainty – on the oil and natural gas prices
that have underpinned much of SWF growth.
This is why in 2013 not only have we observed SWF
lower aggregate investments, but allocations have
changed. The same slowdown that led to declining
fund accumulations in developing countries has also
35
SWF Investment in 2013
THE GREAT REALLOCATION
led to the same markets being less appealing investment targets. We call this process the Great
Reallocation, with implications across geographies
and sectors.
Figure 13: Number of Direct Investments
by Top Spending SWFs, 2013
The biggest beneficiaries of this reallocation have
been developed economies, primarily Europe, and
the United States, and Australia. Within this
region, SWF selectively slowed down investment in
manufactures indirectly exposed to emerging market growth, and focused on real estate especially
commercial properties in Europe, and safe assets as
infrastructure. But the real surprise is a new
emphasis on lodging, with, first and foremost,
Qatar, but also Brunei, Abu Dhabi and Singapore
acquiring hotel chains and trophy properties.
Amongst BRICs, Russia remained on the radar
screen only thanks to the strong capital injections
from Chinese funds.
160
The easiest trend to forecast is that, despite the
slowdown in the accumulation of central bank and
SWF reserves we have discussed, SWFs are likely to
keep growing, even if at a somehow slower pace
than over the recent past. In a world of increasing
economic uncertainty and market volatility, all else
is difficult to forecast, but, as SWFs continue internalizing wealth management, the recent trend of
co-investments and partnerships is likely to expand.
QIA’s leading role within the Doha Global
Investment Company heralds a new evolution in
this trend – that of a SWF being not just a partner
of other, private-sector, investors, but a leader and
catalyst. We expect SWFs in the future to increasingly leverage their investment power by creating
such investment partnerships and we wonder how
36
180
22
140
6
6
7
8
120
14
100
26
26
60
20
New Zealand Superannuation
Fund
Mubadala Development Company
PJSC
Oman Investment Fund
Government Pension Fund Global
80
40
Other
29
Abu Dhabi Investment Authority
(ADIA)
Qatar Investment Authority (QIA)
China Investment Corporation
(CIC)
Government of Singapore
Investment Corporation (GIC)
Temasek Holdings Pte Ltd
31
0
Publicly available data for direct SWF equity & real estate deals, joint ventures
and capital injections. Source: Sovereign Investment Lab, Università Bocconi
long will it be before SWFs, just like their privatesector counterparties, start doing so the old-fashioned way, by large-scale debt issues. The trend has
already begun – Singapore’s Temasek has issued
bonds to institutional investors since 2005 and
Malaysia and Abu Dhabi have experimented with
bond issues linked to their SWFs – but, in a world
facing challengingly low yields, we suspect this
trend might intensify.
The growing share of funds that is internally managed is also leading to increased control and SWFs
are more frequently taking an assertive role in the
firms in which they invest. In many ways, internal
management, increased assertiveness, and better
diversification are all manifestation of the same
process of evolution of these funds. To a large
extent, prior to the 2008 financial crisis, SWFs
were happy to outsource fund management and to
concentrate their direct investments into Western
financial companies. Their passive stance – along
with their love for the North American financial
sector – are both casualties of the 2008-2009 crisis. SWFs are maturing in both capabilities and
expectations – yet, for active investments to
become a reality, their staffing levels will have to
increase.
The landscape of sovereign investment is changing
rapidly. We are seeing several developing countries,
primarily from Africa, launching organizations
which could graduate soon into fully-fledge SWFs.
Whether they will grow up in size and respect, it is
too soon to tell. Sure, we will keep track.
SWFs will keep seeking diversification, away from
government bonds – especially away from US
Treasuries – and into private markets and alternative asset classes. Over the recent years, we have
seen private equity funds increasing their allocations
to the syndicated loans market and we suspect that
SWFs might follow suit, filling the gap that Western
banks, hobbled by increasingly stringent capital
requirements, are leaving and that is increasingly
being filled by non-traditional lenders.
Whether SWF investments in Europe will continue
in the future to retain the lion’s share of SWF asset
allocations depends, largely, on the performance of
European economies – and there is a large degree of
uncertainty in that. Our bet is that safe assets in
developed economies will remain the targets of
choice in 2014.
37
Articles
Sovereign Shareholder Activism:
How SWFs Can Engage in Corporate Governance
Paul Rose
Ohio State University
Introduction
As the number of, and assets controlled by, sovereign
wealth funds (SWFs) has increased dramatically in
recent years, so too has scrutiny about how SWFs are
making use of these assets. With respect to equity
investments in publicly traded firms, one facet of this
concern is that SWFs will become “activist” shareholders. Notwithstanding genuine concerns about
how governments exercise political power through
economic entities, two threshold issues must be
addressed before one can develop and evaluate proper policy responses to sovereign shareholder activism.
for an identical 3% interest in an Australian company. Likewise, Italy may view an investment from the
Alberta Heritage Fund as qualitatively different from
an investment by the Russian National Wealth Fund,
even though the same Italian regulatory framework
may be used to analyze each investment. That SWFs
are quite different and that they operate in very different political contexts is well known to asset managers, most SWF researchers, and of course, SWF
officials, but these important distinctions are often
lost when SWF activity is reported in the press and
even in some academic literature.
First, SWFs are often viewed through a single paradigm when, in reality, SWFs differ along many dimensions, including the way in which they are organized,
their legal status, and their stated policies.1 Even if
one sets aside differences in internal governance and
legal status, each SWF operates in unique political
environments, and geopolitical realities affect their
use and the ways in which they are viewed by other
countries. For instance, Australia may view an investment by China’s CIC as very different from an investment by Norway’s GPF-G, even if the investment is
The second problem, which has received less attention, is one of equivocation on important terms in
corporate governance, and particularly equivocation on the term “activism”. Understanding the different forms of shareholder activism that occur
today gives insight into how sovereign investors can
engage in corporate governance while minimizing
the risk of adverse regulation by host countries.
1
Capapé, Javier and Guerrero Blanco, Tomas, “More Layers than an Onion:
Looking for a Definition of Sovereign Wealth Funds” (June 1, 2013).
SovereigNET Research Papers; ESADE Business School Research Paper No. 21.
Available at SSRN: http://ssrn.com/abstract=2391165 or
http://dx.doi.org/10.2139/ssrn.2391165.
Types of Activism
Activism is linked to the increasing importance of
corporate governance, a phrase that itself “only
came into vogue in the 1970s in a single country—
the United States—[and] became within 25 years
the subject of debate worldwide by academics,
regulators, executives and investors”.2 Even as
39
Articles
THE GREAT REALLOCATION
SWF may shift from passive
to active shareholders to protect
long-term returns
by monitoring governance
recently as the 1990s, institutional investors spent
relatively little time on corporate governance matters, and the most prominent activist investors
were “gadfly” individual investors that took
stakes in companies in order to agitate for governance—and frequently, social—changes at publicly traded companies. Corporate governance has
taken on increased importance for institutional
investors for a variety of reasons, including
enhanced focus on governance issues by regulators, as well as the rise of the corporate governance industry and proxy advisory services such
as Institutional Shareholder Services. More recently, hedge funds have become important activist
investors by pushing for governance and tactical
changes at companies around the world.
The types of activism engaged in by hedge funds and
most other institutional investors, such as public
pension funds, differ in important ways. These differences are important to highlight when consider2
Cheffins, Brian R., “The History of Corporate Governance” (December 1, 2011).
OXFORD HANDBOOK OF CORPORATE GOVERNANCE, Mike Wright, Donald
Siegel, Kevin Keasey and Igor Filatotchev, eds., Oxford University Press, 2013;
University of Cambridge Faculty of Law Research Paper No. 54/2011; ECGI Law Working Paper No. 184/2012. Available at SSRN:
http://ssrn.com/abstract=1975404 or http://dx.doi.org/10.2139/ssrn.1975404.
40
ing how sovereigns could (and perhaps should)
engage in corporate governance. As Cheffins and
Armour have recently noted, hedge funds tend to
engage in what they term “offensive” shareholder
activism. Offensive activism is typically event-driven: the offensive activist agitates for change at the
company, seeking to squeeze out value that, in the
view of the activist, may be locked up in a subsidiary
or in cash reserves. Under what has become a traditional strategy, the activist may seek to force the
company to (among other things) spin off a subsidiary or pay a special dividend.
ability” activism that is most commonly associated
with large public pension funds and even some sovereign wealth funds. Norway’s NBIM, which manages
the Government Pension Fund – Global, provides
perhaps the best example of this sort of activism
among SWFs. In 2013, for example, NBIM submitted
three shareholder proposals requesting access to the
corporate proxy, which would enable a shareholder
that has held 1% of the company’s outstanding common stock for one year to nominate one director for
the company’s board of directors.
An important feature of successful offensive activist
campaigns has been the ability of the hedge fund to
convince other shareholders, including relatively
more passive shareholders such as mutual funds,
pension funds and other large institutional
investors, to support the hedge fund. Often, the
hedge fund will seek approval of the strategy by
proxy advisors, who can help influence large institutions. Supporting hedge funds does not make the
other investors “activists”—they were not the ones
instigating the change, after all—but simply means
that the offensive activists’ value-creation story was
convincing to other shareholders.
Moving Beyond the Passivity Paradigm
In contrast to these two types of activist shareholders, most shareholders are largely passive. They may
choose not to exercise their shareholder rights at all,
or simply to follow any management proposal.
Many SWFs fit in this category. This passivity is
attributable to the fact that SWFs tend to be what
Bortolotti et al. have termed “Constrained Foreign
State Investors” that “will refrain from taking an
active corporate governance role in target companies in order not to generate political opposition or
a regulatory backlash.”3 Even efforts to influence (as
opposed to control) companies may result in dramatic regulatory consequences. For example, a SWF
that pressures a poorly-performing CEO to step
down could subject its investment in the company to
review and even divestment under U.S. law.
In contrast to the offensive activism of hedge funds,
some large institutional investors are engaged in
“defensive” activism. The defensive activist monitors
the firm not to seek ways to force value-creating
changes, but to prevent losses from mismanagement.
In other words, whereas offensive activism is
designed to produce wealth in the short to medium
term, defensive activism is designed to protect wealth
in the long term. It is this type of defensive, “account-
Because they are long-term investors and often
under political and regulatory scrutiny that makes
them less likely to sell, SWF capital tends to be captive capital. Thus, protecting long-term returns by
monitoring governance is a priority for many sovereign investors.4 The difficulty for most SWFs,
then, is how to hold mangers accountable without
selling or directly engaging in ways that would concern regulators.
Fortunately for SWFs, the market for corporate
influence in many countries has become sufficiently
robust that portfolio companies with poor governance tend to be targeted early by activist investors;
in other words, SWFs typically need not worry
about initiating governance engagement, at least
with firms that have significant institutional investor
ownership. Hedge funds and, not infrequently, pension funds may be already pressuring a poorly-performing corporate management. Because SWFs are
often large but passive blockholders, they can exert
significant influence simply through the exercise of
their voting rights.
While this kind of corporate governance engagement may seem like governance free-riding, it is
3
Bortolotti, Fotak, Megginson and Miracky, “Quiet Leviathans: Sovereign Wealth
Fund Investment, Passivity, and the Value of the Firm”, FEEM Note di Lavoro
22.2009. Available at http://www.baffi.unibocconi.it/wps/allegatiCTP/SWFpaper-RFS-Final-oct25_2010.pdf.
And yet, a consensus appears to be developing that
large institutional investors, including SWFs,
should be aware of corporate governance issues at
their portfolio companies, even if they choose not
to actively attempt to influence management.
4
I note, however, that there is mixed evidence that active influence by institutional
investors results in stronger performance, and no evidence that influence by
public investors results in stronger performance. However, I am not advocating
influence through defensive activism, but merely engagement through normal
governance mechanisms, including shareholder voting.
41
Articles
THE GREAT REALLOCATION
more accurate to think of it as riding on a reduced
fare; the SWF will incur some costs in developing
robust policies and procedures for the exercise of
voting rights. The effort is essential, however,
because if SWFs fail to exercise their rights as shareholders they risk creating a monitoring deficit that
has the perverse effect of entrenching poor managers.5 This risk is increasingly relevant as SWFs
take larger minority positions.
SWF should be as transparent as possible about how
they intend to use corporate governance rights. For
example, a SWF may believe, as NBIM does, that
companies should apply the principle of one share,
one vote, so that a shareholder’s voting rights and
dividend payments reflect the size of his or her
shareholding.6 Publishing such governance and voting policies, on the Internet and in annual reports,
provides an important signaling effect to companies
and other shareholders. It also provides a strong signal to the sponsor sovereign and its citizens of the
quality of governance at the SWF itself. Moreover,
so long as the SWF merely exercises its voting rights
and does not directly try to influence the company,
it is unlikely to run afoul of host country regulations. As the Santiago Principles make clear in
GAPP 21, transparency with respect to the exercise
5
This hypothesis finds support in Bortolotti, Bernardo, Fotak, Veljko and
Megginson, William L., “The Sovereign Wealth Fund Discount: Evidence from
Public Equity Investments” (September 17, 2013). Baffi Center Research Paper
No. 2013-140; FEEM Working Paper No. 22.2009. Available at SSRN:
http://ssrn.com/abstract=2322745 or http://dx.doi.org/10.2139/ssrn.2322745.
6
Norges Bank Investment Management, Equal Treatment of Shareholders
(accessed May 2014). Available at http://www.nbim.no/en/responsibility/
responisble-investments/equal-treatment-of-shareholders/.
42
of corporate governance rights helps to “dispel concerns about potential noneconomic or nonfinancial
objectives.”
Many SWFs will not choose to engage portfolio
companies as Norway has (and indeed, the political
reality is that many SWFs would invite unwelcome
regulatory scrutiny if they did so). But all SWFs can
and should develop a stated policy on corporate
governance issues, even if the SWF believes that it,
like most mutual fund companies, will generally
support management.
Sovereign Wealth Fund Investment Performance:
Some Stylized Strategic Asset Allocation Results1
Michael Papaioannou and Bayasgalan Rentsendorj
International Monetary Fund
Introduction. The Markowitz portfolio theory has
been used during the past six decades by various
institutional investors, including sovereign wealth
funds (SWFs), to determine their asset allocations.
Our analysis of the strategic asset allocation of the
world’s largest sovereign wealth fund –The Norway
Government Pension Fund Global (GPFG), demonstrates that it is broadly consistent with that generated by a simple one-period Markowitz model. This
investment performance critically depends on the
fund’s permissible asset classes, risk tolerance, and
strategies in attaining the set portfolio objectives,
such as stability of returns over an assumed time
horizon. Further, appropriate asset weight rebalancing allows for higher returns and achievement
of long-term investment objectives. The obtained
results for the GPFG need to be contrasted with
that of other sovereign wealth funds to establish
whether there is a broader conformity with investment allocations proposed by the Markowitz
model.
Asset management often faces challenges with
regards to the risk-return characteristics of asset
classes. This is particularly important for SWFs
that are owned by governments and are mandated
to a certain performance, based on set benchmarks. This challenge has been more pronounced
during the last few years, especially after the recent
global financial crisis and current low-return envi-
ronment. In this connection, our investigation
shows that the GPFG successfully rode out the
recent financial crisis and grew stronger through
successive portfolio rebalancing actions. For example, the GPFG had progressively taken advantage
of investment opportunities of mispriced equity
assets, realizing that active management does not
contradict the modern efficient market hypothesis.
This helped achieve historic returns of 25.6% in
2009, with the equities portion having been
increased to 62.4% in the total portfolio from less
than 41% in 2006 (GPFG Annual Report, 2009).
This countercyclical investment behavior, which
led to the increase of volatile (yet high potentialreturn) assets when other long-term institutional
investors tried to contain the equity risk, required
strong independent institutional and governance
frameworks, which the GPFG had been able to
establish before the financial crisis. This behavior
also helped avoid pro-cyclical investment SWF
“herding” phenomena, where asset allocations
move in tandem with market fluctuations, as was
the case for many institutional investors that
increased their fixed-income share rather than the
equity share in their portfolios during 2008 and
2009 (Papaioannou, et al., 2013).
1
The views expressed in this note are those of the authors and should not be
attributed to the IMF, its Executive Board, or its Management. Authors’ e-mail
addresses: mpapaioannou@imf.org, brentsendorj@imf.org
43
THE GREAT REALLOCATION
Articles
Figure 1: Total Assets and Asset Allocation of GPFG (% of Total Portfolio)
Figure 2: Portfolio and Individual Asset Class Returns of GPFG (%)
70%
5.000
4.500
60%
4.000
50%
3.500
Total Portfolio (Right)
Equity
Fixed income
20,0
Real estate
Fixed income
Real estate
3.000
40%
Equity
25,0
15,0
Portfolio Return
10,0
5,0
2.500
Source: Annual and Quarterly Reports, GPFG, Norges Bank Investment Management
Source: Annual and Quarterly Reports, GPFG, Norges Bank Investment Management
Asset allocation decisions require in depth macrofinancial analysis. As a long-term investor, the GPFG’s
focus on systematic risk, while allowing flexibility for
a given market opportunity with substantial adjustment room, improved its overall risk-adjusted return.
An example of this approach was the GPFG’s decision
to enter the global real estate market in 2011, right
before the international real estate surge in 2012.
Since 2009, asset allocations of many SWFs manifest
a significantly increased share in equities over time,
while their fixed-income share is steadily reduced
(Bodie and Briere, 2013). This has taken place against
the background of the current prolonged low-return
financial environment. In particular, the GPFG’s longterm portfolio composition has been rebalanced, with
its risk appetite being increased. The share of fixedincome in the composition of the GPFG’s portfolio has
gradually been reduced to 37% of the total portfolio
compositions with highest perceived return and lowest risk level, of long-term investors may be tested by
market volatility. For the GPFG, the dynamics of
global economic integration and various market
shocks have challenged its optimal asset allocation,
especially with regards to investing in line with the
efficient frontier allocations of other long-term institutional investors. Despite these challenges, the
GPFG’s efficient frontier has demonstrated a broad
conformity with asset allocations being generated by
a simple one-period Markowitz model. Further, the
flexibility in the GPFG’s asset allocation allows higher yield results and generates optimal outcomes (see
Figure 3). The GPFG’s case has illustrated that countercyclical portfolio rebalancing has played an important role in accomplishing the set portfolio objectives,
e.g., stability of risk-adjusted return over time.
Examples of countercyclical asset allocation, e.g.,
44
in 2014, from 59% in 2006, while the global equity
share was substantially increased to more than 62%
of the total portfolio in 2014, from 41% in 2006. The
increase in the equity share in its portfolio, with an
increased mean variance for the overall portfolio, did
not alter the theoretical return and position on the efficient frontier. As countries’ contributions to global
GDP evolve over time, the GPFG’s portfolio adapted
to this trend and increased its emerging markets’
share, with careful consideration on its historically
high level of risk. The extent of correlation and possible causality in the GPFG’s portfolio investments, in
response to increasing market volatility, needs to be
examined further.
