Sovereigns show an increased appetite for risk
“North Asia large sovereign organisations were the first to come back into the market,” says David Jiang, the CEO in the Asia Pacific region for BNY Mellon Asset Management and co-chair of the company’s new sovereign advisory group. Post Lehman, while the smaller institutions sat on their hands, Jiang says sovereign wealth funds remained active, looking for value investments in global equities or in turnaround opportunities. “At the margin it was the sovereign organizations who were active at the height of the market turmoil. During the peak of volatility in October they were looking at opportunities.”
Depending on the categorisation you use, sovereign wealth funds currently have between US$13 trillion and US$16 trillion in assets under management, a total that is down by as much as 25% from its peak.
Jiang declined to comment on the actions of sovereign wealth funds in selling down the US dollar and returning capital to Asia. “That’s a hot potato,” he says. “I think there are lots of eyes on this exact issue.” He added that he hopes Western governments have realized, during the financial crisis, that Asian and Middle Eastern sovereign funds are important partners, rather than menacing predators. “We can only hope that there have been some lessons learnt. Sovereign funds are interested in the global opportunities, they are responsible for their own investment returns and their careers depend on it.”
The question of what is a sovereign fund has been exacerbated recently by a number of situations where reserve funds have been put under pressure by their national governments to invest more of their assets domestically. In China and as far away as New Zealand, there are infrastructure investment demands. Meanwhile the sovereign or reserve fund is trying to remain independent in the management of its assets. To ask it to focus on the short term national need rather than the long term return, often goes against the reasons why the fund was set up. Many of these funds were set up to invest for absolute return with a long term return target, rather than a short term fix.
As an example, the New Zealand Superannuation has been a political football since it was established by the previous left-leaning Government. The new National (right wing) government recently reduced the amount of annual contribution to the fund and issued a directive that puts pressure on The Guardians of New Zealand Superannuation to invest as much as 40% of the fund’s assets in New Zealand, to boost infrastructure development among others things. The fund has typically held around 10% in NZ assets.
Despite the NZ government’s claims, its directive is at odds with the letter and the spirit of the Super Fund’s statutory obligations. Adrian Orr, CEO of the NZ$12.5 billion fund has told Finance Minister Bill English that it would be unlikely the fund would reach the 40% target to domestic investments requested by the government: “The New Zealand investment management market is not deep and hence securing appropriate investment managers is not guaranteed. We are unable to offer an assurance as to how much, if at all, the fund’s New Zealand assets will increase”
Laurence Bailey, Asia Pacific CEO of J.P. Morgan Worldwide Securities Services says, “It just highlights the fact that these funds are set up for different reasons. Although they tend to be included in broad calculations of sovereign assets, funds like Australia’s Future Fund and the NZ Super Fund do not want to be thought of as sovereign funds.”
With a similar focus, China is looking to establish a domestic-oriented SWF with at least $7.3 billion of initial capital referred to by some as a ‘CIC No2’. The plan has been outlined in a draft proposal submitted to the State Council, “That may be an acknowledgement by China that they need a fund that is focused on domestic investments,” says Bailey. “I am not sure if that will be the trend now - setting up two pools of assets, but it does help remove the tug-of-war that goes on when there is just one fund.”
Sovereign funds, once they become large enough, tend to have a well diversified and sophisticated investment policy. Baley says, “They tend to follow a consistent pattern of investing in direct equities as a start, then some alternatives, more likely private equity than hedge funds. They are also setting up long/short vehicles. So they tend towards a high level of sophistication in a short time span. The early movers, the likes of Temesek and GIC in Singapore, are a highly sophisticated machine within an SWF context. Others have more of a steep learning curve in the current environment. So there’s a real thirst for knowledge and a requirement for services.
