Soverieign wealth fund cash is pouring into listed compabies, but at potentially what cost?
Move over, hedge funds: sovereign wealth funds (SWFs) are the bigger investors now. Massive, mysterious and possibly misunderstood, SWFs have the world financial markets riled, sparking a heated debate at the World Economic Forum in Davos that still smolders.
Demands for transparency and governance are fueling global outcries, but fear of outsiders may also be to blame. The fact is that SWFs, with holdings estimated at about $2.5 tn and growing, represent the investments of governments, making it difficult to separate politics, protectionism and even xenophobia from concerns about what investors need to know.
The investment community is getting to grips with a big relative shift in wealth from the traditional investor countries toward the emerging markets. As ownership of much of this new wealth is in the hands of the government rather than in the private sector, ‘that implies a different way of thinking about the world,’ explains Ted Truman, senior fellow at the Peterson Institute for International Economics in Washington, DC.
Historically, emerging countries have kept their reserves in relatively safe, liquid short-term investments such as foreign treasury bills. Now, for various reasons – some undisclosed – they’re forming SWFs to make bolder investments in riskier vehicles such as equities.
Truman says SWFs have become a major focus ‘because of their size, their lack of transparency, their potential to disrupt foreign markets and the risk that political objectives might influence their management.’
SWFs are growing in scale. Experts agree that, as a group, SWF holdings have already surpassed the size of hedge funds. Non-oil Asian exporters could also become as important as oil exporters, says Stephen Jen, global currency strategist at Morgan Stanley. ‘By 2015, the two groups will be roughly the same size – at around $6 tn each – with China’s Huei Lian Company being the largest single SWF.’
Clearer picture
Despite the efforts that are under way to develop an international code of behavior for SWFs, not everyone expects to see changes soon. ‘Many companies in China and other parts of Asia are not transparent,’ explains Daniel Chow, a law professor at Ohio State University. ‘I would be surprised to find greater transparency at Chinese entities any time in the near future, because it is part of Chinese corporate culture – and Chinese culture in general – to keep things less than transparent.’
Ironically, SWFs may be doing themselves a disservice by not providing more disclosure. ‘There is a great deal of apprehension about them, partly because many of them, although not all of them, are quite mysterious about what they do,’ Truman says. ‘If they had more accountability to their own citizens, as well as other countries’ citizens, some of this misunderstanding and mystery would be removed.’
Christopher Balding, a research analyst at the Milken Institute, is noticing some expected patterns. ‘SWFs have money in stocks and in bonds,’ he points out. ‘They take small percentages of their overall portfolio and place them with private equity groups, and they take small percentages of their portfolios and place them with hedge fund groups. We see them acting as most other investors do, trying to diversify their risk and increase their return.’
Pros and cons
Companies can also expect SWF fund managers to operate just like their mutual fund counterparts. ‘If I’m sitting with the Chinese fund or the Dubai fund, or with any large American investor, I’m going through exactly the same analysis of the risks and returns of different kinds of assets around the world,’ says John Rutledge, chairman of private equity fund Rutledge Capital.
The perception of SWFs may improve in the future. ‘I think that CEOs and management will actually like SWFs because they tend to be long-term investors,’ says Michael Maduell, founder of the Sovereign Wealth Fund Institute. ‘Historically they have taken a non-voting position and, if faced with what seems to be a sensitive investment to the host country, they will take non-voting shares.’
The worry that SWFs are fronts for foreign government political strategies is ‘vanishingly small’, says Rutledge. ‘But the danger of foreign investors, including the sovereign funds, deciding that it’s not worth it – that the dollar is not good to hold – is very real. If these large holders of global assets decide to reduce their allocations in the dollar, that would result in a big drop in the dollar and in the value of US assets.’
