Demands for SWF transparency 'will fail'

GLOBAL - Growing demands for transparency by sovereign wealth funds (SWFs) from recipient countries will fail unless more diplomacy is used, asset management giant State Street has claimed.

In the latest in its series of Vision reports, entitled 'Sovereign Wealth Funds: Assessing the impact', State Street claimed while central banks have become more transparent since the late 1990s, it is "not immediately obvious" that the same level of transparency required of these policy-making bodies should be applied to SWFs.

The report, co-authored by John Nugée, head of the Official Institutions Group, Andrew Rozanov and George Hoguet, claimed many of the arguments made in favour of SWFs being more transparent seem "somewhat simplistic and have ignored the long history of these official bodies operating with minimal fuss, publicity and controversy and yet in harmony with markets and other participants".

Nugée said at the launch of the report increased demands, particularly from recipient countries of SWF investment, for more transparency "will fail for two reasons".

He argued, by definition, SWFs are sovereign institutions "so you don't demand, you have a dialogue or a debate", as the only way to advance the issue of transparency is to avoid "political posturing" and instead gain consensus and reach an accord.

Secondly, Nugée suggested if other market participants continue to insist on transparency SWFs will question why they are being singled out for attention, and not other investors such as hedge funds and private equity.

State Street revealed while SWFs are already attracting attention because of their size - collectively they are worth $3trn (€2trn) in assets under management - it is estimated the total size of SWFs will rise by 17-20% a year to reach $20trn by 2020, albeit State Street noted this figure could rise further as assets increased by 25% in the last 12 months alone on the back of the rapid rise in oil prices.

In addition, State Street said SWFs are predicted to receive an additional $5trn in 'new' assets over the next five years, so were they to invest just 60% of this in equities, the global equity risk premium would fall as equity yields drop and bond yields rise.

At present, the collective asset allocation of all SWFs is just under 50% in equities, although State Street expects this to increase to 60%, while fixed income investment will fall to 30% as the remainder is allocated to alternatives.

The report also suggested were SWFs to invest 60% of the $5trn in 'new' money into the FTSE Global All-0Cap Index, they would own about 5.2% of each of the 8,009 companies in the index, and if they invested the same percentage into the MSCI All-Country World Index the institutions would collectively own approximately 5.5% of each company in the index.

In addition, the report suggested a move by SWFs to invest in emerging markets could increase pressure on the US dollar, particularly if the institutions start to diversify away from US fixed income and US currency into more global portfolios.

On the plus side, State Street also pointed out the willingness of SWFs to invest in innovation could lead to the development of new asset classes, particularly in frontier markets, infrastructure and local currency emerging debt.
 
However, as SWFs become more diversified and start exploring wider asset classes, State Street suggested an important question is whether these funds have the skills to manage the increasingly large funds.

The report noted several countries have decided to establish a specialist investment agency to manage non-typical assets, while many central banks are "increasingly willing to outsource the actual management of the assets to the private sector".

Nugée said: "Does the official sector have these skills? In most cases I would say yes, some not yet. But for all cases they are getting there fast."

Meanwhile, Rozanov, head of Sovereign Advisory at State Street, highlighted differences in the liability profiles of SWFs - some are equity funded and some are debt-funded - could make a 'one size fits all' approach to "best practice" guidance "unworkable" - such as those currently under development by the OECD and the International Monetary Fund (IMF).

At the launch of the report, Rozanov pointed out liability profiles of SWFs do not remain static but evolve, as is the case with the Norway Government Pension Fund - Global, for example, which started as a stabilisation or "fixed liability' fund but is now a form of endowment or "mixed liability" fund.

He said: "As SWFs start evolving they will need to redefine and review their target returns, perhaps moving from nominal returns to real returns, and they will also probably need to redefine their risk too."

As a result, State Street warned the current debate on the impact of SWFs need to take full account of differing investment styles, the sources and uses of the funds and view each SWF on a "case-by-case basis".

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