A stylized efficient frontier
The efficient frontier, the set of optimal portfolio
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00
7
2.000
12
/1
/2
00
6
30%
increased share of high-volatility assets with consequent reduced share of less volatile fixed-income
assets during periods of market crisis have been
observed over time (see Figure 1). Illustrative calculations indicate that, given a return level, risk can be
reduced by 0.3% if the equity share is reduced by
5.9%, while the fixed-income share is increased by
2.0% and the real estate portion is reduced to almost
zero in the overall portfolio. These results, of course,
depend on the used sample period (1998-2013).
The GPFG’s actual investment portfolio, which is
broadly consistent with the one-period Markowitzgenerated efficient frontier, takes into account
social, ethical, and environmental considerations.
The investment universe and permissible asset classes are scrutinized by Norway’s parliament. The fund
is the signatory of the United Nation’s Principles of
45
THE GREAT REALLOCATION
Articles
Figure 3: Efficient frontier of Norway Government Pension Fund Global
asset classes, selection of benchmarks, determination
of risk tolerance levels on different asset classes, performance measurements, application of accounting
standards, accepted rating(s) for investment instruments, and related market predictions. In the case of
the GPFG, the Ministry of Finance ultimately sets the
benchmark indexes for investment portfolio compositions and global mandates, considering market
weights (GDP weights). The GPFG benchmark
indexes are quite open to changes, so as to support
an active asset management framework that ensures
higher returns over time.
0,6
Frontier
Target
Benchmark
EXPECTED RETURN %
Current
0,4
Equity only
Fixed income only
Real estate only
0,2
0
0
1
2
3
4
STANDARD DEVIATION %
Publicly available data for direct SWF equity & real estate deals, joint ventures and capital injections. Source: Sovereign Investment Lab, Università Bocconi
Responsible Investment (PRI), which advocate more
relevance on environmental, social and corporate
governance issues than on pure returns in investment practices. Accordingly, the GPFG has a very
strong Council of Ethics that frequently reviews the
fund’s global investments with respect to an adopted ethical guideline framework, without regards to
yield implications. In particular, it reviews whether
companies in GPFG’s investment portfolio are within the framework of socially responsible, humanitarian, ethical, and environmentally friendly standards.
Thus, the total number of companies excluded from
the allowed investment portfolio reached 48 in
2009, 51 in 2010, and 55 in 2011 (GPFG Council
on Ethics Report, 2011). The rationale for responsible investments is based on the premise that: “…
organizations that manage environmental, social
and governance (ESG) factors effectively are more
46
likely to endure and create more value over the longterm than those which do not” (GPFG Strategy
Council Report, 2013). Examples of companies that
are excluded from the GPFG’s investment portfolio
are: all tobacco producers, due to human health
concerns, Barrick Gold Corp. and Rio Tinto, due to
alleged environment damages, and Boeing Co. and
Northrom Grummanm Corp., due to their production of arms. While the GPFG has been consistently
adhering to its ethical and transparent investment
principles, its investment activities have not precluded it from generating long-term returns well within
its set objectives (Clark and Monk, 2010).
Challenges in a SAA Optimization
There are several challenges in carrying out an SAA
optimization, including the decision on admissible
The adoption of a comprehensive framework for
timely portfolio rebalancing is another challenge in
managing a diversified global portfolio. The
GPFG’s performance illustrates the possibility of
enhancing overall returns with a lower risk level,
through rebalancing of asset classes that is in line
with market trends. This adjustment involves
dynamic asset allocations that allow funds to rebalance in line with their strategic policy/benchmark
target compositions. The timing and frequency of
asset weight changes, especially in response to
intense market volatility, require a strong institutional development and risk management framework, along with close monitoring of market developments. For the GPFG, the changes in asset allocation to increase the equity composition over time
paid off significantly in recent years, yielding higher returns. In particular, in 2013, the investment
portfolio provided an exceptional performance of
15.9 %, following actions that deviated from the
benchmark index, mostly driven by the equity
investments in North America and European equities (GPFG Annual Report, 2013).
The strategic allocation
of GPFG is broadly consistent
with that generated
by theoretical models
Despite its long-term investment horizon, the GPFG
appears to be resilient to market volatility, based on
a VaR analysis (GPFG Report to the Storting, 2014).
As the recent global financial crisis has showed, it is
not possible to fully assess ex ante the market risk
from emerging external shocks, which can then
become a major challenge in the investment rebalancing process. In this regard, the GPFG’s broad
diversification approach (i.e., global GDP-weighted
diversification) is justified, especially in view of the
size of the fund. Although our analysis indicates that
the GPFG’s current asset allocation is broadly consistent with that of the Markowitz approach, it also
highlights that there is room to reduce risk by curtailing the equities share, even though past experience has shown that the GPFG is able to effectively
absorb market risk.
Sovereign wealth funds’ asset allocations need to be
frequently reassessed. Especially a low-return environment may significantly affect a fund’s portfolio
composition and return on assets. The GPFG’s portfolio composition indicates continuous adaptations
in the dynamics of its strategic asset allocation,
while its efficient frontier illustrates the constraints
in its effective portfolio diversification from low
returns of employed fixed-income assets. Also, it
should be noted that restrictions in the investment
47
Articles
THE GREAT REALLOCATION
mandate to allocate a certain portion of the portfolio to specific assets, e.g., public investments, services, or energy and infrastructure projects, may
impose a significant constraint to the efficient frontier. In turn, the risk tolerance level, risk-adjusted
returns and portfolio rebalancing may need to be
appropriately modified, while frequent stress testing
should be used to improve the optimal strategic
asset allocation. In general, funds should rebalance
their portfolios as needed, especially following
changes in the global macroeconomic and market
conditions, and assess their performance regularly.
Concluding remarks
Our study shows that (i) the strategic asset allocation
of GPFG broadly conforms with a Markowitz efficient frontier, (ii) a countercyclical active asset management framework or flexibility of benchmark deviations works perfectly in case of a large SWF that
aims to enhance long-term returns over time, and
(iii) socially responsible investments have not apparently distorted the asset allocation returns and efficient frontier over time. It should also be pointed out
that the GPFG’s long-term strategy has been supported by transparent governance and operational management that advocates long-term investment behavior, even during periods of global financial crisis.
Similar analyses of the investment portfolios of
other SWFs could be undertaken to examine
whether there are commonalities in their investment
behavior with that of the GPFG. If such pattern
could be established, we could argue for a broader
conformity of SWFs’ investment allocations with
those proposed by the Markowitz theory.
48
References
Bodie Zvi and Marie Briere, 2013, Sovereign Wealth
and Risk Management: A Framework for Optimal
Asset Allocation of Sovereign Wealth Optimal Asset
Allocation for Sovereign Wealth Funds, available via:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=
1460692.
Clark, L. Gordon and Ashby H. B. Monk, 2010,
The Norwegian government pension fund: Ethics
over efficiency, Rotman International Journal of
Pension Management, 3(1): 14-19.
Norway Government Pension Fund Global, 20062013, Annual Reports, Norges Bank Investment
Management, Available via: www.nbim.no.
Norway Government Pension Fund Global, 2011,
Council on Ethics for the Government Pension
Fund Global, Annual Report, available via:
http://www.regjeringen.no/pages/1957930/Annual_
Report_2011.pdf.
Norway Government Pension Fund Global, 2013,
Responsible Investment and the Norwegian
Government Pension Fund Global, Main Report by
Strategy Council, available via: http://www.regjeringen.no/pages/38525979/sc_mainrreport.pdf.
Norway Government Pension Fund Global, 2014,
Recommendations of the Ministry of
Finance of April 4, 2014, approved by the Council
of State, The Management of the Government
Pension Fund in 2013, Report No. 19 to the
Storting (white paper), 2013-2014.
Papaioannou, Michael, Joonkyu Park, Jukka
Pihlman, and Han van der Hoorn, 2013, Procyclical
Behavior of Institutional Investors During the
Recent Financial Crisis:Causes, Impacts, and
Challenges, IMF Working Paper, 13/193.
Long Term For Real: SWF's Growing
Investments in Infrastructure
Massimiliano Castelli
UBS Global Asset Management
Historically the key provider of long-term financing
has been the banking sector. Debt financing has historically accounted for 70 to 90 per cent of initial
project funding, with the equity component being
provided by either the public or the private sector.
According to data provided by the World Economic
Forum,1 from 1999 to 2009 commercial banks provided an estimated 90 per cent of all private debt with
large banks in developed economies acting as a major
source of financing to emerging markets as well.
Due to both cyclical factors (in particular the ongoing deleveraging in Europe) and structural factors
(capital charges making long-term capital commitment by financial institutions more expensive), the
banking sector has substantially reduced the amount
of project finance it provides for long-term investing. Globally, project finance loans fell by between
10 and 30 per cent in 2012 alone and the reduced
availability of debt has also reduced the equity provided by private investors or governments.
The reduced lending by the banking sector has
widened the long-term investment gap, which is
now estimated at about USD 1.5 trillion globally.2
Who could realistically fill this funding gap over the
next decades?
appear to be the ideal candidates to fill the gap.
Their asset base is growing at a good pace, their
investment horizon is typically long-term driven by
the long-term nature of their liability structure and
over the last few years there has been a significant
shift in their investments towards alternative asset
classes to capture the liquidity premium and boost
returns.
Indeed, according to estimates from the World
Economic Forum, in 2012 institutional investors
provided about 20 per cent of all project finance
lending with insurers accounting for 7 per cent and
pension funds for 3 per cent. However, several factors make it very unlikely that insurance funds and
pension funds can substantially raise their allocations to long-term investing. Insurance funds are
being impacted by new regulations such as
Solvency II capital charges in Europe which discourage long-term investing. For instance, according to these regulations, a 25 year A-rated bond
(very common in infrastructure investing) would be
charged at 18 per cent; a 5 year A-rated bond
would be charged at 7 per cent. It is not surprising
that, given the ongoing regulatory changes, the G20
1
World Economic Forum, Infrastructure Investment Policy Blueprint, February
2014.
Institutional investors, including pension funds,
insurance funds and sovereign wealth funds,
2
Swiss Re, Institute of International Finance, Infrastructure Investing. It Matters,
2014.
49
Articles
THE GREAT REALLOCATION
SWFs and public pension
funds are ideally placed to fill the gap
in infrastructure investment
has recently asked the Financial Stability Board to
assess the impact of new capital standards on the
supply of long-term capital.
Within the pension fund sector, the shift from
defined benefit schemes to defined contribution
schemes is discouraging long-term investing as the
latter are often restricted from illiquid investments
such as infrastructure lending. Furthermore, the
demographics in a number of advanced economies
are pushing many defined benefit schemes to lock
in the recent gains in equity prices by aggressively
shifting their asset allocation towards fixed
income assets such as government and corporate
bonds.
Within the institutional investor universe, Sovereign
Wealth Funds and public pension funds appear to be
the ideal candidates to contribute to filling the gap
in long-term investing.
While diverse in terms of their investment mandate
and organizational set up, sovereign institutions
share two important features: first, directly or indirectly they are government funded entities and as
such their mandate often goes beyond returns to
include strategic objectives such as enhancing investments and promoting growth. Secondly, by being
mandated to preserve the wealth of the nation they
50
generally have a relatively conservative asset allocation with a large exposure to government bonds of
advanced economies.
leading SWF, has recently announced that it will
invest in the Brazilian sewage sector by injecting
equity into a local utility company.4
Indeed, in the aftermath of the financial crisis we
have already witnessed an evolution of these institutions in this direction. For instance, most of the
recently established Sovereign Wealth Funds, in
addition to having the traditional macroeconomic
and long-term saving mandates, are often also
tasked with enhancing domestic development
through the funding of long-term investments often
in cooperation with other investors.
What is remarkable about this Brazilian deal, and
many other similar deals, is that SWFs often coinvest together with Multilateral Development
Banks, leveraging the sector expertise and knowledge of the recipient countries of these institutions.
For instance, the Japan Government Pension
Investment Fund has recently formed a partnership
with Development Bank of Japan and the Ontario
Municipal Employees Retirement System to jointly
invest up to USD 3 billion (about 0.2 per cent of its
asset base) into infrastructure projects.5 And this
month the African Development Bank announced
the setting up of a USD 3 billion infrastructure fund
with funds raised from regional and non-African
pension funds, insurance companies and Sovereign
Wealth Funds.6
This trend is particularly visible in the African continent where the infrastructure funding gap is estimated at about USD 50 billion per year and the
enhancement of basic infrastructure is a must to
maintain recent strong economic growth of these
economies. Some of the recently established
Sovereign Wealth Funds have an explicit mandate to
increase the flow of investment to the infrastructure
sector by either providing funding or by acting as a
catalyst for other investors.
Some of the most established SWFs, with sufficiently strong in-house capabilities to deal with complex
investments such as infrastructure, have also been
very active. For instance, last year the Kuwait
Investment Authority announced that it is seeking to
invest up to USD 5 billion in infrastructure assets
mostly in the UK, echoing a similar move by the
Sovereign Wealth Fund from Qatar.3
And SWFs are not afraid of investing in infrastructure in emerging markets. Singapore’s GIC, another
All these initiatives can make a difference by
increasing the fire power of the multilateral development funds in a time when governments do not
appear to have the appetite for providing them with
additional funding.
Another fundamental driver of the rising interest
from Sovereign Wealth Funds in investing more in
the infrastructure sector is the ongoing shift in their
asset allocation towards so-called real assets.
Despite the increasing diversification across asset
classes, SWFs (in particular so-called stabilization
funds) have a large allocation to fixed income assets,
in particular government bonds denominated in currencies of advanced economies.
As a result of the ultra-loose monetary policies in
these economies, these assets currently provide a
very low yield in nominal terms and zero or even
negative returns in real terms. Furthermore, given
the long-term fiscal challenges faced by most
Western economies, these reserves are exposed to an
increasing sovereign risk should any Western
economies default on their public debt or debase
their currency in the years to come.
Over the last few years, the shift towards real
assets has been very visible in the real estate sector
where the flow of investments by SWFs has been
very large, reflecting the fact that this asset class is
very accessible and very bankable. However, similar to real estate, infrastructure assets are also a
very good fixed income diversifier as they provide
steady higher cash flows thus making them attractive for more income-oriented investors.
Furthermore, infrastructure assets often provide a
good hedge against inflation over the medium-to
long-term.
Are Western economies taking advantage of
Sovereign Wealth Funds’ growing demand for infrastructure assets? While we are witnessing the previously mentioned growing flow of sovereign assets in
this space, there is no doubt that, given the existing
long-term investment gap, the potential is certainly
larger.
3
Infrastructure: Asset class gains more appeal, Financial Times, July 7, 2013.
4
Singapore SWF invest in Brazilian sewage, Financial Times, October 2, 2013.
5
GPIF joins DBJ, OMERS to invest up to USD 2.7bn in infrastructure, Asian
Venture Capital Journal, March 3 2014.
6
Africa set to gain USD 3bn in infrastructure fund, Financial Times, May 1, 2014
51
THE GREAT REALLOCATION
The good news is that long-term investing is now
high on the agenda of the G20, and a number of
institutions including the OECD, the European
Commission, the World Bank and the IMF have
started consultations with stakeholders to promote
long-term investing. In Europe, the European
Commission and the European Investment Bank
have launched the “2020 Project Bond Initiative”
with the goal of creating a more harmonized project
bond market across Europe. At international level,
the G20 and OECD have recently finalized their
“High Level Principles of Long-Term Investing”.
Last but not least, emerging markets have also
launched new initiatives with the most prominent
one being the BRICs led Development Bank.
As the competition to attract funds from Sovereign
Wealth Funds and other long-term investors will
intensify in the future, individual countries should
be encouraged to take two policy actions: enhance
the regulatory framework surrounding infrastructure projects and better communicate their existing
bankable projects to attract the interest of SWFs and
other institutional investors.
52
Spotlights on research
In this section, we attempt to present the most interesting studies pertaining SWFs that have been published (or that have made public) in 2013. Our
selection is by design limited, with the goal of identifying a roadmap to the most debated topics and
the most influential works.
Overall, it is encouraging to see
the emergence of a literature
that is more broadly considering
the importance and role of SWFs
not from a westerncentric perspective,
but that dares to ask whether
SWFs are indeed the best allocation
of the wealth of emerging,
commodity-dependent economies.
Much of the research about SWFs published this
year pertains the allocation of funds and investment
selection, which is a herculean task given the insufficient data and heterogeneity of the funds.
Bernstein et al. (2013) find that political interference leads to more short-term investment at the
expense of return maximization, but the opposite
view if championed by Ghahraman (2013), who, in
his careful analysis of fund allocations, finds no evidence of geopolitical priorities affecting investment
decisions. Johan et al. (2013) examine how the allocate funds between public and private equity and
find that SWFs prefer private equity when investor
protection law is low and where the bilateral political relations are weak.
A second topic that has attracted considerable
attention is whether SWFs are an optimal vehicle
for the allocation of financial resources. Wei and
Han (2013) present a complex quantitative model
for the optimal allocation of wealth to foreign currency reserves and SWFs accounting for governments with different investment horizons and liquidity needs. Van der Ploeg et al. (2013) discuss
how the optimal allocation of wealth to a commodity-based SWF should take into account not
just the oil being extracted, but below-ground
reserves as well. Rashid (2013) tackles directly the
question whether a SWF should be established in
Iraq, while Kalter and Schena (2013) more broadly address the same question for a range of emerging economies.
The impact of SWFs on investment targets, which
has received so much interest in the previous years,
is being examined by Fernades (2013), who concludes that SWF ownership leads to positive changes
in corporate market values and operating performance of investment targets.
The historical evolution of SWFs is the subject of a
paper by Braunstein (2013), who takes a broad view
contrasting 17th century financial mercantilism
with the 20th century monetary mercantilism to
explain the recent role of SWFs in the global economy. Fei et al. (2013) more narrowly focus on the
recent financial crisis and on how the related market
turmoil changed the investment strategies of SWFs.
Finally, two recent papers focus on the regulatory
framework: Ghahramani (2013) writes about how
SWFs are leading to new challenges in transnational
law and institutions, while Jog and Mintz (2013)
more narrowly discuss how sovereign exemptions
creates tax advantages for SWFs in Canada – and
advocate for changes.
55
Spotlights on research
THE GREAT REALLOCATION
Asset Allocation
and Investment Selection
Bernstein, Shai, Josh Lerner, and Antoinette Schoar.
2013. “The Investment Strategies of Sovereign
Wealth Funds.” Journal of Economic Perspectives,
27(2): 219-238.
Sovereign wealth funds have emerged as major
investors in corporate and real resources worldwide. After an overview of their magnitude, we
consider the institutional arrangements under
which many of the sovereign wealth funds operate.
We focus on a specific set of agency problems that
is of first-order importance for these funds: that is,
the direct involvement of political leaders in the
management process. We show that sovereign
wealth funds with greater involvement of political
leaders in fund management are associated with
investment strategies that seem to favor short-term
economic policy goals in their respective countries
at the expense of longer-term maximization of
returns. Sovereign wealth funds face several other
issues, like how best to cope with demands for
transparency, which can allow others to copy their
investment strategies, and how to address the
problems that arise with sheer size, like the difficulties of scaling up investment strategies that only
work with a smaller value of assets under investment. In the conclusion, we discuss how various
approaches cultivated by effective institutional
investors worldwide—from investing in the best
people to pioneering new asset classes to compartmentalizing investment activities—may provide
clues as to how sovereign wealth funds might
address these issues.
