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Sovereign wealth funds get back to basics

Sovereign Wealth Funds and the Financial Crisis Anthony Harrington

The financial meltdown did not just devastate Western economies. It also took large bites out of the sovereign wealth funds and inflicted some harsh lessons on those charged with running these funds, many of whom have solid careers behind them as bureaucrats and bankers rather than as mainstream investment managers.

In a recent analysis of sovereign wealth funds post the crash [PDF, 3.36 MB], State Street anatomized the funds’ reactions and strategies. The report is the second on this theme by the company’s three authorities on SWFs, John Nugee, Andrew Rozanov, and George Hoguet.

One of the major changes that has come about as a result of the recession, the authors argue, is that the days when sovereign wealth funds, with their enormous reserves, could sit above the day-to-day fray and pick their targets have faded into history. As their own countries became embroiled in the effects of the crash, sovereign wealth managers had to roll up their sleeves and engage in substantial local investment and bail-out programs to keep their own industrial crown jewels afloat.

At the same time, many of their investments in Western stocks took a massive hammering as markets lost some 50% of their value. The fact that equities have bounced back strongly since the doldrums of January 2009 has not lessened the sharpness of the lessons inflicted on sovereign wealth managers. On the plus side, the report says, the crisis “has marked a coming of age for the funds, underlining both their importance within the global financial system and the challenges they share with each other and with other investors.”

As John Nugee notes in his chapter, “SWFs coming of age: Unrivalled titans to uncertain mortal,” what a difference a year makes. At the start of 2008 some market observers were predicting that collectively the SWFs were likely to reach $15–20 trillion by 2020. That amount of money potentially washing into the markets at the whim of invisible, inscrutable, and unaccountable investment managers had the potential to create problems on a grand scale.

Post the crash, although SWFs have ridden the storms relatively well and, as Nugee says, have even progressed in some areas, they took enough of a battering to make them more amenable to cooperation and to adopting standardized codes of practice. The era of 2006 and 2007, when SWFs looked to many in the West to be super-rich corporate raiders, and hence fearsome, underwent a major change in the depths of the downturn when SWFs started to look like potential “white knights,” capable of rescuing cash-strapped Western companies.

Then, as they seemed to be the only players in town with bottomless pockets, they started to look (and act) like financial titans, moving into riskier and less liquid investments such as direct equity stakes, real estate, and other asset classes. Inevitably, as the markets kept crashing, this resulted in many SWFs racking up losses on a grand scale. Vehement criticism by their own public has brought SWFs under close scrutiny and has forced a sustained rethink of their investment strategies.

As Nugee puts it:

“Like all investors many (SWFs) are uncertain about where value lies in today’s markets and prefer a wait-and-see approach. They have not ceased their investment activities completely, although a number of SWFs—like so many other investors—have put portfolio reorganisations on hold, delayed asset allocations and sought safety ahead of risk for their investments.”

At the same time, as a natural corollary of this “pause for thought” there has been a major debate both within the SWF community and in the wider financial sector over what exactly are the legitimate objectives of SWFs and who, exactly, they should be accountable to. That debate is still ongoing and the answers promise to be both fascinating and far reaching…

Further reading on sovereign wealth funds

Tags: equities , Middle East , recession , sovereign wealth funds , stocks and shares
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