Sovereign Wealth Funds

By Kavaljit Singh

Nowadays newspapers and television channels are full of stories of sovereign wealth funds (SWFs) on a buying spree and therefore are attracting much attention in the international policy circles.

Given the estimates that the SWFs currently manage as much as $3 trillion in assets, they are considered as “new actors” in the global financial markets. Contrary to popular perception, sovereign wealth funds are not “new actors” as some funds (such as those of Kuwait, Abu Dhabi, Norway and Singapore) have existed for decades. The first SWF was created in 1956 in Kuwait. The Abu Dhabi, the largest SWF in the world, was created in 1976.

The SWFs are essentially government-owned investment funds, set up for a variety of purposes. The SWFs are owned by state agencies such as central banks, state investment companies, state pension funds, and oil funds. Therefore, the SWFs come in various forms: oil stabilization funds (e.g. Russia), pension funds (e.g., Norway) and fiscal and export surplus funds (e.g., China and Singapore). Some people confuse SWFs with state-owned companies. For instance, Russia’s Gazprom and China Development Bank (CDB) are operating companies and therefore should not be construed as SWFs.

The SWFs are typically long-term investors and invest in stocks, bonds, infrastructure, real estate, luxury hotels. Thanks to high oil prices coupled with global imbalances, oil exporters and several Asian countries have accumulated massive foreign exchange assets which are channeled through sovereign wealth funds for investment globally.

According to estimates calculated by Morgan Stanley, the combined assets of SWFs would reach $12 trillion by 2015. These estimates are based on speculation instead of hard data as many SWFs don’t reveal their exact asset size and financial returns.

Now the moot question: from where they get so much money? There are two main sources of SWFs. The biggest source is petrodollars. More than 73 per cent of world’s SWFs are based in oil and gas exporting countries. As oil prices are rising over the past few years, a portion of this money is made available by these countries to the SWFs for investments.

The second major source of SWFs is the current account surplus and huge foreign exchange reserves accumulated by several Asian countries such as China, Singapore and South Korea. China, for instance, has reserves of $1.6 trillion and is pilling up $1 million every minute in its forex kitty. The burgeoning foreign exchange reserves create problems in these export-led countries because their national currencies appreciate and consequently their exports become uncompetitive in the international markets. Also there is a growing concern over the depreciation of the US dollar and many countries would like to diversify their investments away from dollar-denominated assets.

It would not be incorrect to argue that Asia has become the epicenter of SWFs. In September 2007, China created its own SWFs called China Investment Corporation (CIC) with $200 billion as seed money. The CIC is expected to invest directly and indirectly in financial markets, private equity funds, commodities, oil, gas and other natural resources.

The growing economic clout of SWFs has raised concerns among the developed world about their economic clout and motives. Since the SWFs are state-owned, most concerns expressed by Germany, France and US reflect speculation on whether some of the funds operate with hidden political agendas in their investments decisions.

Another important concern is whether SWFs pose a threat to the stability and functioning of financial markets. With the lack of substantial evidence, however, it is hard to establish that SWFs are investing for other motives than maximizing financial returns, or causing increased market volatility. On the contrary, the recent market developments reveal that the SWFs have acted as a stabilization force in the financial markets by investing huge amounts in several big banks (such as Citigroup, UBS and Morgan Stanley) whose financial conditions became vulnerable in the aftermath of sub-prime mortgage crisis in the US.

It also needs to be emphasized here that SWFs are long-term investors and are not highly leveraged institutions such as like hedge funds and private equity funds which have the potential of posing a greater risk to the global financial system.

However, transparency remains a key policy issue in the debate on sovereign wealth funds. Except Norway (and to some extent, Singapore and Russia), most SWFs don’t reveal their exact asset size, investment portfolios and financial returns. The lack of transparency also fuels speculations about their investment motives. This is an issue where SWFs need to improve upon. Transparency and better governance standards are not only desirable for addressing concerns of the recipient countries and international institutions but, more importantly, to build domestic support among their citizens.

At the same time, it needs to be acknowledged here that many well-known US and European private equity firms and hedge funds are equally opaque. Therefore, any strategy to single-out and penalize SWFs alone for lack of transparency and governance standards may prove to be counter-productive and meaningless.

Nevertheless, the policy makers of home countries SWFs should give greater attention to eliminating poverty and improving living standards of poor people at home instead of buying stakes in luxury hotels, shopping malls and companies.