56
Bodie, Zvie and Marie Briere. 2013. “Optimal
Asset allocation for sovereign Wealth Fund: Theory
and Practice.” Bankers, Markets & Investors, 128:
49-54.
This paper addresses management of sovereign
wealth from the perspective of the theory of contingent claims. Starting with the sovereign’s balance
sheet, we frame sovereign fund management as an
asset-liability management (ALM) problem, covering all public entities and taking explicit account of
all sources of risks affecting government resources
and expenditures. Real-life SWFs asset allocations
differ strongly from theoretical ones. Financial management of the sovereign balance sheet is hampered
by a lack of aggregate data, which compromises the
coordination of sovereign wealth management with
fiscal policy, monetary policy and public debt management. In this framework, we suggest institutional arrangements that could overcome this obstacle
and enable efficient coordination.
Johan, Sophia, April Knill, and Nathan Mauck.
2013. “Determinants of sovereign wealth fund
investment in private equity versus public equity.”
Journal of International Business Studies, 44: 155172.
This paper examines the investments of 19 sovereign wealth funds (SWFs) in 424 firms (both public
and private) around the world from 1991 through
2010. The data indicate that SWFs, similar to other
institutional investors, are less likely to invest in
private equity than in public equity internationally.
However, the economic significance of this impact
is surprisingly low. Unlike other institutional
investors, SWFs are more likely to invest in private
equity compared with public equity in target
nations where investor protection is low, and where
the bilateral political relations between the SWF
and the target nation are weak. Surprisingly, cultural differences play a marginally positive role in the
choice to invest in private equity investment outside
an SWF’s own sovereign nation. Comprehensively,
we find that SWFs act distinctively from other traditional institutional investors when investing in
private equity.
Resources Management
and Optimal Strategy
Wei, Xiaoyun and Liyan Han. 2013. “Optimal
Allocation between International Reserves and
Sovereign Wealth Funds for Different Horizons.”
International Journal of Applied Mathematics and
Statistics, 39(9).
We present a dynamic model to allocate international reserves and sovereign wealth funds for different
horizons. Particular attention is paid to dynamic
rebalancing cases. The numerical method was used
to obtain optimal allocation ratio of two assets. The
results show that, in both buy-and-hold and rebalancing cases, there are strong horizon effects.
Government with a longer horizon chooses significantly more reserves than someone with short horizon in buy-and-hold case. The reason is long-horizon governments have an intrinsically larger need
for reserves to quell possible M2 flight and repay
short term external debt for stability purpose. In
rebalancing case, however, when the horizon is
lengthened, the government should hold less liquid
reserves, for high yield of SWFs makes the demand
for liquid assets decrease when government extends
its horizons in rebalancing case. We also conclude
that, for horizon presented here, the governments
who optimally rebalance their portfolio at regular
intervals would hold significantly less reserves than
ones implementing buy-and-hold policy. A possible
reason is they could receive updated information at
the end of each period and rebalance portfolio based
on existing information.
Van der Ploeg, Rick, Samuel Wills, and Ton van den
Bremer. 2013. “The Elephant in the Ground:
Managing Oil and Sovereign Wealth.” OxCarre
Research Paper 129.
Many oil exporters accumulate large sovereign
wealth funds, though their portfolio allocation does
not take into account below-ground assets, like oil.
Similarly, the above-ground portfolio does not
affect the decision to extract oil. This paper shows
that subsoil oil wealth should change a country’s
above-ground asset allocation in two ways. First,
the holding of all risky assets is leveraged because
there is additional wealth outside the fund. Second,
more (less) is invested in financial assets that are
negatively (positively) correlated with oil to hedge
against the riskiness of subsoil exposure.
Furthermore, if marginal oil rents move pro-cyclically with the value of the financial assets in the
fund, then oil will be extracted slower than predicted by the standard Hotelling rule. This leaves a
buffer of oil to be extracted when both oil prices
and asset returns are high. Finally, any unhedged
residual volatility must be managed through additional precautionary saving.
57
Spotlights on research
THE GREAT REALLOCATION
Rashid, Samee Omer. 2013. “Sovereign Wealth
Funds and the Possibilities of Establishing Them in
Iraq.” University of Wisconsin Legal Studies
Research Paper.
This research discusses the Sovereign Wealth Funds
phenomena in Iraq as well as their types and
sources. It first explains the concept of Sovereign
Wealth Funds and some main characteristics of
them. In addition, it attempts to answer the question
of whether Iraq has Sovereign Wealth Funds, and
whether the Development Fund for Iraq is considered to being a Sovereign Wealth Fund. Then it discusses corporate governance of SWFs by explaining
their organizational and legal structure and investment strategy by giving two different examples, Abu
Dhabi Investment Authority (ADIA) and
Government Pension Fund Global (GPF-G) of
Norway that may have an impact on governance
structure of the potential Iraqi Sovereign Wealth
Funds. Moreover, this research identifies benefits
that SWFs offer to Iraq as well as challenges that
need to be addressed in order to develop SWFs role
in supporting Iraq’s economy. Overall, this research
encourages the Iraqi government to consider building a well-diversified investment portfolio that
would create a sustainable source of revenue, reduce
the economy’s dependence on oil and act as a savings fund for the future. This would also help in
realizing the future strategic plan of the government
of Iraq to develop non-oil dependent economy in the
next decade.
Kalter, Eliot and Patrick Schena. 2013. “Into the
Institutional Void: Managing the Sovereign Wealth
of Emerging Economies.” In Investing in Emerging
58
and Frontier Markets, Euromoney Books, London.
The number of sovereign wealth funds has expanded dramatically since 2000. Most of these new funds
have been established in emerging economies. This
paper analyzes the evolution and role of SWFs in
emerging markets in the context of economic institutional-building.
ties that are likely to provide companies with a
lower-cost (as well as more “patient”) source of
equity capital; and (3) as politically well-connected
strategic investors that enable their companies to
leverage important connections when accessing new
product markets.
Historical Perspectives
Corporate Value and SWFs
Fernandes, Nuno. 2013. “The Impact of Sovereign
Wealth Funds on Corporate Value and
Performance.” Journal of Applied Corporate
Finance, 26(1):76-84.
The last few years have seen a remarkable increase
in the participation of sovereign wealth funds
(SWFs) in global capital markets. In this article, the
author draws on a unique dataset of SWF international holdings—one that dates back to the year
2002 and includes individual SWF holdings in more
than 8,000 companies in 58 countries—to provide
evidence of the impact of SWFs on corporate values
and operating performance. Contrary to claims that
SWFs expropriate minority investors and pursue
political agendas, the main finding of the author’s
study is that SWF ownership is associated with positive changes in both corporate market values and
operating returns. In support of these findings, the
author also identifies three important ways that
SWFs work to increase the performance and value
of the companies they invest in: (1) as long-term
holders that provide a stable source of financing; (2)
as representatives of deep pools of international
capital in search of global diversification opportuni-
Braunstein, Jürgen. 2013. “The Novelty of
Sovereign Wealth Funds: The Emperor’s New
Clothes?” Global Policy, Forthcoming.
This article broadens the empirical and conceptual
perspective on sovereign wealth funds (SWFs). This
is first done through providing a definition of contemporary SWFs. Using recent literature it suggests
that SWFs can be differentiated into discrete categories in terms of their funding, governance and
investment structures. Using this definition, the subsequent history section identifies earlier instances of
SWFs in the context of 17th century financial mercantilism and 1930s monetary mercantilism. This
leads directly to a number of investment deals in the
2000s where some countries with SWFs were subject to intense media and government scrutiny. In
the aftermath, commentators warned of protectionism and a resurgence in financial and monetary mercantilism by pointing to emerging economies, most
notably China. Though contemporary SWFs are not
the same as earlier state-related pools of capital,
there are important similarities concerning policyrelevant variables, highlighted by the SWF literature. A historical interpretative approach provides a
bridge between historical instances and a reconcep-
tualised notion of SWFs, linking historical evidence
directly to functional claims about the purposes of
contemporary SWFs.
Fei, Yiwen, Xichi Xu, and Rong Ding. 2013.
“Sovereign wealth fund and financial crisis – a shifting
paradigm.”
China
Finance
Review
International, 3(1): 42-60.
Purpose – The purpose of this research is to empirically analyze the influence of the financial crisis on
the investment behavior of sovereign wealth funds
(SWFs).
Design/methodology/approach – Using 615 deals
from 20 SWFs, a series of research are designed and
conducted to compare the SWFs’ governance, external environment, investment strategy and financial
markets’ feedback around the crisis.
Findings – The paper finds that the recent financial
crisis did not only bring SWFs heavy losses and the
pressure to improve its image and governance structure, but also a precious opportunity of a better
external environment by easing the nerves of the
recipient country’s government. Their investment
strategies will be more positive, diversified and complementary to their own real economy. The event
studies illustrate that financial markets turn to be
more effective after the crisis. The market reaction to
SWF’s investment tends to mitigate speculative trading to a larger extent, which is shown by the lower
cumulative abnormal return and turnover volatility.
Originality/value – This paper tries to test the
change of SWFs’ behavior pro- and post-crisis. It
reveals that SWFs have changed their effects on
SWF’s home country, SWF’s host country, the financial market and the real economy after the financial
59
Appendix
THE GREAT REALLOCATION
crisis, which is helpful for government and institutions to maintain the stability of the national economy and security market.
Transparency, Legal and Political Issues
Ghahramani, Salar. 2013. “Sovereign Wealth
Funds, Transnational Law, and The New Paradigms
of International Financial Relations.” Yale Journal
of International Affairs, 8(2): 52-64.
International financial relations have largely been
defined by cross-border trade, foreign direct investments, and global banking relations. This paper
demonstrates that another activity, sovereign investments by special vehicles known as sovereign wealth
funds, is rapidly redefining the traditional paradigms, providing both opportunities for further integration of the financial markets as well as posing
particular challenges for policy makers.
Jog, Vijay and Jack Mintz. 2013. “Sovereign Wealth
and Pension Funds Controlling Canadian
Businesses: Tax-Policy Implications.” School of
Public Policy Research Paper 6(5).
In a world without taxes, investors that take over
companies would do so because they expect to be able
to operate the business efficiently and at a high rate of
return. But in Canada today, some acquirers enjoy tax
advantages over others. And that could mean that certain buyers, who may not be best suited to owning a
particular company, are able to outbid those who are
better positioned to run that company at optimal efficiency. That is a problem not just for investors who
end up outbid, due to Canada’s uneven tax policy, but
60
for the Canadian economy, which suffers from the
resulting economic inefficiency. With respect to registered pension plans, the so-called 30-per-cent rule puts
a cap on the amount of voting equity in a company
that they are permitted to own. Meanwhile, however,
sovereign wealth funds — whether controlled by
China or Australia — face no such limit when purchasing stakes in Canadian firms. The number and
size of sovereign wealth funds, globally, is only growing — and rapidly. But as Canada increasingly attracts
foreign capital, with foreign-controlled governmentaffiliated funds seeking out Canadian takeover targets,
much of the discussion around public policy has
focused primarily on the Investment Canada Act and
the “net benefit test” for foreign direct investment.
Another component in ensuring that Canadian interests are preserved, however, is the question of whether
Canadian institutional investors can operate on a level
playing field with foreign sovereign wealth funds.
With the 30-per-cent rule limiting equity purchases for
one but not the other, it would appear that they are
not. The most appealing remedy to this imbalance is a
tax solution: limiting the corporate deductions on
interest, fees, royalties, rents, and the like, that so
often factor in to the takeover calculation, as part of a
tax-minimization strategy. This would not only put
pension funds and sovereign wealth funds on equal
footing, but it could also be applied to investors operating from low- or zero-tax jurisdictions, as well. This
approach is not without disadvantages. But overall,
the neutrality it could achieve among different types of
institutional investors, and the potential it has to
enable those investors best able to maximize management excellence and synergies, make it the preferable
policy direction for ensuring the greatest level of efficiency in the Canadian economy.
Methodology
Our research methodology focuses on two main
objectives: comprehensiveness of research and accuracy of information. To ensure comprehensiveness,
we survey multiple sources, primarily relying on
established business and financial databases but
employing also press releases, published news, fund
annual reports and many other data sources. To
ensure accuracy, we follow a strict process for capturing deal information and we establish a clear hierarchy of sources, based on our estimate of reliability:
1 Financial transaction databases: Bloomberg,
SDC Platinum, Zephyr (we have also used
Datamonitor and Dealogic in the past).
2 Database for target firm information:
DataStream.
3 Sovereign Fund disclosures, including annual
reports, press releases and other information
contained on their websites.
4 Target and vendor company disclosures: press
releases and other information contained on their
websites.
5 Regulatory disclosures: stock exchange filings for
publicly listed companies; Regulators; SEC 13D
and 13G Filings; Land Registries; Competition
Commissions, and Bond/IPO prospectuses etc.
6 Service provider disclosures: such as lawyers,
investment banks, and project financers working
with the SWFs.
7 Information aggregators: LexisNexis and
Factiva. Those include news reported by
newswires (Dow Jones, Reuters, Business Wire,
Associated Press and others) and national news
agencies (KUNA, Xinhua, WAM etc.) numerous
well-regarded selected newspapers (e.g. The Wall
Street Journal, Financial Times, New York
Times), and their regional equivalents (e.g.
Economic Times, China Daily, The National),
and the local trade press.
8 Other websites, including Zawya.com, Google
Finance, Yahoo! Finance, AME Info, BBC News
and others. Most of the deals are amassed and
consolidated from the financial transaction databases, while the other sources are mostly used for
corroboration where necessary. At least one highquality source is captured for each data point,
and, where possible, multiple sources are identified. News items from information aggregators
such as LexisNexis are carefully examined to
ascertain the reliability of the original source.
61
Notes
62
63
design: studio Cappellato e Laurent – Milan
Sovereign Investment Lab
The Sovereign Investment Lab is a group of researchers brought together in
the Baffi Center on International Markets, Money and Regulation at Università
Commerciale Luigi Bocconi. The Lab tracks the trends of sovereign fund
investment activity worldwide and conducts path-breaking research on the
rise of the State as an investor in the global economy. Research output aims to
meet the highest scientific standards, but also to be accessible for a variety of
stakeholders also outside academia: institutional investors, policymakers,
diplomats, regulators, and the media.
Editor
Bernardo Bortolotti
Director, Sovereign Investment Lab – Baffi Center, Università Bocconi
and Università degli Studi di Torino
bernardo.bortolotti@unibocconi.it
THE FUNDO SOBERANO DE ANGOLA - FSDEA
Many of the new upcoming Sovereign Wealth Funds are sponsored by emerging countries, as in the case of Angola,
Brazil, Mongolia and others. They are called to perform an important role in the promotion of sponsor countries
development. In this case, development concerns, as a matter of fact, the increase of Sovereign Wealth Funds’ assets
and the improvement of the financial and economic growth of the sponsor countries, but it also takes into account,
according to a more comprehensive definition, the overall wealth of the citizens and the standard of life of the entire
population that is, or should be, the real ultimate beneficiary of the Fund’s activities. In this sense, development
should include both social and economic goals, measurable through the reduction of poverty levels, the increase of
the standard of life of the citizens and the construction of the necessary infrastructures for a sound and prompt
development of the country. In a period of volatility, risk and uncertainty where developed economies are still
suffering and recovering from the 2008 global financial crisis, Sovereign Wealth Funds, have an extended capacity
of liquidity’s injection in the international markets, counter-cyclical investments as well as appropriation of
technologies and specific know-how from all over the world.
Upcoming SWFs in Africa
Map 1: SWFs in Africa
Source: Elaboration by the Author (January 2014)1.
1
With specific reference to Ashby Monk’s blog.
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 1
The lack of a generally agreed definition of SWFs and of their status, among academics analysts and professionals,
leads to different interpretations on the overall number of SWFs, with specific reference to those of the African
Continent. Some sources take into consideration only those SWFs that are already active, while others consider also
the planned ones and the established but still not active ones. As a result, the number of SWFs could be different,
according to different sources, as presented hereafter. However, combining data from different sources, it is possible
to say that Africa counts 11 already active SWFs 2, 3 established but still not yet completely active SWFs 3 and 10
only planned SWFs4.
According to the SWF Institute5, as for the following table, the total number of African SWFs is 10 and includes
those of Algeria, Angola, Botswana, Equatorial Guinea, Gabon, Ghana 6, Libya, Mauritania, Mauritius7 and Nigeria
for a total amount of around $ 160.45 billion.
Table 1: SWF Institute List of African SWFs
AFRICA SOVEREIGN WEALTH FUNDS
SOVEREGN WEALTH FUND
COUNTRY
ENDOWMENT ($)
Libyan Investment Authority
Libya
66 billion
Revenue Generation Fund
Algeria
77.2 billion
Pula Fund
Botswana
6.9 billion
Fundo Soberano de Angola
Angola
5.0 billion
Nigerian Sovereign Wealth Fund
Nigeria
1.5 billion
Gabon Sovereign Wealth Fund
Gabon
0.4 billion
National Fund for Hydrocarbon Reserves
Mauritania
0.3 billion
Fund for Future Generations
Equatorial Guinea
0.08 billion
Ghana Petroleum Funds
Ghana
0.07 billion
Mauritius Sovereign Wealth Fund (*)
Mauritius
3 billion
(*)Proposed
TOTAL
160.45 Billion
Source: SWF Institute updated by the Author in July 2014
According to Thouraya Triki and Issa Faye 8, the total number of African SWFs is of 15 for a total amount of around
$143 billion and includes Algeria, Angola, Botswana, Chad, Congo, Equatorial Guinea (Future Generations Fund),
Equatorial Guinea (Stabilization Fund), Gabon, Ghana, Libya, Mauritania, Namibia, Nigeria, Sao Tome’ and
Principe, South Sudan, as for the following table.
Table 2: Thouraya Triki ad Issa Faye's List of African SWFs 2011
Fund
Country
Inception
Source
Fund type
(US$bn)
Year
Fonds de régulation des
recettes
Algeria
2000
Oil
Stabilization
59.34
2009
Fonds de stabilisation des
recettes budgétaires
Chad
2006
Oil
Stabilization
0.003
2010
2
Mauritania, Algeria, Libya, Sudan, Nigeria, Gabon, Namibia, Botswana, Equatorial Guinea (2), Sao Tome and Principe.
Angola, Ghana, Rwanda.
4
South Africa, Zimbawe, Zambia, Mozambique, Tanzania, Kenya, Uganda, D.R. Congo, Liberia, Tunisia.
5
http://www.swfinstitute.org/fund-rankings/.
6
SWF still under development.
7
SWF still under development.
8
Thouraya Triki and Issa Faye: “Africa’s Quest for Development: Can Sovereign Wealth Funds help?” AfDB Working Paper Series n. 142, 2011,
Tunis.
