There was little fanfare in December 2007 when the senior management of China Investment Corporation (CIC) visited New York. The sovereign wealth fund (SWF) had been founded earlier that year and its presence in the city passed without even a whisper in the press until it announced a $5 billion investment in Morgan Stanley.
Just two years earlier, US politicians had been in an uproar over the prospect of foreign state-backed entities buying national ports and Unocal, a domestic oil company. But the shift in attitude was starkly evident by late 2007 and 2008, when a handful of sovereign wealth funds were thrust centre stage as the saviours of capitalism, with bailouts aplenty for investment banks.
Now western governments and international investors alike are looking once more to SWFs for injections of capital. Talk of potential aid from these entities even gives dismal financial markets a temporary boost. But there has been little sign of these funds as the sovereign debt crisis has gathered pace in Europe, wreaking havoc in financial markets.
Earlier this year, embarrassed Spanish officials were forced to back pedal on claims following a meeting between Prime Minister Jose Luis Zapatero, CIC and Chinese premier Wen Jiabao that the sovereign fund would invest in the country’s troubled savings banks. The Spanish had been preceded earlier by the Greeks. No details have emerged from an announcement earlier this year by Qatar that it would pump 300 million euros into Spanish banks.
In mid-September, Italian officials claimed on the eve of a crucial bond sale that they were in talks with CIC and China’s State Administration of Foreign Exchange (Safe) over possible investments in Italian bonds and companies. This was followed by quick denials from the Chinese.
China’s premier Wen Jiabao has also signaled China’s reluctance to play the role of Europe’s saviour in its time of crisis and use some of its $3.2 trillion in foreign exchange reserves to buy eurozone bonds. In a recent speech in Dalian, China, Wen said: “Countries should fulfil their responsibilities and put their own houses in order.
“Developed countries must take responsible fiscal and monetary policies. What is most important now is to prevent further spread of the sovereign debt crisis in Europe.”
But others have claimed that China’s motivation behind buying eurozone debt would most likely be – if anything – to maintain a favourable exchange rate with the euro by pushing the single currency higher. China’s purchases of peripheral eurozone bonds are said to have been limited, while the nation’s euro-denominated reserves are understood to be largely invested in German bonds.
Michael McCormack, executive director at Z-Ben Advisors, says governments and investors have erred in judging CIC’s appetite for bailing out European states. “Buying into a bank is a commercial decision; buying into a country is a political issue,” says McCormack. “They’re certainly not going to make any explicitly political gestures of investment or support.”
He points out that CIC is nearly fully invested, and governments would be better placed to approach Safe.
STILL SMARTING
The macro environment is simply too unstable for state investors to stride into the eurozone as white knights, analysts say. The inability of European policymakers to come up with a firm and definitive response to the crisis has seen volatility in financial markets spike to levels last seen in the dark days of 2008 and 2009, when countries fled to the IMF for aid, and banks sought lifelines from states.
A host of unprecedented deals between banks and sovereign funds were inked in that period. Some did not work out so well, and the memories still sting. Singaporean SWF Temasek’s acquisition of a stake in Bank of America later resulted in estimated losses of $3–4.6 billion. Nursing losses from its investment in Citigroup, the Abu Dhabi Investment Authority (ADIA) filed an arbitration claim in 2009 against the investment bank, claiming it was misled in connection with the sale. Citigroup has denied the allegations and said it will defend itself “vigorously”.
Mubadala, the Abu Dhabi fund, may have lost up to half the value of its $1.85 billion investment in private equity group Carlyle, based on data included in the latter’s recent IPO filing. CIC’s deep pockets did not insulate it from criticism in Beijing when its stake in Blackstone was valued at $2 billion instead of the $3 billion it paid the previous year.
As low as valuations may fall, there appears to be little desire amongst sovereign wealth funds to relive these painful experiences, particularly when the outlook is so uncertain.
“Are we in a double dip? What sort of macro uncertainty are we facing?” asks Andrew Rozanov, head of sovereign advisory at Permal Investment Management. “Most of the decision makers at SWFs are not quite as confident or not quite as definite in their views with respect to where we are in the business cycle and what constitutes good value today. It is just too early in the game for people to have formed very strong views as to at what level a troubled bank or a distressed company looks like a great equity investment.”
GREATER CAUTION
Rozanov, who coined the moniker ‘sovereign wealth fund’ in 2005, says that funds’ mindset and policies have changed since the beginning of the financial crisis. Many have increased liquidity levels and are more cautious about investing, he says.
