overview

This note considers sovereign wealth funds (SWFs) and sovereign investment, larger - and for some more threatening - than hedge funds and private equity.

It covers -

• this introduction
• studies - points of entry to the literature on sovereign wealth funds (including natural resource funds)
• issues - transparency, instability, corruption and other issues
• exits - disinvestment by SWFs and disasters such as KIO's Grupo Torres
• Australia - the shape of the Australian sovereign wealth fund
• overseas - funds in Kuwait, Norway, Alaska, Abu Dhabi, China, New Zealand and other locations
• stakes - indicators of what some funds own, from Australian skyscrapers and Optus to coal mines and retailers
• figures - data on the size and growth of sovereign funds

It supplements discussion elsewhere on this site regarding private equity, hedge funds, investment and the digital economy.

     introduction

National and provincial governments have traditionally acquired and owned assets in other jurisdictions - eg embassies and legations in other countries - for administrative purposes rather than to generate revenue.

However, the past 50 years has seen some governments invest 'offshore' on a commercial basis, typically because the domestic economy was too small - and frequently too unsophisticated - for substantial investment or because a ruling family and associates feared regime change.

Most of that investment has been funded by natural resources, eg exploration licences, extraction licences, taxes on oil/gas or mining companies and even revenue from state owned enterprises (SOEs) - particularly after nationalisation. 'Petro-resources' (oil and gas) have attracted most attention, particularly after successive 'oil shocks' accompanied by anxieties that Gulf states would buy enterprises ranging from Krupp and Fiat to Citigroup and CBS. However investment has included money from copper, tin, coal, phosphates and cocoa - involving states in Africa, Latin America and the Pacific rather than merely those in the Middle East.

Some investment offshore by governments in emerging economies has been powered by tax revenue, by profits from domestic SOEs (often operating on a monopoly basis) and even by domestic or international borrowings (some governments having access to capital at lower costs than commercial competitors). That investment has often been made by diverse SOEs - a notable example is Singapore's Temasek - that are justified as vehicles for nation building and may benefit from restrictions on offshore investment by individuals.

The preceding paragraphs encompass what has been broadly described as sovereign wealth investment (or sovereign wealth funds), often characterised as an attribute of emerging economies and involving bodies such as the Kuwait Investment Authority, Dubai International Capital and Abu Dhabi Investment Authority.

However, anxieties in advanced economies regarding a changing tax base through an ageing population (or opportunistic responses to criticism regarding privatisation) have led some governments to establish sovereign funds as government-owned counterparts of private equity funds.

Those funds are expected to generate substantial revenue from domestic (even international) investment on an ongoing basis, with receipts serving public purposes such as paying for hospitals, research and a public pension scheme (an integenerational transfer). They have been established, with varying success, in countries such as Australia, New Zealand, France and Ireland.

Sovereign wealth funds (SWF) have attracted attention because of -

• the size of the figures (eg estimates that the Abu Dhabi Investment Authority has over US$250 billion under management and that collectively the funds have US$2.5 trillion assets),
• fears that particular funds will buy the "commanding heights" of a nation's economy or increase instability in the international financial system
• criticisms that the operation of funds lacks transparency
• disagreement about how money should be invested (onshore v offshore, on a purely commercial basis or on 'social infrastructure'?)
• disquiet that funds are partnering with hedge funds and private equity, thereby underpinning speculation and job destruction through irresponsible asset stripping by 'locusts'

They were in vogue in late 2007. In December 2008, following substantial losses through the Subprime Crash, the Economist sniffed that

Scary sovereign-wealth funds were going to buy up the world. Then they were heroically going to rescue the banking system. Now they are in hiding, counting their massive losses and wondering where all their money went.

Like the very best scary monsters they will, however, be back.

     types of funds

Definitions of sovereign wealth investment vary, a variation exploited by some entities that seek to defer criticism on the basis that they are enterprises (supposedly good) rather than investors (bad).

Observers have often distinguished between formal funds - often with a private equity fund structure and at an arm's length from the government - and direct investment by a nation's central bank, by finance ministry or by the nation's ruler. In practice that distinction is artificial.

Some observers have suggested that sovereign investment should be categorised as follows, reflecting the source of capital and investment strategies -

• Resource stabilisation funds
• Sovereign wealth funds
• Sovereign private equity funds
• State owned enterprises

The differentiation is often tendentious; in practice it is probably most valuable to consider each fund (or each nation/province, particularly as some jurisdictions have multiple funds) on an instance by instance basis.

Resource stabilisation funds

For some observers resource stabilization funds (RSFs) - aka Natural Resource Funds (NRFs) - are the 'classic' sovereign funds, emerging in the early 1950s and flowering in the 1970s. They have been used by resource exporters to balance fluctuating revenue from oil or other commodity sales, to insulate a national economy (with capital outflows for example expected to reduce appreciation of the nation's currency) and even to support commodity prices.

Such funds are typically more conservative in their asset allocation than other funds, for example concentrating on bonds rather than shares and avoiding 'alternative investment' such as hedge funds or art. Management may be undertaken by the central bank or by an autonomous investment authority.

Examples are Russia's petro stabilization fund, Kazakhstan's national fund and Kuwait's General Reserve Fund (GRF).

Sovereign wealth funds

Other observers have referred to 'pure' sovereign wealth funds, which typically invest through a portfolio of equities, property and bonds, taking only small equity stakes in major enterprises and avoiding management control. They may also invest through private equity and hedge funds. Most appear to rely on external specialists for day to day fund management, with supervision by a government authority, the central bank or finance ministry.

Examples are Norway's Government Pension Fund (the formal Oil Fund), Australia's Future Fund, Singapore's Government Investment Corporation (GIC), the Kuwait Investment Authority (KIA) and Abu Dhabi Investment Authority (ADIA).

Sovereign private equity funds

They have been distinguished from 'sovereign private equity funds', entities that are wholly or predominantly state-owned but in contrast to the 'pure' funds seek management stakes (eg 20% or more of an enterprise's shares rather than 2 or 3%). They may rely on leverage, make hostile bids and aim for high returns. They thus adopt a private equity ethos. Some may operate as arms of state investment agencies alongside pure funds.

Examples are the Qatar Investment Authority, Abu Dhabi's Mudabala and Istithmar in Dubai.

State owned enterprises

The fuzziness of categorisation is evident in considering SOEs, which include conglomerates such as Singapore's Temasek and Dubai World (some of which have portfolio investment units alongside financial, service and industrial arms), acquisition vehicles such as Abu Dhabi's TAQA and state owned financial institutions or resource extraction/processing businesses that increasingly are pursuing foreign direct investment (FDI) opportunities for commercial and/or political advantage.




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