3
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 2
Reserve fund for oil
Pula fund
Fonds de stabilisation des
recettes budgétaires
Fonds de stabilisation des
recettes budgétaires
Fonds de réserves pour
générations futures
Fonds souverain de la
République gabonaise
Angola
Botswana
2004
1994
Oil
Diamonds
Stabilization
Development
0.2
6.9
2008
2010
Congo
n/a
Oil
Stabilization
1.64
2010
n/a
Oil
Stabilization
1.39
2010
Unknown
Oil
Development
0.080
2010
Gabon
1998
Oil
Development
0.380
2010
Minerals development fund
Ghana
1994
Libyan investment authority
Fonds national des revenus
des hydrocarbures
Minerals development fund
Excess crude fund (account)
Libya
2006
Gold and other
minerals
Oil
Development
70
2010
Mauritania
2006
Oil
Stabilization
0.03425
2009
Namibia
Nigeria
São Tomé and
Principe
1995
2004
Minerals
Oil and gas
Development
Stabilization
NA
3
2010
2004
Oil
Development
0.010
2009
South Sudan
2002
Oil
Stabilization
0.15
2009
National oil account
Oil revenue stabilization
fund
Equatorial
Guinea
Equatorial
Guinea
Development
Source: Triki T. and Faye I: “Africa’s Quest for Development:Can Sovereign Wealth Funds help?”, 2011
According to the AfDB Chief Economist and Vice President, Professor Mthuli Ncube, there are 14 SWFs in Africa
representing 3%9 of global SWFs. Other sources include in the list of the African SWFs also the upcoming ones
from Kenya10, Liberia, Mozambique, South Africa, Tanzania, Uganda and Zambia whose creation is encouraged by
the latest oil discoveries.
Among all the African SWFs, the oldest one is the Pula Fund of Botswana, created in 1994 while the largest one is
the Algeria’s Revenue Regulation Fund with $77.2 billion of assets under management, followed by the Libyan
Investment Authority with $66 billion of assets under management. Nowadays only four of the African SWFs, the
Botswana Pula Fund, the Fund for Future Generation of Equatorial Guinea, the Nigeria Sovereign Investment
Authority and the Libyan Investment Authority, are members of the IFSWF 11 and have officially voluntary ratified
the Santiago Principles12. Among the upcoming African SWFs, one of the most committed to the sustainable
development of the sponsor country and the wealth of its citizens is the Fundo Soberano de Angola (FSDEA).
Angola Overview
Since the global economic slowdown experienced in 2008/2009, Angola has been gradually recovering and,
nowadays, the Country presents solid economic growth prospects due to higher oil prices and increased spending.
According to the AfDB African Economic Outlook 2012 13, Angola’s GDP recorded 8.2% in 2012 and 7.1% in 2013.
The country is rated BB- by Fitch (July 2014), Ba3 by Moody’s (July 2014) and BB- by Standard and Poor’s (July
2014). Oil is the backbone of the Angola’s economy. After twenty-seven years of a civil war that ravaged the
country, Angola has emerged as the second largest oil producer in Africa 14 with over 1.9 million barrels per day
(bpd)15. In 2011, crude oil, refined oil products and gas exports accounted for more than 95% of the total exports and
47% of the GDP was related to the oil sector. Second to oil, diamonds are the main exports driver. According to the
9
http://www.afdb.org/fr/blogs/afdb-championing-inclusive-growth-across-africa/post/the-boom-in-african-sovereign-wealth-funds-10198/
http://www.institutionalinvestor.com/blogarticle/3036532/Blog/Welcome-Kenya-To-The-SWF-Club.html
11
http://www.ifswf.org/
12
http://www.iwg-swf.org/pubs/eng/santiagoprinciples.pdf
13
http://www.africaneconomicoutlook.org/fileadmin/uploads/aeo/PDF/Angola%20Full%20PDF%20Country%20Note.pdf
14
According to the IMF Country Report No. 12/194, Nigeria produced 2.4 million bpd in 2011.
15
Most of the oil related revenues are coming from Cabinda’s Province.
10
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 3
OPEC estimates, the Angola’s proven oil reserves reached 10.5 billion barrels (0.9% of the OPEC share16). Angola’s
dependency on oil is evident. Oil revenues account for around 75% of budgetary revenue and oil is the main driver
of reserves accumulation. This dependency is the reason why after the acute oil price drop in 2008-2009, Angola
faced macroeconomic instability and public authorities sought support from the IMF, signing, in November 2009,
the IMF Stand-By Arrangement program, which comprises in particular fiscal and monetary, tightening. Among the
IMF recommendations there was also the establishment of a brand new SWF 17as part of the Country’s commitment
in building up a medium-term macroeconomic framework to guard in particular against volatility in the oil price and
to create a more resilient and diversified economy. The diversification of the national economy, in fact, represents
one of the main goals of this new economic deal, able to, on the long term, (i) avoid the effects of the Dutch disease,
(ii) foster the overall social and economic improvement of the Country (iii) assure the equal distributions of wealth
across generations. Furthermore, many characteristics of the Angola’s Economy such as being a fast-growing
country, with important oil reserves, make the establishment of a SWF recommendable. Moreover, despite
recovering progressively, the country still presents some delay in reducing poverty in particular in rural areas, in
promoting job-intensive activities and in fostering inclusive growth. Income inequality remains high, unemployment
rate is estimated at around 26% (the oil sector is capital-intensive and does not dramatically foster employment,
counting less than 1% of the total labor force 18) and the country is currently ranked 148 out of 187 countries in the
UNDP19 Human Development Index (HDI) 20 ranking and is categorized as a “low human development” country.
The Fundo Soberano de Angola could be beneficial for all the above mentioned areas.
The Fundo Soberano de Angola: a Sovereign Wealth Fund set up to foster
Angola’s economic and social development.
The Fundo Soberano de Angola has been announced in 2008, legally notified in 2011 and officially launched on the
17th of October 2012. FSDEA counts $5 billion of assets under management and a specific mandate to support the
social and economic development of the country through (i) the stabilization of the economy (ii) the creation of
employment and (iii) the transfer of wealth across generations. The FSDEA is funded by oil revenues and it is
expected to account a yearly growth of $3.5billion in order to achieve, by 2020, assets for around $30 billion,
becoming, eventually, one of the largest 30 SWFs in the world.
Table 3: List of the 10 biggest SWFs that belong to the IFSWF 2014 (July)
Country
Norway
UAE
Saudi Arabia
China
China
Kuwait
China – Hong
Kong
Singapore
Singapore
Qatar
Fund
Government Pension Fund (GPF)
Abu Dhabi Investment Authority (ADIA)
SAMA Foreign Holdings
China Investment Corporation (CIC)
SAFE Investment Company
Kuwait Investment Authority (KIA)
Hong Kong Monetary Authority
Investment Portfolio
Government of Singapore of Investment
Corporation (GIC)
Temasek Holdings
Qatar Investment Authority (QIA)
AUM ($US bn)
878
773
737.6
575.2
567.9
410
Inception
1990
1976
n/a
2007
1997
1953
Source
Oil
Oil
Oil
FX Reserves
Non-Commodity
Oil
326.7
1993
Non-Commodity
320
1981
181
173.3
1974
2005
Fiscal Surpluses,
FX Reserves
Fiscal Surpluses
Oil
16
More than 80% of the world's proven oil reserves are located in OPEC Member Countries, with the bulk of OPEC oil reserves in the Middle
East, amounting to 66% of the OPEC total. However, the biggest proven reserves are those of Venezuela: 24.8% of the OPEC total.
17
http://www.imf.org/external/np/loi/2010/ago/082710.pdf
18
http://www.africaneconomicoutlook.org/en/countries/southern-africa/angola/
19
United Nations Development Program.
20
The HDI is a way of measuring development by combining indicators of life expectancy, educational attainment and income. A ranking is
published every year by the UNPD. The current ranking refers to year 2013.
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 4
Sources: Swf Institute 2014
At the domestic level the FSDEA acts accordingly to the national macroeconomic plan, developed and approved by
the Government. It is still not clear which will be the Fund relationship with Sonangol, the National Oil Company.
According to some sources21, indeed, there is a possibility that FSDEA will take the role of investor previously
performed by the National Oil Company Sonangol that used to buy stakes in companies and that might transfer its
stakes to the Fund. The fund is supposed to be independent from the Government and managed by an independent
Board of Directors. The structure of the Fund comprises: a Board of Director, an Advisory Council, a Fiscal
Council, an Audit Board and the Executives, as described, more into details, hereafter.
Table 4: FSDEA Structure
Role
Board of Directors
It defines the Fund’s
investment strategy
and oversees the
Fund’s activities and
assets.
Advisory Council
It reviews investment
proposals and the strategy
recommendations made by
the Board of Directors and
offers recommendations to
the President of the
Republic of Angola who
ultimately approves the
Fund’s investment policies.
Composed
by
- Chairman: Jose’
Filomeno de Sousa
dos Santos
- Member of the
Board of director:
Hugo Migule Evora
Goncalves22
- Artur Carlos
Andrade Fortunato
- Armando Manuel,
Minister of Finance
- Abraão Pio dos Santos
Gourgel, Minister of
Economy
- Job Graça, Minister of
Planning and Territorial
Development
- José de Lima Massano,
Governor of the National
Bank of Angola
Executive
Executive roles
include:
- Fiscal Council
- Risk Management
Committee
- Chief Risk Officer
- Chief Compliance
Officer
- External Asset
Managers
Fiscal Council
It ensures
compliance with the
laws and regulations
applicable to the
Fund. The Fund will
be subject to regular
annual audits
conducted by
independent
auditors.
Source: Fundosoberano.ao
The SWF has recently appointed Deloitte as independent auditors of the Fund’s financial account to ensure the
highest level of transparency across all of its areas of business. It also has appointed the Audit Board and the
Primary Custodian. The Audit Board ensures the compliance of the Funds activity with the investments and
operations policy and quarterly reports to the National Director for the Public Sector Accountability of the Ministry
of Finance. The three components of the Audit Board are:
-
Ari Nelson Correia Brandao – Accountant and independent auditor (President)
Emanuel Maria Maravilhoso Buchartts – Chief of Staff of the Minister of Finance (Member of the Board)
Dilma Rosa Neto Semedo – Senior Executive of the Ministry of Finance (Member of the Board)
The FSDEA’s commitment to transparency has been also confirmed by the disclosure of the key future milestones to
be met by the end of 201423.
21
http://taighde.com/w/Fundo_Soberano_Angolano
Former manager at Standard Bank of Angola and head of Pension and Development Fund of Angola.
23
http://www.swfinstitute.org/swf-article/transparency-still-remains-elusive-for-most-sovereign-wealth-funds/
22
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 5
Table 5: 2013-2014 FSDEA Key Milestones
First quarter
2013
Publication of the FSDEA Social Charter (the
Charter will address a number of key social
challenges faced by Angolans).
2014
The FSDEA annual report.
First Linaburg-Maduell
Index FSDEA rating.
Transparency
Publication of the Government approved
FSDEA Investment Policy
Second quarter
The appointment of internationally recognized
independent auditors.
Third quarter
The FSDEA mid-year update to include
executive commentary on investment activities.
The FSDEA mid-year update to include
executive commentary on investment
activities.
Fourth quarter
-
-
Source: Fundosoberano.ao
As mentioned in the milestone the Fund has recently released its investment policy, illustrated hereafter in the table.
FSDEA is expected to focus in investing in the domestic market and in fields such as: real estate, infrastructures,
hospitality (mainly luxury hotel), agriculture, water, power generation, transport, etc. The Fund aims to gradually
diversify its investment portfolio across a number of industries and asset classes. The main driver of investment is
pure economic return with a mostly conservative investment strategy that aims at a low risk and long-term
investment able to provide the Fund with stable returns both in economic and social terms.
In terms of geographical allocation of the investments, priority is supposed, according to different sources, to be
given to emerging countries with specific reference to Sub-Saharan Africa and Asia but also Europe could represent
a possible target. The Fund’s asset allocation mix will support three criteria: preservation of capital, long-term
return, maximization and infrastructure development. The 50% allocation to cash, fixed income and G-7 stocks is
modeled after the first criterion. The other 50% is open-ended with an opportunistic lens including domestically
Angolan prospects like the hotel industry24.
The FSDEA, indeed, will firstly focus on the hospitality sector by establishing a “Hotel Fund for Africa” in order to
capitalize on the significant undersupply of hotel management capacity while addressing the urgent need for skilled
local talent by supporting the establishment of a Hotel School. In addition to this, the Fund has also declared that
will provide regular updates to international markets on investments and governance.
FUNDO SOBERANO DE ANGOLA – ASSET ALLOCATION
ASSET GROUP
CASH, FIXED INCOME, G-7
PUBLIC EQUITIES
ALTERNATIVES
OBJECTIVE
Preservation of Capital
Maximization
development
ASSET ALLOCATION TARGET
50%
50%
INVESTMENT UNIVERSE
CASH
EMERGING MARKETS
SOVEREIGN AGENCIES
HIGH YELD
SUPRANATIONALS
COMMODITIES
LARGE COMPANIES
(INVESTMENT GRADE)
AGRICULTURE AND MINING
24
and
infrastructure
www.swfinstitute.org
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 6
FINANCIAL INSTITUTIONS
INFRASTRUCTURE
DEVELOPED PUBLIC EQUITIES
PROPERTY
BRIC AND FRONTIER MARKETS
EQUITIES
DEPRECIATED OPPORTUNITIES
As expected from a newly launched SWF, the FSDEA will use external management in its portfolio allocation.
FSDEA will also look to promote the generation of income through small and medium sized enterprises (SMEs), by
sponsoring programs aimed at the most economically deprived segments of the society in Angola.
With the establishment of a dedicated Social Charter, the FSDEA will consider investments not only on the basis of
their profitability, but also on the basis of their capacity to address national social challenges such as access to clean
water and healthcare services, and to support government social programs and general economic growth.
As a key component of the Investment Policy, FSDEA will make a commitment of 7.5% to social development and
socially responsible projects in the areas of education, income generation and off-the-grid access to clean water,
health care and energy. Among the projects that will receive FSDEA’s funding for the empowerment of school
children in economically vulnerable areas of Angola, in accordance with the SWF Social Charter, there is the Don
Bosco Schools multi-year project “Kamba Dyami” that is a part of the One Laptop per Child international program.
This project encourages computer-based learning in traditional classrooms at an early age and it was launched in
2011 in the outskirts of Luanda but there is the intention to extend this initiative to additional schools in suburban
and rural areas of Angola to enable the next generation to fully embrace the country’s future opportunities.
From 2013 to 2015, 1,200 additional laptops will be made available, which will allow 2,400 more children to benefit
from computer-based learning. Father Santiago Christophersen SDB, the Director of the Dom Bosco School in
Luanda, commented: “Empowering our children with knowledge is fundamental and the Kamba Dyami Project has
shown the progress children make through computer-based learning. We have seen a tremendous impact on the
learning process through the use of the computers and the children are very enthusiastic to work with this interactive
education tool. We are therefore very pleased that the FSDEA also recognizes the importance of not only the project
but its future expansion. We look forward to working closely with the Fund’s leadership to expand the education
system in Angola”25.
The Fund will also develop initiatives in healthcare such as the strategic partnerships with the national tropical
disease institutes, able to increase the access to life saving surgical procedures or the establishments of a first aid
help post throughout the rural and suburban areas, in partnership with the International Committee of The Red
Cross.
The FSDEA will be guided by a set of values that act as its guiding principles in everything it does. Concretely, the
Fund is committed to operating transparently, responsibly and in full compliance with the laws and regulations of
the countries it invests in. In this respect, it is supposed to be committed to the highest level of transparency across
all areas of its business. It is fully accountable for all of its actions and always acts in the best interest of the people
of Angola and all other stakeholders26. It has also declared the willingness to be governed by the Santiago Principles.
“We are committed to promoting social and economic development investing in projects that create
opportunities that will positively impact the lives of all Angolans today and to generate wealth for future
generations”, says José Filomeno de Sousa dos Santos, Chairman of the FSDEA27.
25
http://cfi.co/africa/2013/07/angolas-sovereign-wealth-fund-announces-investment-policy/
http://www.fundosoberano.ao
27
http://www.angola-today.com/tag/investment/
26
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 7
In terms of governance, the Government Pension Fund of Norway - Global represents a significant example for the
Angolan fund, as for the Ghana SWF, with a specific reference to ethical guidelines and social accountability 28. This
has led some sources to think that the FSDEA will replicate the investment strategy of the GPF by purchasing small
stakes of common stock in international companies.
The FSDEA could also represent an important tool for the attraction of other long term investors and of SWFs’
investments. One of the goals of the FSDEA, indeed, is the promotion of Angola as a destination of foreign direct
investment29, as it has been in the case of the Russian Direct Investment Fund and the Italian Fondo Strategico di
Investimento. The Italian Fund, in fact, has just recently signed a $2billion agreement with Qatar Holding30 , one of
the main arms of the Qatari SWF, Qatar Investment Authority, with the scope of investing in the Italian excellences
of Made in Italy, as well as an agreement with the Kuwait Investment Authority (KIA) to invest $676mln in Italian
companies.31
What is the role of the Fundo Soberano de Angola in the development of
Angola?
The FSDEA could represent an important tool for the economic and social development of Angola, with specific
reference to its capacity to:
1) Foster the stabilization of national economy against volatility, reducing fiscal pressure and
representing a lender of last resort in time of financial turmoil.
SWFs, in fact, can foster the stabilization of the economy keeping assets offshore and insulating resources
dependent economies against commodity price swings. They can also function as lender of last resort in
time of financial turmoil reducing the fiscal pressure and the necessity to rely on external help.
2) Support the diversification and internationalization of national economy, and to increase the
capacity of attracting Foreign Direct Investment (FDI).
FDI are a significant driver for growth in developing countries. In this respect, attracting more FDI is a
way to foster the development of domestic economy. According to the UNCTAD32 World Investment
Report 201233, during 2011, major investments continued to flow into Angola, but divestment and
repatriated profits by transnational corporations rendered net inflows negative. The Angolan SWF could
help in attracting more FDI by improving the accountability of the Country and, eventually, becoming a
good interlocutor with other SWFs and long term investors. According to the UNCTAD, SWFs show
substantial potential for investment in development. Their total FDI in 2011 amounts around US$125
billion, with about 25% invested in developing countries. “SWFs can work in partnership with hostcountry governments, development finance institutions or other private sector investors to invest in
infrastructure, agriculture and industrial development, including the build-up of green growth industries”.
The diversification of the economy, furthermore, results beneficial for the reduction of unemployment that
nowadays registers a percentage of the 26% with a specific reference to youth unemployment as the 47.7%
of the population is 14 years younger.
3) Improve the credit rating of Angola.
The implementation of a SWF could be a critical element to take into account when it comes to evaluate
the credit profile of a country. However, in order to provoke a positive credit action, the SWF should be
28
http://www.norad.no/en/countries/africa/angola
http://www.fundosoberano.ao/images/articles/Angola-fund-sees-bright-future.pdf
30
http://www.fondostrategico.it/en/news/fsi-and-qatar-holding-sign-jv-to-invest-up-to-2-billion-in-made-in-italy.html
31
This agreement foresees the founding of a new company with capital of €2.5bn, of which 80% will be owned by FSI and the remaining 20% by
KIA, which will start investing €500mln.
32
United Nations Conference on Trade and Development.