The macro environment is also substantially different today than three years ago: the stresses now stem from concerns over the ability of many European governments to address fiscal problems, and vulnerability in the European banking system because of its considerable exposures to the debt of these countries.
Reports surfaced mid-September that the major emerging economies of Brazil, Russia, India and China (Brics) were in initial talks on increasing their holding of euro-denominated bonds to help ease the eurozone crisis.
But Ousmene Mandeng, head of investment policy advisory at UBS, says: “There are not enough outside resources to help these countries that are too big to be saved.
“There needs to be a critical mass of conviction that there is sufficient willingness for fiscal adjustment in these countries before putting any money in. Otherwise it would be very risky [for sovereign funds].”
In addition, Mandeng, a former IMF official, cautioned that SWFs, like other investors, should be questioning the prudence of their exposures to the eurozone at this juncture. “Particularly because they are very long-term investors, there is a concern that there is a structural deterioration, and this will have implications for their strategic allocations going forward,” he says. While the US and the eurozone made up about 40% of world GDP last year, some projections estimate that this will shrink to 30% within a decade.
SWF SHOPPING LIST
Meanwhile other funds, such as Singapore’s GIC, have been slashing exposure to developed markets in the past year and increasing exposure to emerging markets, as has the Abu Dhabi Investment Authority. ADIA, which reported a 20-year annualized rate of return of 7.5% for 2010, has 80% of its assets managed by external fund managers. The bulk of these are allocated to indexed funds and developed equity investments.
In recent months, some sovereign wealth funds have displayed an increased appetite for real estate and infrastructure assets. ADIA, which currently allocates 2–8% of its assets in private equity, is looking to increase allocations. The sector is not new to ADIA, as it co-invested in KKR’s acquisition of Alliance Boots in 2007.
Earlier this year, Norway’s Norges Bank acquired a 25% stake in London’s Regent Street portfolio, and made its first property investment in France, spending E702.5 million on commercial real estate in central Paris. The fund has committed to investing 5% of their $570 billion in real estate.
CHINA’S COMMODITY PLAY
Natural resources have been another key focus, particularly for China’s sovereign wealth fund.
In mid-August CIC announced a partnership with GDF Suez, the world’s largest utility by sales, as it took a 30% stake in the gas and oil exploration and production business. And in April Xia Bin, an adviser to the People’s Bank of China, suggested that Beijing use its more than $3 trillion in foreign exchange reserves to secure the natural resources the economy needs.
The country’s unrelenting appetite for natural resources has awakened fears over its increased influence. But McCormack of Z-Ben suggests that CIC can be viewed through a different lens.
“CIC is probably the best positioned of any investor in the world to judge China’s long-term effect on certain markets,” says McCormack. “If you’re an investor who genuinely believes that China is going to exercise a significant role in demand for these natural resources, you arrange your bets exactly the way CIC did. It’s difficult to decide whether this a soft power exercise, or this is an investor who believes that he has better information than other people.”
CIC, which earned a return of 11.7% on its overseas investments last year, has evolved its investment style from a focus on liquid instruments in 2008 into a keen focus on private equity investments or the alternative investments it currently has in its pipeline.
This year, as head of the International Forum of SWFs, China is likely to prioritize policy-oriented discussions with lawmakers to help create a “level playing field” with “the same treatment for every sovereign wealth fund regardless of their origin”, McCormack says.
Ashby Monk, a professor at Stanford University, contends that sovereign funds could change the geography of finance, as power is dispersed from London, New York and Tokyo to cities including Abu Dhabi, Baku and Seoul.
But SWFs aren’t entirely tilted towards the emerging economies. Monk also argues that the US itself boasts more sovereign funds than is commonly thought, as there are a host of vehicles set up in states including Montana and Wyoming to manage their profits from natural resources, that also qualify as SWFs. The North Dakota Legacy Fund, only set up last year, receives 30% of the state’s oil and gas tax revenues.
Their popularity as vehicles shows no signs of fading. According to the Oxford SWF Project, which is headed by Monk and Gordon Clark, a professor at Oxford University, more sovereign funds have been created in the past decade than in any other since the debut of the entity in the 1950s. Uganda is now mulling the formation of a sovereign fund, as are Thailand and India, eager to join the race for energy assets and returns.
But with many funds still smarting from past high-profile losses, and given greater public scrutiny of national wealth, SWFs’ approach to investing is likely to be much more targeted than in the past.