SWFs and Extractive Industries

As the bulk of world’s sovereign wealth funds are based in oil and gas exporting countries, their financial linkages with the extractive industries are obvious.
Given the lack of transparency over their operations, however, it is very difficult to assess the involvement of SWFs (except Norway’s fund) in the financing of extractive industries globally.

Since Norway regularly publishes its investment portfolio, returns as well as voting records, one can make an assessment of the Norwegian fund involvement in the financing of extractive industries. For the rest of SWFs, some information about their involvement in the extractive industries could be gathered from secondary sources including industry and news sources in both recipient and source countries. It is generally believed that the SWFs from Asia and Middle East are very actively involved in investing their money in the extractive industries globally.

Following is a brief description of some of the prominent sovereign wealth funds in the world.

• Abu Dhabi Investment Authority (UAE): It is the largest sovereign wealth fund in the world with an estimated $875 billion in assets. In its long history, it has never disclosed its exact asset size, investment portfolio and returns. The ADIA is the second most important institution in Abu Dhabi's economy next to the Supreme Petroleum Council (SPC). The current UAE oil minister and key officials in various ministries in Abu Dhabi have come from ADIA. The Abu Dhabi Investment Co. (ADIC) is the executive arm of ADIA. The ADIA created the International Petroleum Investment Company (IPIC) of Abu Dhabi in 1984. The IPIC is an important player in the international oil markets and has made large-scale investments in East Asia, Europe and North Africa. The logic of IIPC behind oil-related acquisitions abroad is to secure long-term access to premium markets for Abu Dhabi's crude oil, gas liquids, refined petroleum products and petrochemicals. The ADIA came into news recently when it purchased large-scale stakes in the ailing Citigroup and Apollo (US-based private equity firm). The ADIA also maintains close ties with state-owned Mubadala Development Corporation which also bought a stake in Carlyle, the US-based private equity firm.
  
  
• The Government Pension Fund Global (Norway): It is the second largest SWF in the world with over $380 billion in assets. Considered as a “model SWF” for the rest of world to emulate, the Fund invests surplus wealth produced by Norway’s petroleum sector, mostly revenue from taxes and licensing agreements. Thanks to rapid rise in international crude oil prices in recent years, the Fund has now become bigger than Norway’s annual gross domestic product (GDP) at $360 billion in 2007. Though the Fund has invested in more than 7000 companies globally but its stakes are rather small. The average ownership stake is less than 1 per cent. The Fund deliberately does not invest more than 10 per cent in each company to underscore its role as a financial investor. Over the years, the Norwegian fund has invested in a number of mining companies, including Anglo American, BHPBilliton, DRD Gold, Oxiana, Vedanta, and Rio Tinto. In 2004, the Council on Ethics was established at the Fund to examine its investment portfolio and recommend exclusion of companies where there is an unacceptable risk as an owner of complicity in gross or systematic breaches of ethical norms within the areas of human rights and the environment. Due to growing concern over environmental and human rights abuses, the Fund has excluded two major mining corporations (Mac Freeport in 2006 and Vedanta Resources in 2007) from its investment portfolio.
  (For further details, See Kavaljit Singh, “Enforcing Ethical Dimensions in Investments: A Case-Study of Norwegian Sovereign Wealth Fund” and Kavaljit Singh, “The Norwegian Pension Fund Boycotts Vedanta Resources” elsewhere at this web dossier).
  
  
• China Investment Corporation (China): With $200 billion as seed money, the CIC was established in September 2007. Till now, it has made investments in the financial sector with buying stakes in Blackstone (the US-based private equity firm) and Morgan Stanley (the US-based investment bank). In the wake of growing criticism from the developed countries (particularly the US), the CIC brought out a brief publication which gives information about its operations but detailed information about its investment strategy, decision-making processes and structures are not available.
  
  
• Government of Singapore Investment Corporation (Singapore): Among the non-commodity based SWF, the GIC is the largest in the world with assets worth $330 assets under management. Of late, the GIC has started disclosing information about its structure and returns. Traditionally, the GIC has been focused on real estate sector but recently it has made large investments in financial sector such as $11 billion stake in UBS and $7 billion stake in Citigroup.
  
  
• Temasek Holdings (Singapore): It is the Singapore’s second-largest SWF, next to GIC. With $120 billion in assets, it primarily invests in financial sector. It has recently introduced certain disclosure and governance norms under the international pressure.
  