33
http://www.unctad-docs.org/files/UNCTAD-WIR2012-Full-en.pdf
29
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 8
able to perform effectively and it has to be included into a set of economic reforms. On this regards, The
Nigerian Sovereign Investment Authority (NSIA), the newly launched SWF of Nigeria, could represent a
good example. Officially created in 2012, it represented one of the factors leading both Standard & Poor’s
and Moody’s to raise Nigeria creditworthiness in addition to the improved financial stability and the
optimism, over reforms, to the banking and electricity sectors. Fitch Ratings identified the establishment
of the NSIA as a “key reform” underlining, as well, that it is “an area where progress has been slower than
hoped”. In this sense, the establishment of a well-managed SWF could provide Angola with a greater
accountability, a higher level of transparency in the wealth management and a stronger attractiveness for
foreign investors. Most specifically, the FSDEA could help the Country to reach investment-grade
category as it is currently rated 3 notches below34.
35
36
4) Support poverty reduction and Human Development Index (HDI) increase .
The poverty reduction and the creation of sustainable and inclusive growth are common goals for most of
the emerging countries’ SWFs. The concept of “inclusive growth” is synonym of a sustained and long-term
growth that benefits the whole society, including the poorest. According to AFDB definition 37, inclusive
growth is the economic growth that results in a wider access to sustainable socio-economic opportunities
for a broader number of people, countries or regions, while protecting the vulnerable, all being done in an
environment of fairness, equal justice, and political plurality. In that perspective, a SWF can be considered
as a good way to generate this kind of growth. A domestic-focused SWF can also have a positive impact on
increase of the human development index (HDI) as the SWF’s investments are partly directed to sectors
that lead to the improvement of the index such as, among others, infrastructures, water access, health and
primary education. In the specific case of Angola, the HDI country’s value for 2011 was 0,486 38 (148 out of
187 countries) and it was constantly ranking in the bottom group (“Low Human Development”). This value
is higher than the Sub-Saharan Africa HDI value (0,463) but quite far from other Southern African
countries such as Namibia (0,625) or Botswana (0,633). On the contrary, it is not so far from Bhutan
(which HDI value is 0,522) that is the last “Medium Human Development” country (ranked 141 out of
187). Being part of this intermediary group could be an aim shared by the Angolan SWF and monitoring
this index could be a way to assess SWF’s social impact.
5) Support national development through the improvement of national infrastructures.
As in all the emerging countries the need for infrastructures is very high and strictly related to the overall
economic development of the country. In the specific case of Angola, the improvement of the
infrastructures is one of the main goals to be achieved in order to foster both economic and social growth.
A significant example of upcoming project in infrastructure that is supposed to be highly beneficial for the
country is Sonaref, a Sonangol project. Despite being the second oil producer in Africa, Angola has only
one small refinery in Luanda that does not have enough capacity to meet the demand of the rapid
economic growth. For this reason, Angola annually imports 250 million dollars of oil derivative products.
To cover this gap Sonangol undertook the project of building a new modern refinery, Sonaref, with the
goal of making a full integration of the production and refining of crude oil activities.
6) Foster Transparency and fight against corruption.
The implementation of a SWF itself does not guarantee the increase of transparency in the management of
public assets in behalf of the sponsor country’s stakeholders. There are examples, in fact, of SWFs that
34
Angola is currently rated BB- by Fitch (May 2011), Ba3 by Moody’s (June 2011) and BB- by Standard and Poor’s (July 2011).
Today, in Angola, the level of incidence of poverty is of 36%.
36
The Human Development Index (HDI) is a composite statistic of life expectancy, education, and income indices to rank countries into four
tiers of human development. It was created by economist Mahbub ul Haq, followed by economist Amartya Sen in 1990 and published by the
United Nations Development Programme.
37
http://www.afdb.org/fileadmin/uploads/afdb/Documents/Policy-Documents/FINAL%20Briefing%20Note%206%20Inclusive%20Growth.pdf.
38
Between 2000 and 2011, it increased from 0.384 to 0.486, an increase of 27.0% or average annual increase of about 2.2%.
35
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 9
have been created with the purpose of fostering transparency in public wealth management, providing the
sponsor country with financial accountability but that, unfortunately, failed in their intent. So, in order to
foster transparency and, consequently to fight corruption, a SWF should present a clear and well defined
mandate and good governance able to assure transparency and accountability through update reports and
regular annual audits conducted by independent auditors. Transparency is identified as a key element of
success in the whole literature.
7) Transfer wealth to future generation.
One of the common goals of SWFs is the distribution of wealth among its existent shareholders and across
those of the future. In this sense the capacity of transforming the wealth generated by natural resources in
an important resource for the future generations is one of the main task of those SWFs whose asset are
directly generated by the natural resources revenues. Some SWFs present a structure articulated in two
Funds, one of those is specifically dedicated to the transfer of wealth across generations, as in the case of
Kuwait Future Generations Fund.
Nowadays SWFs are dramatically growing in popularity and they are increasingly considered as a potential tool for
fostering African development. They could represent “a new hope for the resource-rich countries of Africa resolving
the paradox of plenty”39 as very often the emergence of oil exports brings many benefits such as sustained capital
inflows that could lead to current account surpluses and a build-up in foreign exchange reserves but, as well, poses
significant challenges such as an increased need for sterilization and, eventually, the necessity to manage Dutch
disease. The current international academic debate focuses on the question if SWFs, and more specifically the
African ones, could be successful in making natural wealth beneficial for the economy of the natural resources-rich
countries, supporting the social and economic development of the sponsor country and of the entire Region,
promoting intra-African investments, enhancing productivity, fostering inclusive growth and reducing the
infrastructures’ gap. It is difficult to find a unique answer due to the heterogeneity of national economic situations
and the different nature of SWFs and of the tools used in order to measure their effectiveness. However, it is
generally recognized that the main condition for a SWF to be successful is a clear mandate able to guarantee good
governance and SWF’s accountability and transparency. Where for Governance it is intended the rules in place
defining the role of the Government, of the governing bodies and of the managers and their independency, with
specific reference to the inflow and outflow of money. Transparency is related to the detailed communication of the
Fund role and objectives and, as well, the timely provision of information on the Fund’s activities and operations.
Accountability, regards the degree to which the SWF and its governing bodies are responsible for their decision as in
Tsani, Ahmadov and Aslanli work40. This assumption is specifically valid for the Fundo Soberano de Angola, and for
the upcoming African Sovereign Wealth Funds, whose effectiveness will be related to these three essential elements
and to the capacity of monitoring and communicating the social and economic goals achieved in order to become a
model for many other SWFs. Once of the major challenge, in fact, for the FSDEA and other African SWFs, is,
without any doubt, the capacity to adapt rules of corporate governance able to ensure real independence from shortterm political interests. In this sense, the structure of a SWF is just as important as its investment decisions, if not
even more, in terms of SWF’s effectiveness and accountability. A good governance and a punctual information of
the goals, of the results, and of the overall benefits for the Country, promoted by the Fundo Soberano de Angola,
would help in gaining the support and the trust of the public opinion, in avoiding critics and failures and the
possibility that a direct distribution of the SWF’s wealth to the population could be wished as a better option for
Angola41.
39
Adam D. Dixon, Ashby H.B. Monk: “What role for SWF in Africa’s Development?”, Oil to cash initiative background paper, October 2011,
Center for Global Development.
40
S. Tsani, I. Ahmadov, K. Aslanli: “Governance, transparency and accountability in Sovereign Wealth Funds: Remarks on the assessment,
rankings and benchmarks to date”, Public Finance Monitoring Center, March 2010.
41
http://www.cgdev.org/section/initiatives/_active/revenues_distribution.
Last update: July 2014, Author: Dr. Celeste Lo Turco.
Page 10
The Bulletin
September 2014
Vol. 5 Ed. 8
Brics and pieces
A world apart on monetary policy
Maria Antonieta Del Tedesco Lins on Brazil and the Brics
Sahoko Kaji on the lessons of monetary union
Celeste Cecilia Moles Lo Turco on African sovereign funds
Gerard Lyons
Joachim Nagel and Christian Erb
Niels Thygesen on central banking transparency
Lamido Yuguda on managing reserves amid low yields
Italy’s quest for sovereign fund link-ups
I
talian Prime Minister Matteo Renzi
embarked in July on an African tour aimed
at bolstering trade ties, visiting Mozambique,
Congo-Brazzaville and Angola.
Italy currently holds the European Union
presidency and this makes the visits even more
important, leading EU foreign policy towards
a new focus on Africa and the Mediterranean
region, addressing economic cooperation,
stability, immigration and terrorism.
Renzi met the presidents of Mozambique,
Congo-Brazzaville and Angola, respectively
Armando Guebuza, Denis Sassou Nguesso
and José Eduardo dos Santos.
Sub-Saharan growth
Trade between Italy and the three
sub-Saharan
countries
has
grown
significantly
in
recent
years
(see
Table 1). Sub-Saharan Africa, with an
expected average growth rate of nearly 5%
from 2012-16, represents an important
economic and political priority for Italy (See
Table 2).
Sectors for possible collaboration are
infrastructure, construction, agro-food,
tourism, culture and education, defence and
energy. Energy is the most important.
During the visit the Italian oil company
Eni, a major foreign oil producer in Africa,
announced investment of $50m in gas
projects in Mozambique. In addition it signed
a cooperation agreement with André Raphael
Loemba, Congo-Brazzaville’s minister of
hydrocarbons, for the development of new
offshore activities.
In Angola the company boosted
cooperation with the state oil company
Sonangol on international expansion and
domestic infrastructure, with a specific focus
on the Lobito oil refinery. Another sector of
high interest is defence. Last year this sector
saw a 40% increase in Angola’s budget. Talks
started when a delegation from Angola visited
some Italian companies active in the military
sector such as Finmeccanica, Fincantieri and
Iveco. Angolan representatives expressed
an interest in Selex control systems, Alenia
Aircraft and the Italian carrier ‘Cavour’.
Italy is seeking to position itself among the
traditional suppliers of Angola such as Russia,
Cuba, China and Brazil.
Attracting investment
In Angola, the prime minister met
the chairman of the Angolan Sovereign
Wealth Fund (FSDEA) to explore possible
collaboration in industry, agriculture,
infrastructure and tourism.
According to the SWF Institute, 10 African
funds with a total endowment of $160.5bn
share the tasks of supporting domestic
development and attracting foreign direct
investment (see Table 3).
In its portfolio allocation, FSDEA
intends to invest half of its portfolio in
alternative investments that can support
domestic development (see Table 4). Possible
collaboration with Italian companies with
significant relevant know-how could be of
great importance.
While Congo-Brazzaville and Mozambique
are in the process of setting up SWFs, the
FSDEA is in its preliminary phase of activity
but has already invested in sovereign bonds
(see Table 5).
FSDEA started its activity in 2012 with an
endowment of $5bn. It is the second biggest
sub-Saharan fund after the Pula Fund of
Botswana, with an endowment of $6.9bn.
The technical details of possible future
collaborations with FSDEA will be discussed
during the follow-up mission, already
scheduled in November, led by Carlo
Calenda, Italian deputy minister for economic
development. He will be accompanied by
Italian businessmen.
A possible partnership with the Italian
Strategic Fund, which already has important
link-ups with SWFs such as the Qatar
Investment Authority, the Kuwait Investment
Authority and the Russian Direct Investment
Fund, has been discussed.
This is the first time that the Italian
government has approached a new SWF, still in
its preliminary phase of activity. This represents
an important addition to the economic policy
of the new Italian government.
Building relationships
According to Italy’s economic policy,
expected GDP growth of 1% could be achieved
in three years through increased exports, the
internationalisation of Italian companies and
the development, among others, of the agrofood and the energy sectors. The expected
results of the mission will work through into
the longer term, as part of Italy’s efforts to
build up its overall relationships in Africa.
During the visit, Italy assured Angola of its
support to become a non-permanent member
of the United Nations Security Council for
the 2015-16 session. This is not the first time
that Italy has supported Angola; it was the
first western European country to recognise
its independence in 1976.
The closeness of links between Italy and
Africa is becoming steadily more apparent.
Renzi’s visit reinforces links that will extend
further in economics and politics, and build
on strong historical ties. ■
Angola
Imports from Italy ($m) 2,072
333
Bilateral Trade ($m)
26
2,405
363
733
533
302
462
353
460
295
255
70
47
557
532
400
502
470
Angola
Population (m)
4.2
Gas production (m m3)
Oil production (m bbl/d)
752
25.9
946
5.9
0.3
African sovereign wealth funds
Sovereign wealth fund
Country
Libyan Investment Authority
Libya
66.0
Algeria
77.2
Botswana
6.9
Angola
5.0
Asset group
($bn)
G7 public equities
Preservation of
capital
Alternatives
and infrastructure
development
Asset allocation
target
Cash
Nigeria
Gabon
0.4
Investment
universe
0.3
Sovereign agencies
High yield
Supranational
Commodities
Large companies
(investment grade)
Agriculture and
mining
institutions
Developed public
equities
Guinea
Infrastructure
Property
Brics and frontier
markets equities
Ghana
3.0
healthcare and energy.
Total
Sovereign wealth fund
Origin
Assets ($bn)
Commodity
5.0
Commodity
Commodity
n/a
Infrastructure; Independence from
September 2014
27
WP/13/231
Sovereign Wealth Funds: Aspects of
Governance Structures and Investment
Management
Abdullah Al-Hassan, Michael Papaioannou, Martin Skancke,
and Cheng Chih Sung
© 2013 International Monetary Fund
WP/13/ 231
IMF Working Paper
Monetary and Capital Markets Department
Sovereign Wealth Funds: Aspects of Governance Structures and Investment Management
Prepared by Abdullah Al-Hassan, Michael Papaioannou, Martin Skancke, and
Cheng Chih Sung1
Authorized for distribution by Luc Everaert
November 2013
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily
represent those of the IMF or IMF policy. Working Papers describe research in progress by the
author(s) and are published to elicit comments and to further debate.
Abstract
This paper presents in a systematic (normative) manner the salient features of a SWF‘s
governance structure, in relation to its objectives and investment management that can ensure
its efficient operation and enhance its financial performance. In this context, it distinguishes
among the various governing bodies and analyzes key aspects of the investment policy and
setting of the risk tolerance level in order to ensure consistent risk-bearing capacity and
greater accountability. Further, it discusses the important role of SWFs in macroeconomic
management and the need for close coordination with other macroeconomic and financial
policies as well as their role in global financial stability.
JEL Classification Numbers: G11, G15, G23, G32, G34
Keywords: sovereign wealth funds, governance structure, investment management, risk
management, macroeconomic coordination
Author‘s E-Mail Address: aalhassan@imf.org, mpapaioannou@imf.org,
martin.skancke@gmail.com, and sungchengchih@gmail.com
1
Martin Skancke and Cheng Chih Sung were the Director General of the Norwegian Ministry of Finance and the
Chief Risk Officer at the Government of Singapore Investment Corporation, respectively. We are grateful to Peter
Dattels, Tom Dorsey, Kelly Eckhold, Luc Everaert, Gregory Horman, Bradley Anthony Jones, Jorge Canales
Kriljenko, Peter Lindner, Brian Olden, and Kazuko Shirono for helpful comments.
2
Contents
Page
I. Background and Motivation ...................................................................................................3
II. Objectives and Governance Structure ...................................................................................4
A. Characterics of SWFs................................................................................................4
B. Macroeconomic Role of SWF Institutions ................................................................7
C. Legal Structure and Institutional Framework............................................................8
III. Investment Management ....................................................................................................14
A. Investment Mandate and Investment Objectives ....................................................15
B. Investment Policy ....................................................................................................17
C. Investment Implementation .....................................................................................21
D. Risk Management ...................................................................................................22
IV. Disclosure and Transparency .............................................................................................25
V. Concluding Remarks ...........................................................................................................27
Table 1. Asset Allocation Characteristics of Stabilization and Savings SWFs .........................6
Figures
1. Asset Allocations at Sovereign Wealth Fund, by Type of Fund............................................5
2. Main Elements of SWF Policy ..............................................................................................8
3. Investment Models ...............................................................................................................11
4. An Illustrative SWF Government Structure ........................................................................12
5. Roles and Responsibilities of Owner and Fund Manager ....................................................18
6. Selected SWFs‘ Performance Based on Asset Composition ...............................................20
7. An Illustrative Example of Internal Organizational Chart ...................................................25
8. SWFs Perception of Value of Transparency ........................................................................26
Appendices
1. Santiago Principles...............................................................................................................29
2. Selected Sovereign Wealth Funds .......................................................................................31
3. Basic Principles of Risk Management .................................................................................32
References ................................................................................................................................33
3
I. BACKGROUND AND MOTIVATION
Total assets under management by Sovereign Wealth Funds (SWFs) have been growing rapidly
over the last few years and estimates of their total holdings vary considerably, depending on
the used definition of a SWF. Upper-end estimates indicate total SWF assets of around
US$5 trillion. This figure, however, may double count some sovereign assets, by including
central bank assets that are already captured in official reserves. Based on the definition of
the International Working Group (IWG) of Sovereign Wealth Funds (2008), which excludes
central banks and state-owned enterprises, the total assets of SWFs—with publically available
data for thirty SWFs—are about US$3 trillion (IMF 2012).2
SWFs have an important role in macroeconomic management and global financial stability.
The operations of the SWFs are closely linked to public finances (through their funding and
withdrawal rules), monetary policy (liquidity conditions), and external accounts (exchange rate
variations). Furthermore, during the global financial crisis in 2008, sovereign investors,
including SWFs, were affected by and responded to the changes in the global financial markets.
For instance, SWFs (saving funds) that are heavily invested in equities experienced large losses
from the sharp decline in equity markets, but they recovered most of the losses in the
subsequent years by demonstrating their willingness to be long-term investors and riding out
the financial turmoil (IMF 2011, and Papaioannou and others, 2013). This behavior was in
tandem with that of official reserve managers that reduced substantially their exposure to
commercial banks deposits (Pihlman and van der Hoorn, 2010).
This ultimate objective of sovereign investors can only be achieved if the SWFs are managed
within a sound governance structure and with appropriate investment strategies. Close
coordination with macroeconomic policies and the management of other assets and liabilities in
the public sector is essential. The SWF objective(s) and consequent investment policy should be
considered within macroeconomic policy setting and objectives, and the design of SWF
mandates should take into account the implication for the broader economy. In addition,
the governance structure must ensure a clear division of roles and responsibilities between
the various governing bodies, as well as operational independence for the manager and
a supervisory system with appropriate checks and balances. This is necessary in order to build
legitimacy for sovereign investment, reduce risk of fraud and mismanagement, and build
a competent investment organization.
The scope of this paper is to present in a systematic manner the salient features of a SWF‘s
governance structure in relation to its objectives and investment management that can ensure its
efficient operation and enhance its financial performance. In particular, this paper intends to be
normative by providing broad recommendations and describing some good practices, taking
2
SWFs are defined by the IWG as: Sovereign wealth funds (SWFs) are special purpose investment funds or
arrangements that are owned by the general government. Created by the general government for macroeconomic
purposes, SWFs hold, manage, or administer assets to achieve financial objectives, and employ a set of investment
strategies that include investing in foreign financial assets.
