Taking control

Sovereign wealth funds, for so long passive investors, are on the threshold of a new phase in their development. The global economic crisis has forced the world’s financial institutions into new and often unusual modes of operating, and there is already talk in academic circles over whether sovereign wealth funds (SWFs) can continue with their traditional, hands-off approach – questions are flying as to whether SWFs are fulfilling their fiduciary duty by forgoing voting rights and board representation.

The man who coined the phrase ‘sovereign wealth fund’, Andrew Rozanov, managing director of State Street Global Advisors, suggests the days of passive SWFs are over. He says: “If they want to maintain political distance while at the same time engaging with management, SWFs should outsource the stakeholding to a shareholder activist hedge fund manager.”

SWFs are already looking to external managers to restructure portfolios in a more cost-effective way. It is estimated that 25% to 35% of SWF assets are managed by external managers and ADIA, the Abu Dhabi Investment Authority, already outsources 50% of its assets. Rod Matheson, assistant deputy minister of Alberta Finance and Enterprise which runs the C$14bn Alberta Heritage Fund, says that it uses external managers and is becoming a more active investor and regularly takes board seats.

Not so special FX

The new found activist tendencies of SWFs may be due more to need than want. “Privately, Chinese sovereign wealth funds wish that they had fewer investments in dollars and deeper and broader holdings in Asia”, says Gerard Lyons, chief economist of Standard Chartered.

Economists think the recent bounce in the US dollar is short term and will not hold up. An unwinding of unsustainable global current account imbalances, a dollar crash and a collapse of the US financial system is expected, according to Donghyun Park, a senior economist at the Asia Development Bank.

The saying you can never go home again truly applies when it comes to FX markets. Ted Truman, senior fellow of the Peterson Institute of International Economics says: “Even if SWFs did want to sell off investments and bring the money back to their home markets – they couldn’t. The money that was abroad would have to pass through the FX markets, causing their own currency to rise and the dollar to drop further.”

The money that is currently invested in foreign markets will most likely remain there but it doesn’t mean that future investments will continue to be made along the current patterns. The China Investment Corporation is currently set up to invest two-thirds in the home market and one-third in foreign markets, but those percentages could, and possibly should, be changed to reflect the market conditions.

Export-dependent countries realise that the model will not work for ever. Thirty five percent of China’s economy is based on exports; the Government understands this revenue is unreliable because it is based on Western consumer demand, which is falling. Chinese policy is to bring down the share of assets spent on export-related growth and increase it domestically to encourage domestic consumption from the emerging Asian middle class.

Kevin Lu, director and CFO of the Multilateral Investment Guarantee Agency, says that the first thing to do is improve social security. The Government needs to improve social security and broaden the pension system so consumers will not feel compelled to hold such high rates of savings. This increased spending will stimulate domestic growth.

New markets

Though the outlook for emerging markets growth has deteriorated with the economic crisis, the perceived safety of Western markets has also eroded, leading many SWFs to look elsewhere.

China has recently launched a new SWF, the US$5bn China-Africa Development Fund (CADF). Mark Fung, general counsel of CADF, says: “Asset prices in Africa have dropped by 40%, there is investment opportunity there for sure.” Tax free and special economic zones in China started the boom at home, and the CADF wants to see the same principles adopted throughout Africa.

China isn’t the only country looking to Africa for opportunities. Gazprom has just made its most ambitious investment in Nigeria and Shell has added US$36bn to the Nigerian economy. The Nigerian Reserve Fund is looking to become an SWF itself – it currently holds US$11bn in its excess crude account and US$55bn in foreign exchange reserves, according to Babajide O. Ewuoso, divisional head of public sector advisory at BGL Investment Banking Group.

Sovereign wealth funds are becoming more active investors in the West. They will demand board seats and take a more hands-on approach with regard to managing their investments. They will combine these foreign adventures with increased investment at home, providing liquidity in markets that have traditionally lacked such a source.