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What are SWFs?
A Sovereign wealth Fund (SWF) is a state owned investment fund or entity that is commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatization, governmental transfer payments, fiscal surpluses, and/or receipts resulting from resource exports. While SWFs have been around for nearly a century the concept really took off only in the last fifteen years. (SWFI)
Objectives
The primary object of a SWF is to channel some of the enormous wealth generated by commodity exporters, mainly oil producers, and to invest them in various assets including bonds and equities. All SWFs aim at providing their societies with a cushion when their natural resources run out. The Kuwait Investment Authority (KIA) is the oldest sovereign wealth fund in the world. It was started in 1953 to invest the state's surplus oil revenues. The KIA says its long-term objective is to provide "an alternative to oil reserves, which would enable Kuwait's future generations to face the uncertainties ahead with greater confidence." The fund has $592 billion of assets under management. (July 17, 2015, CNBC).
Investment splurge
In recent years, with surpluses flowing in from high commodity prices, many SWFs have gone on a buying binge. The size of the average deal has shot up to $516million in 2014, much above the 2013 levels. The top ten acquisitions accounted for more than 50% of the total investment. Similarly purchases of real estate have also jumped. There were 32deals worth $31.5billion in 2014; this forms 46% of the total reported investment in 2014. (Sovereign Wealth Annual Report 2014, Baffi Carefin, Bortolotti)
Norway's SWF, the largest in the world, is worth almost $900billion, while Abu Dhabi's fund is worth more than $700billion. The Chinese and Saudi Arabian funds all hold more than $500billion each. By last year SWFs had an estimated $7trillion under their control, and were becoming some of the most influential players in the capital markets.(Moneyweek, 17/10/2015).
Troubles
With commodity prices tumbling, many resource rich countries are struggling to make ends meet. For example, the IMF estimates that Saudi Arabia needs an oil price of $106/barrel to balance its budget. With prices at less than half that level, the Saudis are likely to pull funds from their SWF to finance current expenditures, while Russia reportedlyhas already withdrawn $14.5billion.For the first time, even the well managed Norwegian SWF has drawn $450millon from its fund. Modest though this figure may be, it points to the direction in which things are going. A problem for investors and analysts is that the SWFs of the Gulf countries are not known for transparency. This adds a layer of difficulty in understanding the play between commodity prices, share market prices and whether draw downs by the SWFs are affecting financial markets.
International Action
These problems are not new and SWFs have tried to get their act together.This took shape in what has become known as the Santiago Principles. Theseprinciples were agreed to in October 2008 in a unique collaborative global effort between countries with sovereign wealth funds, investment recipient countries and international organizations. (IFSWF)
The Santiago Principles comprises 24 Generally Agreed Principles and Practices (GAPPs), broadly arranged in three 'pillars':
Pillar 1: Legal Framework, Objectives, and Coordination with Macroeconomic Policies.
Pillar 2: Institutional Framework and Governance Structure.
Pillar 3: Investment and Risk Management Framework.
In 2009, the big SWFs set up the International Forum of Sovereign Wealth Funds to create a platform for evolving sound investment principles. The Santiago Principles are adhered to voluntarily by the Forum's members. The Forum has assumed the global ownership of the Santiago Principles and is responsible for furthering the mission and mandate of the founding principles. A critical function of the Forum is the regular exchange of experiences and views on how the Principles are being implemented on the ground.
New Strategies
Economic slowdown and sluggish commodity markets have forced a rethink on the strategies followed by the big SWFs. In the period 2011 to 2014, SWF's assets expanded 20% fuelled primarily by high oil prices. Over the last year oil prices have halved and do not look like going anywhere but down in the near future. This has prompted SWFs to change their investment strategies. They are now prepared to take greater risks, looking for investment opportunities in innovative enterprises. They are now focused on sustaining the higher returns they had enjoyed till now. "A surprising appetite for innovative sectors, with a venture capital twist: In 2014, SWFs overcame their conventional reluctance to invest in broadly defined "strategic sectors" by completing 13 deals for a reported deal value of $2.1 billion in high-tech sectors, often at the early stage."(Sovereign Wealth Annual Report 2014, Baffi Carefin, Bortolotti).
"It is a new era," says Massimiliano Castelli, head of strategy of global sovereign markets at UBS Global Asset Management. Sovereign-wealth funds "will have to adapt to this new environment and work harder to achieve the return expectations of their stakeholders,"he said (Marketwatch Sept 30, 2015)
Implications
While the world economy is sluggish, there has been considerable turbulence in world markets; witness the recent rout in the Chinese market. Analysts are trying to see how currencies and markets are likely to perform even as they wait with bated breath for the US Fed to raise rates.
The sale of assets by SWFs forms one of the biggest imponderables in the current scenario. While no one can predict how it will end, if the SWFs sell large chunks of their assets, markets are likely to decline sharply. An indication of just how large their selling has been comes from a recent estimate that SAMA (Saudi Arabian Monetary Agency) has pulled out between US$ 50-70 Bn from global markets in the last six months, to cover budget deficits in Saudi Arabia, caused by the deep slump in oil prices.
The thing with withdrawing to plug budget holes back home is that one never knows what will be sold first. Would SWFs sell out from loss making investments first and allow their profitable ones to ride? Or will they take profits where they find them, and avoid the pain of booking losses, as a retail investor normally does?
The answer to this question is what to some extent will determine how much of ongoing selling we are likely to see from FIIs in the Indian market. Our market has held up relatively well, and seems poised for better days ahead. Will that motivate SWFs to ride their Indian investments and exit elsewhere, where prospects are not as bright? We need to hope that this be the case, as the alternative case of taking profits where available will mean that Indian equity markets will bear unintended adverse consequences of travails in the SWF world.
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