4
into account the Generally Accepted Principles and Practices (GAPP) by the IWG. The paper
distinguishes between different governing bodies and analyzes key aspects of a SWF‘s
investment mandate, including the need to specify the risk tolerance level well in order to
ensure consistent risk-bearing capacity over time and greater accountability, and the need to
establish prudent and effective risk management frameworks. Further, it discusses the important
role of SWFs in macroeconomic management and the need for close coordination with other
macroeconomic and financial policies as well as in global financial stability. Though the key
aspects of governance structures and investment management are discussed within the context
of SWFs, they are also applicable to other sovereign investors, such as central banks,
government pension funds, development funds, etc.
The paper is structured as follows: Section II discusses the objectives and governance structure
of SWFs, including their legal framework and governance structure. Section III discusses
the investment management framework, including investment objectives and mandates, key
considerations for investment management implementation and risk management. Section IV
analyzes key issues for SWFs‘ disclosure policies, including transparency, accountability and
reporting, as well as implementation of the Santiago Principles (Appendix I).3
II. OBJECTIVES AND GOVERNANCE STRUCTURE
The policy objectives of SWFs vary, depending on the broad macrofiscal objectives that they
aim to address. The organizational structure needs to have a clear separation of responsibilities
and authority. As such, a well-defined structure builds a decision making hierarchy that limits
risks by ensuring the integrity of and effective control over SWF management activities.4
A. Characterics of SWFs
Sovereign wealth funds are usually distinguished based on their stated policy objectives and
consequent asset allocation. Though there are many SWFs with multiple objectives, based on
IMF and the Santiago Principles taxonomy, five types of SWFs can be distinguished (Figure 1
and Appendix II):
3
The Santiago Principles represent generally accepted principles and practices that properly reflect SWFs
investment practices and objectives. The Principles are voluntary, which the members of the IWG support, and
which they either have implemented or aspire to implement.
4
See Santiago Principles GAAPs 1-16.
5
Figure 1. Asset Allocations at Sovereign Wealth Fund, by Type of Fund
Stabilization Funds
Saving Funds
4% 5%
16%
4%
6%
Cash
22%
16%
Other f ixed income
Sovereign f ixed income
Equities
Others
69%
58%
Pension Reserve Funds
Reserve Investment Funds
3%
6%
8%
34%
16%
6%
19%
1%
41%
66%
Source: IMF, Global Financial Stability Report (April 2012).
Stabilization funds are set up to insulate the budget and economy from commodity price
volatility and external shocks (e.g., Chile (Economic and Social Stabilization Fund),
Timor-Leste, Iran, and Russia (Oil Stabilization Fund)). Their investment horizons and
liquidity objectives resemble central banks reserve managers, in view of their role in
countercyclical fiscal policies to smooth boom/bust cycles. They tend to invest largely in
highly liquid portfolio of assets (and sometimes in instruments that are negatively
correlated with the source of risk being addressed with the fund) by allocating over
80 percent of their assets to fixed income securities, with government securities
consisting around 70 percent of total assets.
Savings funds intend to share wealth across generations by transforming nonrenewable
assets into diversified financial assets (Abu Dhabi Investment Authority, Libya, Russia
(National Wealth Fund)). Their investment mandate emphasizes high risk-return profile,
thus, allocating high portfolio shares to equities and other investments (over 70 percent).
Development funds are established to allocate resources to priority socio-economic
projects, usually infrastructure (e.g., UAE (Mubadala) and Iran (National Development
Fund)).
Pension reserve funds are set up to meet identified outflows in the future with respect to
pension-related contingent-type liabilities on the government‘s balance sheet
6
(e.g., Australia, Ireland, and New Zealand). They held high shares in equities and other
investments to offset rising pension costs.
Reserve investment corporations intend to reduce the negative carry costs of holding
reserves or to earn higher return on ample reserves, while the assets in the funds are still
counted as reserves (e.g., China, South Korea, and Singapore). To achieve this objective,
they pursue higher returns by high allocations in equities and alternative investments—
with up to 50 percent in South Korea and 75 percent in Singapore‘s Government
Investment Corporation.
The objectives of SWFs depend on country-specific circumstances, which may evolve over
time. Many funds in resource-rich economies have multiple objectives, such as
stabilization/savings (Azerbaijan, Botswana, Trinidad & Tobago, and Norway), saving/pension
reserve (Australia), or stabilization/saving/development (Kazakhstan).
Investment decisions and portfolio allocation of SWFs are often closely linked to their stated
investment objectives and governance structure. Table 1 shows the main asset allocation
characteristics of stabilization and saving funds. Moreover, Figure 1 shows the asset allocation
of various types of SWFs, indicating that equities, as a share in SWFs‘ portfolio, tend to
increase from 0–5 percent for stabilization funds to around 40 percent in pension reserve funds,
and around 60 percent for saving funds and reserve investment funds.
Table 1. Asset Allocation Characteristics of Stabilization and Savings SWFs
Stabilization funds
Saving funds
Investment horizon
Short term
Long term
Asset composition
Limited to highly liquid assets
Broader asset classes
Currency composition
Negatively correlated with commodity Matching net import of the country
prices
Performance benchmarks
Minimizing expenditure volatility and
maintaining adequate liquidity
Achieving real expected returns for longterm periods to maintain the long-term
purchasing of the wealth
Risk tolerance
Low risk-return profile
Active investment management with
higher risk-return profile
Asset and liability management
Ensuring the sustainability of future
fiscal expenditure
Maximizing net value of the fund taken into
account the correlation between asset
prices and liabilities
Source: IMF.
22
An effective benchmark for a constituent asset class is a neutral (i.e., unbiased)
representation of the universe of securities from which a rational investor could be expected
to select portfolio holdings. It should reflect the passive alternative. When multiple indexes
are available for benchmarking, an index is chosen that is consistent with investment
objectives and also, to the extent possible, constructed with objective selection criteria,
complete, replicable, investable and accepted by investors. It is not always possible to find
benchmarks that have all of these characteristics.
Developing an active risk budgeting framework for a SWF in anticipation of increases in
active management activities is critical. Based on the same principles of diversification and
risk efficiency underlying Modern Portfolio Theory, a formal active risk budget seeks to
optimize the expected excess return by allocating more active risk discretion to managers
who are better at generating risk-adjusted returns, while controlling for the fund‘s total
tracking error risk relative to the SAA. The effectiveness of such a framework will be
enhanced when complemented by detailed attribution analysis that is able to analyze manager
skills along the same set of risk factors or decision variables used for risk measurement.
The choice between internal versus external management needs to be clearly defined. It is
essential that SWF managers have clear rules with regard to what investment functions are to
be outsourced and what can or must be managed internally. Selection, appointment and
monitoring procedures for external managers are also essential, ensuring that due process is
followed.
D. Risk Management
The risk management framework should build on the same principles as the rest of
the governance system. This implies a framework for risk management characterized by
clearly delegated mandates, defined roles and responsibilities, accountability, transparency,
and professionalism.
As a global investment fund, a SWF is exposed to a wide range of risks. The scope of risk
management should cover all material aspects of risks: market risk, credit risk, operational
risk, liquidity risk, legal risk, regulatory risk, agency risk, governance risk, and reputation
risk (Appendix III). Also, services provided by third parties could be demanding and
challenging especially for low-capacity institutions; and thereby, there is a need to examine
the aggregate risk from all third parties.
A SWF needs to have a strong risk management culture, where top management is engaged
in developing and enforcing the risk management process. Adherence to high standards in
risk management with sound operational controls and systems are necessary to meet
the objectives of the SWF, and to preserve legitimacy domestically. It will also be seen by
the international community and markets as necessary in achieving the aim of preserving
international financial stability, as well as maintaining a stable, transparent, and open
investment environment. This risk management process would typically consist of
the following components:
7
B. Macroeconomic Role of SWF Institutions
SWFs have an important role in macroeconomic management and hence ought to be in close
coordination with other government institutions. SWF assets—and the returns they generate—
can have a significant effect on public finances, monetary conditions, external accounts and
balance sheet linkages with the rest of the world. In particular:
Fiscal policy might be affected by SWF funding and withdrawal rules that are usually
derived from a fiscal rule, often based on Permanent-Income-Hypothesis
considerations;5
Monetary policy may be impacted by wide fluctuations in fiscal revenues and
procyclical implications for aggregate demand that typically affect inflation and the real
exchange rate; and
Exchange rate variations could be mitigated by investing the SWF‘s resources abroad.
Therefore, the SWF should be considered within the context of the overall sovereign balance
sheet. From the risk-return perspective, it is ―sub-optimal‖ to optimize isolated balance sheets
rather than the consolidated sovereign balance sheet (Das et al. 2012). Although asset-liability
objectives and strategies might be optimal for each institution (e.g., central bank, pension fund,
SWF, etc.) in terms of local risk-return profile, it may not be the case from the sovereign
balance sheet perspective. Mismatches in the financial characteristics of sovereign assets and
liabilities may expose the sovereign balance sheet to a wide range of risks, including interest
rate and exchange rate risks. Therefore, to manage better these risks, there needs to be close
coordination among the institutions involved in the management of sovereign assets and
liabilities, with appropriate legislation that institute policy guidelines (to avoid substantial
mismatches) and sharing of information.
Sound public financial management calls for limiting the procyclicality of fiscal policy. Policies
and rules for an SWF‘s funding, withdrawal, and spending operations should be clear and
consistent with the purpose(s) of the fund. A stabilization SWF usually has clearly laid-out rules
for the deposit and withdrawal of resources to smooth the fluctuations in the government
budget. Savings-type SWFs receive contributions from excess revenues, but their purpose is to
help ensure that earnings or profits are spent—through the budget process—in a way that makes
it possible to share wealth with future generations. For pension funds, the mandate is to match
asset accumulation to the actuarial implication of the demographic profile, while having little
scope to influence the business cycle or the revenue implications of commodity price
fluctuations. To this end, the rules of transferring funds between an SWF and its owner should
always be spelled out. Also, while fiscal processes often call for some flexibility in
the withdrawals from these funds, so as to avoid borrowing, this approach will have to be taken
into account in the strategic asset allocation (SAA).
5
This will be determined by the absorption capacity of the economy, which include needed public infrastructure,
investment in human capital over the long term.
8
The investment objectives of the SWF also need to be consistent with the government‘s broad
macrofiscal objectives. Although investment objectives of SWFs vary according to
the underlying purpose, they must be compatible with macrofiscal objectives and policy
priorities. For instance, the investment strategies of commodity-based SWFs are frequently
designed to fit closely the respective country‘s policy framework by minimizing the distortions
that large and volatile commodity flows might cause to the fiscal accounts, inflation, and
the exchange rate and addressing possible sovereign explicit contingent liabilities.
In particular, the SWF‘s investment strategies can help alleviate the ―Dutch Disease‖
phenomenon and ensure external stability. In resource-based economies, upward swings in
commodity prices tend to result in a boom in aggregate domestic demand, inflationary
pressures, and thus an appreciation of the real exchange rate vis-à-vis trading partners. Those
conditions, in turn, make non-oil sector less competitive in international markets—
a phenomenon known as the Dutch Disease. By augmenting the country‘s net external asset
position in a way consistent with economic structure and fundamentals, the SWF would help
maintain external stability over the long term. Furthermore, the accumulation of foreign assets
in tandem with changes in hydrocarbon exports would help mitigate macroeconomic—and
social—risks associated with the appreciation of the real exchange rate especially under
the fixed exchange rate regime and loss of competitiveness in non-hydrocarbon sectors of
the economy.
C. Legal Structure and Institutional Framework
The optimal investment strategy for an SWF will have to reflect the objectives of the SWF. In
most cases, these objectives will be directly interlinked to the governance structure, investment
strategy, and transparency requirements (Figure 2).
Figure 2. Main Elements of SWF Policy
Objective(s)
Investment
strategy
Governance
Reporting
Source: Authors.
9
Legal structure
A robust legal framework is required to promote sound institutional and governance
arrangements for the effective management of SWFs. The SWF legal framework should among
other things (i) provide clearly for the legal form and structure of the SWF and its relationship
with other state bodies (including the ministry of finance (MoF), central bank); (ii) be consistent
with the broader legal framework governing government‘s budgetary processes; (iii) ensure
legal soundness of the SWF and its transactions; (iv) support its effective operation and
the achievement of its stated policy objective(s), which should be economic and financial in
nature; and (v) promote effective governance, accountability, and transparency.
In practice, there is a wide variety of legal frameworks for SWFs. This partly reflects the fact
that different countries have chosen different legal forms for these funds. Generally, SWFs are
established (i) as separate legal entities under law with legal identities and full capacity to act;6
(ii) take the form of state-owned corporations also with distinct legal persona;7 or (iii) as a pool
of assets owned by the state or the central bank, without a separate legal identity.8 All of these
forms are compatible with recognized practices and principles, but the legal basis for a SWF
must clearly establish which form the SWF has. In practice, the different legal forms may have
implications for both the tax position and immunity of investments. Investments through central
banks will normally be protected by sovereign immunity and may also enjoy tax privileges in
recipient countries. Taxation of investments through corporate structures may depend on
the extent to which these investments are viewed as an integrated part of the government‘s
financial management. Tax treatment of SWFs investment can also depend on provisions in
bilateral tax agreements (e.g., Norway has negotiated tax exemptions for its SWF investments in
several bilateral tax treaties).
There is also a wide variety when it comes to the degree of granularity of primary legislation.
This will partly reflect different traditions and/or constitutional requirements across countries.
Some countries have very short primary legislation but more granular secondary legislation.9
There are also differences with respect to how much delegation of authority laws in different
countries provide for. Again, many levels of granularity may be compatible with recognized
international practices. But, it is essential that the overall legal framework provides for real
delegation from owner to manager and that it grants the operational manager independence
within the guidelines set by the owner.
6
Australia, Kuwait, New Zealand, and UAE (ADIA).
Temasek (Singapore).
8
Botswana, Chile, Norway, and Timor-Leste.
9
The law on the Norwegian SWF has nine short sections, giving the Ministry of Finance the power to manage the
Fund. The Ministry, however, has issued a comprehensive and publicly available mandate for the management of
the fund, which is carried out by Norges Bank Investment Management, the investment arm of the Central Bank of
Norway.
7
10
Institutional framework
The institutional frameworks across SWFs differ. Regardless of the governance framework,
the operational management of an SWF should be conducted on an independent basis to
minimize potential political influence or interference that could hinder the achievement of
the SWF‘s objectives.
The ―manager model‖ and the ―investment company model‖ are the two dominant forms of
institutional setup for SWFs. The models are illustrated in Figure 3.
In the manager model, the legal owner of the pool of assets constituting the SWF (usually
the ministry of finance) gives an investment mandate to an asset manager. Within this model,
there are three main sub-categories:
a.
The central bank manages the assets under a mandate given by the ministry of finance
(e.g., Norwegian Government Pension Fund Global, Botswana, and Chile). In this case,
the central bank may choose to use one or more external (private) funds for parts of
the portfolio.
b.
A separate fund management entity, owned by the government, is set up to manage
assets under a mandate given by the ministry of finance, such as the Government
Investment Corporation (GIC) of Singapore. In this case, the manager may also have
other asset management mandates from the public sector. For instance, GIC manages
parts of the reserves of the Monetary Authority of Singapore.
c.
The ministry of finance gives mandates directly to one or more external (private) fund
managers. This model is generally not recommended, since awarding contracts to
external fund managers is in itself an investment decision that should be carried out at
arm‘s length from a political body, and the evaluation, monitoring and termination
of management contracts requires specialized skills more likely to be found in a
dedicated investment organization. However, for countries with severe human capital
constraints, it can be the only feasible solution.
In the investment company model, the government as owner sets up an investment company
that in turn owns the assets of the fund. This model is typically employed when the investment
strategy implies more concentrated investments and active ownership in individual companies
(Temasek, Singapore), or the fund has a development objective in addition to a financial return
objective.
11
Figure 3. Investment Models
Manager Model
Investment Company Model
Source: Authors.
The institutional arrangements for a natural resource or other fund should be appropriate and
commensurate for its objectives and the nature of its investments. Funds that function
operationally as separate legal entities (e.g., Trinidad and Tobago and China) usually have
a governance structure that differentiates an owner, a board, and the operational management of
the SWF. Where the fund is a unit within the central bank (e.g., Saudi Arabia and Algeria)
operational independence could be embedded in a clear legal foundation and internal
governance structure in which the decision making framework and oversight functions are clear
and the relationship between the principal (owner) and its agent (central bank) is well
established. An important consideration in adopting either approach is the cost. Setting up
a fund as a separate legal entity has costs, while a unit in the central bank makes use of existing
infrastructure and human resources. Therefore, it could be more cost-efficient if a small size
fund were to be managed within an existing institution.
The governance structure must be commensurate with the risks and complexities of the
investment strategy. As funds move into riskier assets and more complex investment strategies,
governance and risk management must be strengthened. This approach is not only applicable to
SWFs, but also to large institutional investors as they have been moving toward adopting a risk
factor based approach to portfolio construction.
In the organizational structure of a SWF, it is useful to distinguish between governing and
supervisory bodies. The governing bodies constitute a system of delegated asset management
responsibilities. The authority to invest is delegated from the top entity of the governance
system, through the various governing bodies down, to the individual (internal or external)
managers of assets. The delegation implies a gradual increase in the granularity of regulations
pertaining to responsibilities as we move down the ladder of the organizational system. Each
governing body should establish a supervisory body to assist in supervising the governing body
directly below. The role of the supervisory body is to verify that the supervised unit is acting in
accordance with the regulations set by the governing body immediately above it in the
governance structure.
12
It is also helpful to distinguish between those bodies that are internal to the organization and
those that are external. While the internal bodies are part of the legal structure of the SWF,
the external bodies are (or belong to) other legal persons that have a clearly defined role in
managing the SWF (e.g., as owner or external auditor). Figure 4 illustrates a general SWF
structure that differentiates governance from supervision, and internal from external bodies.
Figure 4. An Illustrative SWF Government Structure
Source: Authors.
In a generic SWF setup, we can distinguish between five governing bodies at different levels
with specific roles and responsibilities:10
The owner of the SWF, which is typically the central government. The parliament
approves the laws that establish the legal structure of the SWF and, thus, the legal basis
for its operations. Depending on the general division of authority between the parliament
and the executive branch of government, parliament may also have a role in determining
the appropriate aggregate risk level of the SWF.
In most cases, the government (i.e., the cabinet or the council of ministers) or
the minister of finance will be carrying out the functions of the owner of the SWF. This
10
This generic setup does not cover the special case where a ministry of finance has given a direct mandate to an
external (private) asset manager, where there thus is no separate SWF management institution.
13
role implies inter alia the task of setting a mandate for the investment organization,
within the general framework provided by parliament.
The executive board is the highest governing body inside the legal structure of the SWF
management organization. It sets internal rules and regulations (e.g., investment
guidelines), within the mandate and legal constraints set by the owner. It also appoints
the chief executive officer (CEO) of the investment organization.
The CEO is the administrative head of the investment organization. He/she is
responsible for day-to-day operations within the guidelines set by the executive board.