  
• Korea Investment Corporation (Korea): The Korea Investment Corporation (KIC) was officially launched in July 2005. It is essentially a foreign exchange stabilization fund (with a corpus of $20 billion) meant to achieve sustainable return on foreign-currency assets. The management of KIC is independent of the government and plans to disclose its financial positions and investment strategies regularly.
  
  
• Khazanah Nasional (Malaysia): The Malaysian sovereign fund manages $17 billion in assets and invest primarily abroad. It maintains a relatively high level of transparency and regularly publishes its financial records. Most of its investments are into utilities, media and infrastructure sectors, particularly in its neighboring countries.
  
  
• Kuwait Investment Authority (Kuwait): The oil-revenue backed KIA has an estimated $215 billion in assets but very little is known about investment patterns and criteria. The KIA came into public notice in the late 1980s when it acquired 21 per cent stake in the UK-based British Petroleum (BP). But the UK authorities forced the KIA to divest stake as they did not want an OPEC member-country’s state fund to hold a major share in the BP. Recently, the KIA has made investments in Citigroup, Merill Lynch and Daimler.
  
  
• Qatar Investment Authority (Qatar): With an estimated $60 billion in assets, the QIA was set up in 2005 and is funded by country’s huge gas reserves. It came into news recently when it reported interest in acquiring a 20 per cent stake in the London Stock Exchange and $20 billion stake in Sainsbury (UK-based retailer). It reveals very little information about its investment patterns and returns.
  
  
• State General Reserve Fund (Oman): The Fund has an estimated $6 billion in assets but very little is known about its investment portfolio. It is generally believed that most of its money has been invested domestically.
  
  
• Stabilization Fund of the Russian Federation (Russia): Established in 2004 by the Ministry of Finance, the Fund has more than $120 billion in assets. In February 2008, the Fund was split into two: The Reserve Fund (which invests primarily abroad in low-yield securities) and the National Welfare Fund (which invests in high-yield securities). The Reserve Fund manages $125 billion while the National Welfare Fund manages $32 billion. The funds get money from the export duty for oil and the tax on the oil mining operations. The purpose of both funds is to absorbing excessive liquidity, reducing inflationary pressure and insulating the Russian economy from volatility of raw material prices. Contrary to popular belief, the funds maintain higher standards of transparency. Their investment strategy is based on a strict investment policy framework established by the Ministry of Finance. It also publishes reports on the assets, investment patterns and spending of the funds.
  
  
• National Fund (Kazakhstan): This fund has an estimated $15 billion in assets. It also provides reasonable level of disclosure about its investments. But generally it keeps a low profile.
  
  
• Permanent Reserve Fund (Alaska): Launched in 1976, the $40 billion Alaskan oil fund is largely run like any pension fund and makes annual dividend payments to the citizens of Alaska. It publishes annual public reports with information on its asset size, holdings and returns. The Fund has a diversified investment portfolio consisting of equities, bonds and real estate.
  
  
• Economic and Social Stabilisation Fund (Chile): It manages an estimated $10 billion in assets, almost 10 per cent of Chile’s GDP. The Fund was officially launched in 2006 and the assets from its previous Copper Stabilisation Fund were incorporated into it. The copper-rich country is flush with surplus money thanks to the rapid rise in the international copper prices. The main purpose of the Fund is to keep Chile’s foreign earnings offshore so that country’s exports do not decline. However, very little is known about the Fund’s investment patterns and criteria. It is believed that a portion of the Fund’s money is being used to fund housing, education and health sectors domestically.
  
  
• National Development Fund (Venezuela): With an estimated $27 billion in its kitty, this fund was set up by the Hugo Chavez government in 2005. Most of the Fund’s money comes from national oil companies and it acts as an oil stabilization fund. The authorities view Fund as a vehicle to redistribute the oil income in the country. The bulk of Fund’s money is invested domestically in public projects such as roads, ports, energy, housing and hospitals. In 2007, National Development Fund and China Development Bank together created a joint development fund (with a corpus of $6 billion) which will invest in various development projects in both countries. Long before the creation of National Development Fund, Venezuela had established Fund for Investment of Macroeconomic Stabilization in 1999. The purpose of this fund is to protect domestic economy from the volatility of income generated by crude oil. This fund is managed by the Central Bank of Venezuela. The main sources of this fund come from oil companies.