Another bank with a renewed focus on sovereign funds is BNP Paribas. Scott Dickinson, head of SWFs for BNP Paribas Securities Services, says, “We take this segment of the market very seriously, as clearly these investors carry a lot of responsibility, in many ways, and they provide much needed funding and liquidity to world markets. They are typically risk-averse organisations and I think what they look for is an institution that will allow them to retain discretion while also delivering some transparency to their actions.”
Dickinson acknowledges that at various points, the SWFs’ investment activities have been quite contentious. “There were a great many questions asked and there wasn’t much information in the public domain. But their reaction to criticism of their investments has always been to say they are buying for legitimate investment reasons. And since all of the major funds have signed up to observe the Santiago Principles, they are now clearly taking steps to adopt a best practice model.”
The current environment puts it in a different perspective. Dickinson says, “Now we find ourselves in a situation of acute financial stress, with Governments having to step in to save multi-national corporations, the actions of the sovereign funds takes on a very different look.”
For the service provider helping a sovereign investor manage its excess reserves, the mandate is clear. An oil-rich client will want to protect their reserves against unstable markets. Dickinson says, “And in this environment, they will want to reserve even more, while funds of all kinds look to retain and protect their assets under management.”
So SWFs are very much increasing their international investments. They suffered losses, like everyone, but they see the opportunity. They don’t realty have a choice, in that they have a pool of money that has to be invested, so they have to start making those investment decisions.
Despite substantial losses on its overseas investments last year, the CIC is continuing to develop its international exposure. Felix Chee, an adviser to the US$200 billion fund, says it will continue to invest in hedge funds, preferably managed accounts, across a spectrum of strategies. The CIC has also continued to build its stakes in specific US companies, including buying another US$1.2 billion in Morgan Stanley shares, in a stock offering designed to repay the U.S. government’s Troubled Asset Relief Program (TARP).
In June, the South Korean government said it would pay US$3 billion into the Korea Investment Corporation (KIC) and allow it to resume overseas. The move marks KIC’s potential return to foreign investing after it came under fire in Korea for losses on an investment in Merrill Lynch last year. KIC plans to use $1bn for investments in hedge funds, real estate and private equity funds. The government plans to pump another $2bn into KIC by the end of this year.
Strategic alliances are the latest trend among sovereign funds. For example, KIC has entered into a cooperation agreement with Malaysia’s Khazanah Nasional Berhad and Australia’s QIC to “expand co-operation” in searching for investment opportunities and sharing information. The funds are understood to be interested in ventures outside of the capital markets. Working together will also allow them to compete for assets with their larger brethren such as CIC and GIC. Between them, KIC, QIC and KNB manage $25bn, $52.5bn $23bn respectively under management.
“What this illustrates”, says Laurence Bailey, “is that agencies recognise this was a global crisis and that nobody could expect to get out of it on their own, so they need to cooperate.”
Sovereign funds are increasingly likely to play a role in securities lending says Scott Dickinson: “They have, in a way, replaced the pension fund sector as a provider of liquidity for stock lending. The large pension funds have suspended their activities in this area and it would be fair to say that while liquidity is always essential to these markets, securities lending is still happening but not to any great extent at this time
Laurence Bailey adds: “The big well-established funds such as GIC and the Middle East agencies have been very active in this area and are starting to move back into it. He says J P Morgan is getting a lot of enquiries from central banks and pension funds in Asia, who are reviewing a whole range of issues, from their collateral management to their risk exposures in the less liquid markets. Clients have also been seeking reassurance about sub-custodian risk and what happens to their assets if other broker agencies default.
Bailey says, “Typically, we are able to assure them that their assets are safe, but the nature of their questions shows they may have not truly understood the risks associated with certain strategies. That is changing as a result of the work they are doing now.”
For Asian sovereign funds in 2009, it has been more about wealth preservation. J P Morgan’s Shaun Parkes, Head of Worldwide Securities services - Asia ex-Japan comments: “If we had been holding client briefings 12-18 months ago, we would have been talking about complex structured notes. Now, while they are still keen on balancing their portfolios , they are not going to consider the more exotic investment ideas.”