The individual managers (internal and external) operate within risk limits set by
the CEO and his/her staff. Normally, the CEO will delegate the running of
the investment department to a chief investment officer (CIO) that operates within
the investment guidelines, with each level down in the hierarchy having a narrower
investment mandate until the individual manager level.
The governing bodies have supervisory bodies working for them to verify that the level
immediately below them operates within the rules and regulations that have been set for them.
These typically include:
The auditor general is, in most countries, appointed by the parliament to audit and
control the activities of the executive branch of the government. One of its roles is to
verify that the ministry of finance (or any other body acting as formal owner) operates
within the laws and regulations laid down by the parliament and that any associated
reporting to the parliament is correct and relevant.
The external auditor will usually be appointed by the governing body representing
the owner (often the ministry of finance). The external auditor audits the accounts of
the SWF and verifies that the SWF is managed within the rules and regulations set by
the owner. The external auditor can also, on an ad hoc basis, perform other control
activities (e.g., assess the quality of the internal control system)11.
The internal auditor is appointed by the executive board and reports to it. The internal
auditor supports the board in supervising the management of the SWF and verifying that
internal regulations are adhered to.
The compliance unit is established by the CEO and serves as a tool for the CEO to
verify that all activities are in compliance with the rules and regulations governing
the SWF‘s operations.
11
There are usually separate supervisory and audit arrangements for central banks, also when they are operational
managers of an SWF.
14
While governance models may differ, inter alia due to differences in political institutions, there
are some common principles that must be considered essential to any well-governed SWF.
The starting point in establishing the governance structure of an SWF should be to recognize
that the bodies established to manage the assets of the SWF are essentially trustees on behalf of
the people. One fundamental concern is, therefore, to establish a structure that will underpin
the legitimacy of the SWF‘s operations and ensure that the decisions taken in the management
of the SWF reflect the best interests of the people as ultimate owners of its assets. This requires
a solid legal basis for the SWF and the establishment of a chain of governing bodies from
the legislature down to the individual asset managers with accountability at every level.
There must be a clear and transparent division of roles and responsibilities between the different
governing bodies. This is a necessary condition for achieving accountability and legal certainty.
When the role of a particular body is unclear, it will not be possible to hold it to account. Both
gaps and overlaps in duties and responsibilities must be avoided. Overlaps give unclear division
of responsibilities and undermine accountability. Gaps in regulations may create room for
unchecked and unwanted risk taking. There must be appropriate delegation of investment
decisions from the owner to the asset manager and within the management organization. Asset
management is highly skill-intensive, and proper delegation to a professional staff is required
for successful implementation of the SWFs investment strategies. Delegation also serves to
focus the attention of each governing body to the issues that are critical for success at their level
in the governance system. Too little delegation will risk overwhelming the top bodies of the
system with operational issues that will distract from higher-level strategic issues. While
a sound and robust strategy is necessary for successful management of the SWF, there must also
be flexibility in the implementation of strategy to deal with changing market conditions. In
many cases, this will require faster decision making processes than a highly centralized system
can provide.
At the same time, the governance structure must allow the owner to determine the appropriate
aggregate level of risk. While investment professionals can make qualified statements about
the relationship between risk and expected return in financial markets, financial theory in itself
cannot provide a definitive answer on the appropriate level of risk for a SWF. This level
depends also on the level of risk aversion of the ultimate beneficiaries of the SWF––the people.
The implication of this is that the level of risk in the SWF should be set by a process that allows
political bodies like the parliament and/or the ministry of finance to establish at least a broad
guideline for the appropriate level of risk for the SWFs investments.
III. INVESTMENT MANAGEMENT
A SWF’s investment policy needs to set an explicit risk tolerance level when designing
the investment strategy in order to ensure consistent risk-bearing capacity over time and
promote greater accountability for the chosen investment strategy. The risk management
framework should have sound operational controls and systems to meet the objectives of
the SWF.12
12
See Santiago Principles GAAPs 18-23.
15
A. Investment Mandate and Investment Objectives
Investment mandate
The owner of the SWF (usually, the ministry of finance) is responsible for setting
the investment policy, after seeking an advice from the investment committee (or board).
Also, consultations with the fund‘s stakeholders (i.e., the parliament, general public,
nongovernment organizations, etc.) reduce the risk of unilateral decisions by any single
party.
There are broadly two key determinants to the setting of an appropriate investment mandate:
(i) the objective of the SWF and (ii) the risk-bearing capacity of the SWF. Both determinants
will have a bearing on the investment universe and the proportion of the SWF exposed to
―risky‖ assets. In general, the longer a fund‘s investment horizon is, the higher its capacity to
take on investment risks is. A short investment horizon signals a lower scope for exposure to
―risky‖ assets. Investment funds with a strong intergenerational savings orientation tend to
view their long horizon and attendant ability to ride through market downturns as a key
competitive advantage, and they allocate more aggressively to ―risky‖ assets.
Risk tolerance
Once the investment objectives for a particular pool of assets have been clarified, the next
step in formulating an investment strategy is to set an appropriate risk tolerance. This is
challenging for several reasons: first of all, ―risk‖ is a complex concept, and the risk of
an investment strategy cannot be fully captured by one single number or indicator. It is
necessary to have a broader approach, and to use several indicators to assess the riskiness of
a particular strategy. Moreover, there is no ―right‖ level of risk because there is no ―right‖
level of risk aversion. For sovereign assets, setting an investment strategy requires some way
of ascertaining the risk tolerance of the (political) bodies that are designated as stewards of
these assets. As the relevant risks may be difficult to capture by simple indicators, this is
often a challenge in itself.
The most common indicator of risk is volatility of returns. This may be a useful indicator of
risk, as most investors would be concerned about variation and unpredictability of returns,
and in particular sudden losses in value. It is, however, not the only relevant measure of risk.
It also has significant limitations as a measure of risk, since it implicitly assumes that returns
are normally distributed. In reality, asset returns are generally not normally distributed—
large losses occur much more frequently than one would expect based on an assumption of
normally distributed returns. Measures of risk that are based on volatility should therefore be
interpreted with great care.
For sovereigns, a more relevant approach to risk is defining it as the probability of failing to
meet some predetermined policy objective. For an SWF set up to transfer wealth to future
generations, it may be misleading to think in terms of ―safe‖ low-volatility fixed income
instruments and ―risky‖ higher volatility equities. Short-term volatility is not the most
relevant indicator of risk in this case. Higher expected returns from equities will make it
16
more likely that the fund will be beneficial to future generations. Locking in very low or even
negative expected real returns in a fixed income portfolio would not be in the interest of
future generations—in this sense, it is a ―risky‖ strategy since it makes it unlikely that
the principal objective of passing wealth on to future generations will be met. The same
argument can be made for assets invested to meet future liabilities in a defined benefit
scheme. If the investment strategy locks in low-returns fixed-income portfolio, the risk that
future liabilities will not be met becomes high. This strategy is thus ―risky,‖ even if the assets
are ―safe.‖
The determination of the risk-bearing capacity of an investment fund is a key driver of
the fund‘s investment strategy. A formally articulated risk tolerance serves as a constraint in
choosing among competing investment strategies. It also prepares stakeholders
psychologically for potential large losses associated with the chosen strategy and helps to
prevent knee-jerk reactions to adverse market movements against the fund. Countries such as
Chile, New Zealand and Singapore have chosen to adopt such explicit risk tolerance for their
sovereign funds.
Risk objectives are typically determined by the owner or the governing body of the SWF.
Broad risk principles are generally established within the law governing the SWF or by
the owner of the fund. Consistent with the SWF‘s overall objective(s) that is whether
the fund serves the objective of economic stabilization, saving for future generation or other),
the owner of the fund would need to formulate and articulate consistent risk tolerance
parameters, such as the fund‘s investment horizon and its overall risk tolerance. Risk
tolerance exemplifies the hypothetical line between acceptable and unacceptable investment
outcomes, and should reflect the fund‘s ability to take risk in the operating environment.
Subsequently, the risk tolerance is translated into a quantifiable risk measure that could be
expressed as a shortfall probability, probability of not achieving a certainty return target or
worst case outcome at a certain confidence level. Other examples of specific risk parameters
are, inter alia, probability of achieving a return in excess of domestic inflation rate, expected
annual shortfall relative to long-term domestic inflation, probability of negative return at
the end of three years, probability of achieving return target over twenty years, or probability
of negative accumulated real return after fifteen years
Owners can also articulate a formal risk appetite statement that serves as a constraint in
choosing among competing candidate SAAs or investment strategies. The manifestation of
the owner‘s risk tolerance can be the choice of an SAA from amongst the candidate SAAs.
Or it can be an explicit risk tolerance statement. An explicitly specified risk tolerance raises
the efficiency and consistency of investment strategy formulation by avoiding protracted
debates on the fund‘s risk-bearing capacity each time a change in strategy is being
contemplated. It also promotes greater accountability for the chosen investment strategy and
checks against procyclical tendency in the fund‘s asset allocation in the face of either
extended bull markets or sharp market sell-offs.
However, if explicit risk tolerance measures are too abstract for policymakers to relate to,
setting broad guidelines for asset allocation—and thus an implicit risk tolerance—is
sometimes a good alternative.
17
The investment policy for the fund needs to take into account the country ability to bear risk.
Although not uncommon, the absence of an explicitly specified risk tolerance introduces
greater uncertainty and complexity into the portfolio construction process, particularly when
major changes in asset allocation are being considered. Without an explicit specification,
the risk tolerance has in practice to be inferred from the fund‘s approved investment universe
and its current investment strategy. In general, the longer a fund‘s investment horizon,
the higher its capacity to take on investment risks (Figure 1). Due to the cyclical nature of
financial markets, investment funds with a strong intergenerational savings orientation tend
to view their higher tolerance for risk and the attendant ability to ride through market
downturns as a key competitive advantage.
Overall, there are several common ways in which an explicit risk tolerance can be specified,
including stress loss or drawdown limit; shortfall probability; and limit on the fund‘s valueat-risk. For a public fund, the formal risk tolerance chosen not only needs to be analytically
robust but must also be readily understood by the stakeholders. As such, a simpler
formulation such as ‗the prospective losses from the fund shall not exceed x percent over
a period of y years may be appropriate. The emphasis on prospective losses estimated on
an ex-ante basis at the point, where the fund‘s investment strategy is being decided, is
an important one as it prevents automatic de-risking of the fund in knee-jerk reaction to
severe market downturns and provides room for more critical reexaminations of
the investment theses underlying the prevailing investment strategy. The process of
calibrating the risk tolerance to the satisfaction of the stakeholders is typically a lengthy one.
B. Investment Policy
Consideration of investment beliefs, the risk-bearing capacity of the SWF and its objective
will give rise to a number of candidate asset classes and combinations of those asset classes.
These combinations are typically expressed as an SAA, which sets a target allocation to asset
classes within the investment universe. The use of an SAA-based model to establish
an investment mandate rests on the belief that the most important determinant of a fund‘s risk
and return characteristics is its exposure to a chosen mix of asset classes. The SAA
encapsulates the spectrum of investment risks that the fund is designed to take on, taking into
account the expected diversification benefits of mixing different asset classes. An alternative
to the SAA-approach, used by the Canada Pension Plan and New Zealand Superannuation
Fund, is a reference portfolio approach. Under this approach the SWF owner grants more
discretion to the SWF manager to determine the appropriate mix of assets, by providing only
a hypothetical mix of listed equities/listed fixed income and the numeraire (together these
comprise the reference portfolio) as guide to the owner‘s risk preference.
Setting of strategic asset allocation
The SWF‘s expressed risk tolerance is typically articulated through an SAA. The SAA
defines the target share of asset classes or risk factors, and should be derived from and be
consistent with SWFs‘ objectives and the owner‘s risk tolerance. There are alternative
approaches as to who ―owns‖ strategic asset allocation decisions. In a more typical set-up
approach, the owner of the fund, usually a ministry of finance, decides on the SAA, approves
the benchmark portfolio representing the SAA and sets active risk limits for deviating from
18
the policy benchmark. Operationalization of the SAA and active management is then
delegated to the fund manager.13 In a less typical approach, the SAA decision is fully
delegated to and owned by the fund manager.14 In the former approach, the SWF‘s owner
internalizes the total risk of the policy benchmark, which represents on average about
80–95 percent of the overall risk, while the fund manager is responsible for the residual risk
arising due to active management, and is held responsible for excess returns relative to
the benchmark. In the latter approach, the fund manager is ultimately responsible for the total
return of the fund, as well as for potentially substantial deviations from the stated return
targets for long periods of time, with the fund owner not having direct control over
investment outcomes. Figure 5 represents separation of roles and responsibilities in
formulating and implementing investment policy between a SWF‘s owner and the fund
manager.
Figure 5. Roles and Responsibilities of Owner and Fund Manager
Responsibilities of the Owner:
Formulation of Risk Tolerance
Parameters
Responsibilities of the Fund:
Implementation of Investment
Policy
•Articulate fund objectives
•Define risk tolerances
•Define investment horizon
•Review investment performance.
•Propose capital market assumptions
•Implement strategic asset allocation
•Manage portfolios in-house or select
external managers
•Measure risk and performance
•Report to the owner and stakeholders.
Retained or Delegated by the
Owner to the Fund
Approve:
•Strategic asset allocation
•Policy benchmarks
•Active risk budget.
Source: IMF.
Usually, the investment model employed by SWFs is centered on the fund‘s SAA.
Commonly adopted by institutional funds, the asset allocation-centric model rests on
the belief that by far the most important determinant of a fund‘s risk and return
characteristics is its exposure to a chosen mix of asset classes. The SAA encapsulates
the spectrum of investment risks that the fund is designed to take on with due regard given to
the principle of diversification. The constituent asset classes are subject to separate decisions
on how these should be managed. When the constituent asset classes are assigned investable
13
This approach is adopted by Norway and Russia.
14
This approach is adopted by Singapore.
19
benchmarks, the SAA is represented by a theoretical portfolio forming the bogey against
which the performance and risk of the fund are measured and managed.
In general, the investment universe of newly established funds continues to place strong
emphasis on liquidity and transparency. Such emphases are appropriate for a SWF at its early
stage of development where expertise and resources for dealing with illiquid and nonpublicly
traded investments are still lacking. Therefore, the financial performances of SWFs are
driven by whether the investment portfolio is predominated by fixed income instruments,
equities, or is diversified across broad set of asset classes (Figure 6).
It is not uncommon for funds seeking to enhance returns to shift out of publicly-traded bonds
and equities into alternative assets such as private equity, real estate, and hedge funds.
However, a shift into alternative assets requires significant enhancements in the SWF‘s
resources, capacity and capability to cope with the added risks and complexity. Investing in
alternative assets requires not only highly specialized investment expertise but also strong
governance, managerial and operational capabilities. Such was the case with the Government
Pension Fund–Global (GPFG) in Norway. Despite having developed considerable internal
management capabilities in bonds and listed equities, it took Norges Bank Investment
Management (NBIM), the manager of GPFG, more than twelve years before it made its first
investment outside of the public markets, or four years after the Norwegian Parliament
approved a 5 percent allocation to global real estate.
The use of derivatives has become prevalent in investment management. When employed
appropriately, derivatives can raise the efficiency of portfolio management (such as in
the passive replication of market exposure), implementation of active strategies, and hedging
of unwanted risks. However, due to the inherent leverage and complexity of such
instruments, derivatives also hold the potential for causing spectacular financial and
reputational losses, if misused or abused. Counterparty risk could be a significant risk
embedded in the use of derivatives. Thus, much more so than for traditional assets, the use of
derivatives needs to be carefully enumerated, controlled, and monitored.
With the likely growth in the use of derivatives, a comprehensive derivatives policy should
encompass some key components. The policy should: (i) enumerate explicitly the permissible
range of derivatives by the purpose and type of the submandates; (ii) impose appropriate
limits on the size of derivative transactions by instrument type to control the associated
liquidity and basis risks; and (iii) require separate monitoring and reporting of derivatives use
and their risk and performance impact on the fund.
20
Figure 6. Selected SWFs’ Performance Based on Asset Composition15
10%
SWFs with Predominant Fixed Income Portfolio
8%
6%
4%
2%
0%
2007
2008
Azerbaijan
2009
2010
Chile (ESSF)
2011
2012
Timor-Leste
SWFs with Predominant Equity Portfolio
60.0%
40.0%
20.0%
0.0%
-20.0%
-40.0%
2007
30%
2008
2009
New Zealand
2010
2011
Norway
2012
SWFs with Diversified Portfolio
20%
10%
0%
-10%
-20%
-30%
-40%
2008
2009
China
2010
Ireland
2011
2012
Canada
Source: Authors’ estimates based on annual reports from SWFs.
15
The investment performance of the individual SWF may not necessarily be based on the same basket of
currencies.
21
C. Investment Implementation
Investment implementation involves the management of the assets of the SWF in accordance
with the SAA. This management can take two forms: (i) exposure to various asset classes
deviating from the target SAA weight; and (ii) active management of assets within an asset
class. Deviations from target weights can be made actively or can occur passively when one
or more asset classes outperform others.
A real return objective is particularly well-suited to the SWFs with the long investment
horizon implied by their investment policy. This naturally leads to the question of
the appropriate measure of purchasing power for the fund as the effect of inflation becomes
more dominant over longer horizons. The choice of the numeraire currency not only affects
the future purchasing power of SWF assets, but also it has a direct bearing on how
the currency risk is perceived and managed. Any investment not denominated in numeraire
currency is deemed to pose a currency risk to the fund. Depending on how seriously such risk
is taken, a numeraire may impede the fund‘s diversification into a broader mix of
international currencies.
Therefore, in choosing numeraire currency, it is important to ensure that the most relevant
measure of purchasing power is used to drive the fund‘s investment strategy going forward.
Ideally, the numeraire should comprise a basket of currencies that best approximates
the procurements that fund assets are expected to finance in the long run. Should that prove
to be too difficult to effect in practice, other alternatives such as broad GDP-weighted or
market capitalization-weighted baskets can be chosen as proxies. This will help to promote
greater diversification of the fund‘s asset and currency risks, and reduce the reliance on
a single numeraire currency as the sole measure of store of value.
The SAA, along with the chosen numeraire, is the benchmark for SWF risk and performance.
When the constituent asset classes of an SAA are assigned investable benchmarks with
appropriate numeraire, the SAA is represented by a theoretical portfolio forming
the benchmark against which the performance and risk of the fund are measured and
managed.
The investment mandate should establish the degree to which the day-to-day allocations to
asset classes in a SWF can differ from the chosen SAA, and therefore at what deviations
the portfolio must be rebalanced. It will also establish how actively assets within each asset
class can deviate from their benchmark weights. When asset prices change, the portfolio
weights will drift away from the (static) SAA weights. The rebalancing policy will determine
when and how the actual portfolio weights will be brought back to the SAA weights.
Rebalancing can add value to the portfolio by systematic buying of assets that have fallen in
value and sale of assets that have increased in value—especially in volatile markets with no
strong trend. Infrequent rebalancing implies a high tolerance for drift away from the SAA
allocation, whereas frequent rebalancing increases transaction costs. This trade-off should be
reflected in the rebalancing policy.
Benchmarks for each constituent asset class of the SAA should be chosen on the basis of
their objectivity, completeness, replicability, investability, and acceptance by investors.
23
Risk policies and procedures: a set of written principles that are endorsed by
the board, implemented by the CEO, and disseminated within the institution.
Risk identification: the process by which a SWF defines and understands the nature of
the risk that it faces, and is an essential part of a risk management process.
Risk measurement: a measurement methodology that allows comparison across
the different dimensions of risks, and enables risk considerations to be factored into
performance measurement and investment management decisions.
Risk monitoring: the operational process by which the SWF ensures that it operates
within its defined risk policies and procedures.
Risk reporting: typically refers to an internal reporting process.
Risk verification and audit: the component of the risk process to ensure that the risk
management systems and techniques are effective.
Financial risks
In assessing appropriate risk levels, it is helpful to distinguish risks that are rewarded or
desirable, and risks that are not. In particular, financial risks generally have a positive
relationship between the risks and expected return, as they carry a premium for assuming
those risks. For example, more risky and/or less liquid asset classes, such as alternative
investments, on average tend to generate higher returns than safer more liquid assets over
medium to long-term investment horizons. The so-called consequential risks, such as
operational and legal risks, are the risks that inevitably arise as a result of being in
the financial/investment management industry.
Given the asset allocation-centric investment model, the ex-ante market risk of a SWF can be
broken down into two components: SAA risk and active risk. SAA risk refers to the risk
inherent in the fund‘s asset allocation strategy without the intervention of active
management, while active risk (also known as tracking error risk when measured in volatility
terms) captures the risk brought on by active management of the fund relative to the SAA.
The active risk comes from two sources: (i) the marginal deviation in the fund‘s actual asset
allocation exposure versus the SAA due to imperfect rebalancing; and (ii) active management
of the fund‘s submandates against their respective benchmarks.
A comprehensive credit risk management framework is critical. The framework should
encompass all sources of credit risk to the fund, including issuer credit risk, counterparty risk
and deposit default risk, and impose appropriate limits and monitoring procedures. This will
allow the SWF to better manage how and where credit risk is to be assumed. Such unified
approach to credit risk management is of particular importance when it comes to banks and
other financial firms which may simultaneously pose issuer, counterparty, and deposit default
risks to the fund.
24
Operational risks
Unlike financial risks, operational risks will not be rewarded, so the objective of operational
risk management is to mitigate (residual) risks to an acceptable level. While exposure to
financial risks leads to greater volatility in the market value of investment assets, but is
expected to lead to higher returns over time, operational risks could potentially lead to
significant losses of principal or even to the failure of the firm. Operational risk is largely
endogenous to the SWF. Apart from external events such as natural catastrophes, it is linked
to the business environment, nature and complexity of the investment activities, the processes
and systems in place, and the quality of the management and of the information flows.
Operational risks cannot be completely avoided or eliminated, and even if operational risk
has no expected return, there will be costs associated with reducing it. There is thus a tradeoff to be made between costs of accepting risk and costs of mitigating it, which should be
made explicit in risk policy documents and is often based on an impact and likelihood
analysis.
The most important operational risk management tool is appropriate internal organizational
structure with clear segregation of duties. The organizational structure should be designed to
achieve appropriate segregation of duties between execution of portfolio transactions and
operations, including compliance monitoring, performance measurement and reporting, and
settlement and accounting. This could be achieved by setting up separate departments with
the head of each department reporting directly to the CEO, who would then delegate specific
and clearly defined roles and accountabilities to each group and position (Figure 7). Public
disclosure of the SWF‘s approach to its risk management policies and key actions related to
governance and the soundness of its operations helps in reassuring domestic and international
stakeholders that the SWF adheres to a high standard of managing operational, regulatory,
and reputational risks.
25
Figure 7. An Illustrative Example of Internal Organizational Chart
CEO
SAA, Risk, Performance
and Reporting
Compliance
IT Infrastructure
Settlement and Controls
Asset Class 1
Asset Class 2
Asset Class 3
Source: IMF.
Moreover, the operational risk management capabilities should include a structured process
for the introduction of new markets and instruments. When venturing into new investment
markets and instruments, there is a general tendency for investment organizations to rush
through implementation by devising ‗work-around‘ procedures to circumvent any
deficiencies in the existing operational systems and processes. Often, these temporary
measures end up staying in place for much longer than originally expected, while scenarios
that had not been anticipated earlier would start to appear, leading to potentially costly
operational errors. A structured ‗new product‘ process will help to instill greater discipline in
ensuring sufficient forethought, time and resources are devoted to the introduction of new
investment activities. If these operational considerations are to put constraints on the actual
investments of the SWF, the mandate from the owner must also give the operational manager
latitude to exclude certain potential investments that are part of the investment universe as
defined by the owner.
IV. DISCLOSURE AND TRANSPARENCY
To strengthen the accountability and oversight framework, communication with the key
stakeholders (general public, parliament, NGOs, financial markets, etc.) is critical in order
to maintain legitimacy domestically and credibility abroad.16
16
See Santiago Principles GAAP 17 and GAAP 24.
26
Reporting and transparency are important elements of governance. In addition to contributing
to legitimacy, and thus to building trust in policies based on saving public assets in a fund,
transparency can improve and discipline management and reduce the risk of corruption and
mismanagement. In applying the principle of transparency, SWFs have engaged in broader
consultation with other government entities and civil society. These outreach activities
increase the legitimacy of the fund, reduce the reputational risk, and require much effort in
explaining key investment decisions and management principles to various stakeholders. For
example, the IFSWF members‘ perception of value of transparency is high in terms of
enhancing domestic legitimacy, communicating with stakeholders, and having a positive
impact on their reputation (Figure 8).
Figure 8. SWFs Perception of Value of Transparency
Source: IFSWF.
It is useful to distinguish between procedures for internal and external reporting. Internal
reporting can be defined as reporting that is part of the governance structure of the SWF,
while external reporting is reporting to the entities outside the governance structure and to
the general public.
External reporting supports transparency to maintain the SWF’s legitimacy. It also
demonstrates the SWF‘s economic and financial orientation, which contributes to
stability in international financial markets and enhances trust in recipient countries.
External reporting requirements should reflect reporting requirement by
the international legislation, as well as domestic legislation of the host country that
SWF invests in. For example, many countries require that investors disclose their
holdings to financial regulators, if ownership shares pass certain thresholds.
Internal reporting is an integral part of the governance structure. In a system of
delegated asset management, the internal reporting is the reflection of delegated
authority. It is an integral part of the system by which governing bodies supervise
27
the bodies below them in the governance structure. As such, it is important for
decision making, risk management and controls at various levels of the SWF, and
should be an integral part of the risk management and investment management
frameworks.
Communication with the general public is a critical part of maintaining legitimacy
domestically, as well as for credibility internationally. Informing the general public about
the characteristics of the investment strategy and the risks that are taken should contribute to
making the implementation of strategy more robust in times of high market volatility. To this
end, it is usual for many SWFs to organize educational seminars, engage with the media,
carry self-assessment against GAPP, publish annual reports, and maintain an active website
with up-to-date information on the SWF‘s activities.
The majority of SWFs publish annual reports that include the evolution of asset allocation
and investment strategy over time as well as the financial statements. The scope of these
reports can be enhanced by including some forward-looking aspects and analytical features
relating to the investment strategy and asset allocation. In the reporting of returns,
the investment horizon of the fund should be emphasized by reporting returns over longer
rolling periods (e.g., 10 or 20 years) in order to de-emphasize short-term fluctuations in
the financial markets. This would provide a better and broader basis for an informed public
debate on important strategy decisions.
In recent years, several SWFs have also conducted and published self-assessments to confirm
the degree of adherence to the Santiago Principles. These assessments help to assure home
and recipient countries that SWFs‘ activities are solely based on economic and financial
considerations. This understanding aims to contribute to the stability of the global financial
system, reduce protectionist pressures, and help maintain an open and stable investment
climate. The self-assessments also have enabled those SWFs to develop, review, and
strengthen their organizations, policies, and investment.
V. CONCLUDING REMARKS
SWFs have increasingly assumed important roles in their domestic economies and global
financial markets. The assets under management by SWFs have grown rapidly over the last
few years, driven by balance of payment surpluses and commodity prices. Based on
the country-specific circumstances, the policy objectives of SWFs vary based on the broad
macrofiscal objectives; therefore, warranting close coordination with macroeconomic
policies and the management of other assets and liabilities in the public sector.
The institutional arrangements for a SWF should be appropriate and commensurate for its
objectives and the nature of its investments. An SWF‘s organizational structure should
establish a clear separation of responsibilities and authority. A well-defined structure creates
a decision making hierarchy that limits risks by ensuring the integrity of, and effective
control over SWF management activities. The governance structure should thus provide for
real delegation to an independent operational manager within overall limits on risk and/or
asset allocation set by the owner.
28
Also, the investment mandate should be aligned with the objective of the SWF and the riskbearing capacity of the SWF. The investment policy needs to adopt an explicit risk tolerance
level when designing the investment strategy in order to ensure consistent risk-bearing
capacity over time and promote greater accountability for the chosen investment strategy.
The strategic asset allocation tends to be the benchmark for SWF risk and performance. Most
importantly, the risk management framework should build on the same principles as the rest
of the governance system, through clearly delegated mandates, defined roles and
responsibilities, accountability, transparency, and professionalism.
For the successful performance of a SWF, asset management skills are of paramount
importance, and a good HR policy is critical for attracting and retaining competent staff.
Professional asset management requires a skill set that is usually in scarce supply in
the public sector. At the same time, access to these skills is a necessary condition for
successful management of an SWF. Hence, HR policies must be a central part of the overall
policy framework for the SWF.
29
APPENDIX 1. SANTIAGO PRINCIPLES17
GAPP 1. The legal framework for the SWF should be sound and support its effective
operation and the achievement of its stated objective(s).
GAPP 2. The policy purpose of the SWF should be clearly defined and publicly disclosed.
GAPP 3. Where the SWF‘s activities have significant direct domestic macroeconomic
implications, those activities should be closely coordinated with the domestic fiscal and
monetary authorities, so as to ensure consistency with the overall macroeconomic policies.
GAPP 4. There should be clear and publicly disclosed policies, rules, procedures, or
arrangements in relation to the SWF‘s general approach to funding, withdrawal, and
spending operations.
GAPP 5. The relevant statistical data pertaining to the SWF should be reported on a timely
basis to the owner, or as otherwise required, for inclusion where appropriate in
macroeconomic data sets.
GAPP 6. The governance framework for the SWF should be sound and establish a clear and
effective division of roles and responsibilities in order to facilitate accountability and
operational independence in the management of the SWF to pursue its objectives.
GAPP 7. The owner should set the objectives of the SWF, appoint the members of its
governing body(ies) in accordance with clearly defined procedures, and exercise oversight
over the SWF‘s operations.
GAPP 8. The governing body(ies) should act in the best interests of the SWF, and have
a clear mandate and adequate authority and competency to carry out its functions.
GAPP 9. The operational management of the SWF should implement the SWF‘s strategies in
independent manner and in accordance with clearly defined responsibilities.
GAPP 10. The accountability framework for the SWF‘s operations should be clearly defined
in the relevant legislation, charter, other constitutive documents, or management agreement.
GAPP 11. An annual report and accompanying financial statements on the SWF‘s operations
and performance should be prepared in a timely fashion and in accordance with recognized
international or national accounting standards in a consistent manner.
GAPP 12. The SWF‘s operations and financial statements should be audited annually in
accordance with recognized international or national auditing standards in a consistent
manner.
17
http://www.iwg-swf.org/pubs/gapplist.htm
30
GAPP 13. Professional and ethical standards should be clearly defined and made known to
the members of the SWF‘s governing bodies, management, and staff.
GAPP 14. Dealing with third parties for the purpose of the SWF‘s operational management
should be based on economic and financial grounds, and follow clear rules and procedures.
GAPP 15. SWF operations and activities in host countries should be conducted in
compliance with all applicable regulatory and disclosure requirements of the countries in
which they operate.
GAPP 16. The governance framework and objectives, as well as the manner in which the
SWF‘s management is operationally independent from the owner, should be publicly
disclosed.
GAPP 17. Relevant financial information regarding the SWF should be publicly disclosed to
demonstrate its economic and financial orientation, so as to contribute to stability in
international financial markets and enhance trust in recipient countries.
GAPP 18. The SWF‘s investment policy should be clear and consistent with its defined
objectives, risk tolerance, and investment strategy, as set by the owner or the governing
bodies, and be based on sound portfolio management principles.
GAPP 19. The SWF‘s investment decisions should aim to maximize risk-adjusted financial
returns in a manner consistent with its investment policy, and based on economic and
financial grounds.
GAPP 20. The SWF should not seek or take advantage of privileged information or
inappropriate influence by the broader government in competing with private entities.
GAPP 21. SWFs view shareholder ownership rights as a fundamental element of their equity
investments‘ value. If an SWF chooses to exercise its ownership rights, it should do so in
a manner that is consistent with its investment policy and protects the financial value of its
investments. The SWF should publicly disclose its general approach to voting securities of
listed entities, including the key factors guiding its exercise of ownership rights.
GAPP 22. The SWF should have a framework that identifies, assesses, and manages
the risks of its operations.
GAPP 23. The assets and investment performance (absolute and relative to benchmarks, if
any) of the SWF should be measured and reported to the owner according to clearly defined
principles or standards.
GAPP 24. A process of regular review of the implementation of the GAPP should be
engaged in by or on behalf of the SWF.
31
APPENDIX 2. SELECTED SOVEREIGN WEALTH FUNDS
Fund Name
Country
Fund Soberanu de Angola*
Angola
Australian Future Fund
Australia
State Oil Fund
Azerbaijan
Future Generations Reserve Fund
Bahrain
Pula Fund
Botswana
Brunei Investment Authority
Brunei
Alberta's Heritage Fund
Canada
Economic and Social Stabilization Fund
Pension Reserve Fund
Chile
Chile
China Investment Corporation
Fund for Future Generation of Equatorial
Guinea
China
Oil Stabilization Fund
Iran
National Development Fund*
Iran
Oil Stabilization Fund
Ireland
Kazakhstan National Fund*
Kazakhstan
Korea Investment Corporation
Korea
Kuwait Investment Authority
Kuwait
Libyan Investment Authority
Libya
Khazanah Nasional Berhad
Malaysia
Mexico Oil Stabilization Fund
Mexico
Fiscal Stability Fund*
Mongolia*
New Zealand Superannuation Fund
New Zealand
Nigeria Sovereign Investment Authority*
Nigeria
Government Pension Fund-Global
Norway
Papua New Guinea SWF*
Papua New Guinea
Qatar Investment Authority
Qatar
National Welfare Fund
Russia
Oil Stabilization Fund
Government of Singapore Investment
Corporation
Russia
Temasek
Singapore
Timor-Leste Petroleum Fund
Timor Leste
Heritage and Stabilization Fund
Trinidad and Tobago
Abu Dhabi Investment Corporation
UAE
Abu Dhabi Investment Authority
UEA
Alaska Permanent Fund
USA
Stabilization Fund
Venezuela
Equatorial Guinea
Singapore
Source: Authors.
Note: *It also includes developmental objective.
Fiscal
Stabilization
Savings
Pension
Review
Reserve
Investment
32
APPENDIX 3. BASIC PRINCIPLES OF RISK MANAGEMENT
Fiduciary Responsibility: The investment manager needs to be conscious at all times of its
fiduciary responsibility to the fund‘s owner in safeguarding the fund‘s interests and
reputation.
Risk Tolerance: The investment manager needs to have a clear understanding of the fund
owner‘s risk tolerance and act accordingly in discharging its investment responsibilities.
Risk Conscious Culture: The investment manager needs to promote a risk conscious culture
within the organization with senior management setting the tone.
Risk Ownership: The ownership of risk should be clearly established within the investment
management entity and between the fund‘s manager and owner.
Risk Governance: There needs to be a well-defined governance structure for risk
management within the investment management entity and for the fund.
Risk Identification and Assessment: All material risks for the fund must be identified,
assessed and accepted through structured and systematic processes prior to investment.
Diversification of Risks: Risks should be diversified systematically to limit concentration of
exposures and reduce overreliance on individual systems, processes, providers and people.
Check and Balance: Investment and operational processes should have in-built checks and
balances, with clear segregation of responsibilities, to minimize errors, avoid conflict of
interest and reduce possibility for collusion.
Risk Measurement: All material risks for the fund should be measured, either quantitatively
or qualitatively, without overreliance on any single metric, and monitored with appropriate
frequency.
33
REFERENCES
Brown, Aaron, Michael Papaioannou, and Iva Petrova, 2010, ―Macrofinancial Linkages of
the Strategic Asset Allocation of Commodity-Based Sovereign Wealth Funds‖, IMF
Working Paper WP/10/9 (Washington: International Monetary Fund).
Das, Udaibir S., Yinqiu Lu, Christian Mulder, and Amadou Sy, 2009, ―Setting up a
Sovereign Wealth Fund: Some Policy and Operational Considerations,‖ IMF
Working Paper WP/09/179 (Washington: International Monetary Fund).
Das, U., Mazarei, A., van der Hoorn, H. (2010). ―Economics of Sovereign Wealth Funds:
Issues for Policymakers‖. Washington: International Monetary Fund.
Das, Udaibir, Yinqiu Lu, Michael Papaioannou, and Iva Petrova, 2012, ―Sovereign Risk and
Asset and Liability Management—Conceptual Issues‖, International Monetary Fund,
WP/12/241.
International Forum of Sovereign Wealth Funds (IFSWF), 2011, ―IFSWF Members‘
Experiences in the Application of the Santiago Principles,‖ Available via the Internet:
http://www.ifswf.org/pst/stp070711.pdf.
International Monetary Fund, 2012, ―Safe Assets: Financial System Cornerstone?‖ Global
Financial Stability Report,
www.imf.org/external/pubs/ft/gfsr/2012/01/pdf/c3.pdf.
International Monetary Fund, 2011, Global Financial Stability Report, Chapter 2 “Longterm Investors and Their Asset Allocation: Where Are They Now?” (Washington:
International Monetary Fund, September).
International Working Group of Sovereign Wealth Funds (IWG), 2008, ―Generally Accepted
Principles and Practices—Santiago Principles
http://www.iwg-swf.org/pubs/gapplist.htm.
Kunzel, Peter, Yinqiu Lu, Iva Petrova, and Jukka Pihlman, 2011, ―Investment Objectives of
Sovereign Wealth Funds: A Shifting Paradigm,‖ IMF Working Paper 11/19
(Washington: International Monetary Fund).
Papaioannou, Michael, Joonkyu Park, Jukka Pihlman, and Han van der Hoorn, 2013,
―Procyclical Behavior of Institutional Investors During the Recent Financial Crisis:
Causes, Impacts, and Challenges,‖ IMF Working Paper 13/193 (Washington:
International Monetary Fund).
Pihlman, Jukka, and Han van der Hoorn, 2010, ―Procyclicality in Central Bank Reserve
Management: Evidence from the Crisis,‖ IMF Working Paper 10/150 (Washington:
International Monetary Fund).
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