Monday, June 01, 2009

Sovereign Wealth Funds Are Generally Sheeps In Wolves' Clothing


Just how have the track record been for sovereign wealth funds. Temasek and GIC were path leaders for the most of last 10 years with their aggressive investing strategies. The Gulf nations SWFs only started to adopt Singapore's aggressive tactics over the last 5 years - joining in at the wrong end of the trend.

Let the record show that when these fund outperform, its largely due to momentum and bull market rallies, rather than astute stock picking. The bulk of the gains were made from telco investing in Asia, banking investing in Asia, followed by the disastrous banking investing in developed nations. For most of the last 10 years, there had been a sharp demand to bid up telco assets in emerging nations as growth prospects struggled in developed countries, thus the higher prices. Same can be said for banking stakes in emerging countries. Temasek, thanks to its connections, got in early acquiring substantial stakes in Chinese banks before they were floated. Take that factor out and you would have seen Temasek figures down the drain, literally.

The Gulf nations SWF, thanks to the surge in petrodollars over the last few years, looked to acquire significant Western assets in exchange for the petrodollars in order to make the money work for them in the future. Alas! What it did was to give back the supernormal gains to the very people who bought the oil at silly prices in the first place.

So, what went wrong? Are SWFs incapable of investing wisely? Firstly, their size makes their strategy limited. They certainly won't be considering investments that have a market cap of less than $250m, because if they do, they would be looking at a portfolio of well over hundreds of companies, how to monitor - attend board meetings also die.

Secondly, they want a substantive stake, not so much to have board seats or board control, but that to be able to influence management somewhat, to be consulted over major investing and capital decisions.

Thirdly, they tend to overpay - when you have identified a good sector or a good company, the sellers will also know its SWFs who are behind the deal, the general feeling is that they will be willing to pay a premium to get that substantial stake because they do not come around too often.

Fourthly, SWFs never seem to "walk through the data and financials" - I have mentioned this before, maybe its the fact that they are always suited up in nice executive dressing, they don't do enough "dirty work" before going ahead with a purchase or disposal. Figures and research reports are all there, and if you stop there, you risk a lot in your investments especially when we are talking about billions of dollars and a substantial stake. Its easy to talk to management, but you need to walk through the financials with a fine comb - go behind the aggregation of data, the assumptions, talk to the mid level managers and their competitors and suppliers, check with their clients, see how satisfied they are, if its a bank thats been showing tremendous growth in certain units, verify why and how that came about, go through the processes that made they stand apart from the competition. If things look too good to be true, all the more reason to look deeper.

That to me are all the main reasons why SWFs are sheeps in wolves' clothing. SWFs need to get away from pure trend investing. They need to think clearly whether to buy something for solid dividend yield protection or organic growth or growth via acquisitions. They need to think 5 years or 10 years out, which sectors would be a lot more lucrative then - I don't think telcos would be, banks would be iffy still, but commodities and food would be great. Its really simple in the end, it when you have too many suits in the room, thats what causes problems.

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Sovereign wealth funds (SWFs) were much in the news last year. As the first wave of the financial crisis hit, Gulf and Asian funds such as the Kuwait Investment Authority (KIA) and Singapore’s Temasek, ploughed billions of dollars into recapitalising prominent Wall Street institutions such as Merrill Lynch and Citigroup. At the time, with oil riding high at more than US$100 a barrel, it seemed very much as if the balance of economic power was shifting rapidly eastward. Despite the fact that their combined value accounted for only a fraction of the size of other investor classes such as pension funds or insurers, there was a brief moment when sovereign wealth was seen by some western politicians as a considerable threat to their economic independence.

The steady steamroller of the global crunch has seen those fears substantially recede. A collapse in demand from manufacturing powerhouses such as China led to a slump in the price of oil last autumn, a downwards journey aided by the exit of speculators. Furthermore, as soon as it became apparent that the instability which began in financial institutions had infected other sectors of the economy, the size of the necessary fiscal response dwarfed the capacity of anything other than a government-led rescue. With the exception of Daimler, which received a $2.7 billion (Dh9.91bn) capital injection by selling a 9.1 per cent stake to Abu Dhabi’s Aabar Investments in March, none of the recent major corporate bailouts has seen sovereign wealth riding the white horse.

As if to confirm the retreat of sovereign wealth from the basic international economic agenda, no mention of it was made in the concluding statement at the end of the Group of 20 (G20) summit of leading and emerging economies in London last month. According to German government sources, the omission was intentional.

SWFs may no longer be in the spotlight but they have not gone away; moreover, the chain of events established by last year’s backlash against sovereign wealth continues to play out. Following a degree of pressure from the US Congress and the EU, an International Working Group (IWG) of SWFs was established last October, under the auspices of the IMF. This group, which includes fund-holders such as the UAE as well as concerned inbound nations such as the US, published a series of investment guidelines called the “Generally Accepted Principles and Practices” (GAPP) – better known as the Santiago Principles after the city in which they were drawn up. The principles call for SWF investments to be based on “economic and financial grounds”, and if not, for the alternative rationale to be clearly stated.


The wording of the accompanying statement to the principles claims they are intended to ensure transparency and accountability. Yet the decision to call the document a “voluntary code of principles”, as opposed to a more binding code of conduct, is telling. According to Dr Sven Behrendt of the Carnegie Middle East Centre, a specialist in SWFs, the Santiago Principles “enable signatories to adhere to a standard, but without any monitoring or enforcement mechanisms”. The result is what Dr Behrendt calls an “unsecure document” – an agreement which is not yet sufficient to prevent unilateral action further down the line from concerned governments of nations receiving inbound investments, if and when SWFs become a political issue once more.

While the Santiago Principles may, thus far, fall short of providing countries such as the US with the guarantees they would like, according to Dr Behrendt the procedure involved to agree upon them marks an innovative concept in global governance. “The IWG reflects a bottom-up approach towards regulation, and is one of the rare occasions when industrial and industrialising nations have come together on an equal footing to agree on a set of principles”, he says. The contrast between the IWG and, for example, the Group of Seven (G7) or the Doha round of world trade talks is stark. Like SWFs themselves, the IWG represents an element of structural transition in the global economic system – one whereby the traditional power centres of the West are having to make room at the table for the growing financial clout of the East – a trend notably repeated at the G20 summit.

As if to confirm the permanence of this structural transition, the IWG is itself evolving into a permanent institution. Following the conclusion of its fourth meeting in Kuwait last month, the body announced it would form a permanent representative forum, with a secretariat to be staffed by the IMF. The forum will be chaired by David Murray, the head of Australia’s Future Fund Board of Guardians, while Bader al Sa’ad of the KIA and Jin Liqun of the China Investment Corporation will serve as deputy chairmen. Its first meeting is planned to be held in Baku this October.

If early 2008 marked the high-water point of sovereign wealth in the media eye, what will be its ultimate long-term significance as a structural element in the global financial system? For example, does it represent as fundamental a shift in the balance of power as the creation of OPEC in the 1970s?

Dr Behrendt presents three possible scenarios: first – and most pessimistic – oil prices remain so severe that funds are forced to liquidate their assets to inject liquidity domestically. This scenario would in effect mark the end of sovereign wealth as a market phenomenon. The second possibility is that SWFs remain essentially where they are, as smaller players compared with pension funds, but with the potential to create the occasional headline in sensitive markets. In this case, the permanent forum will be of most importance as a capacity building institution for the less-experienced SWFs.

The third possibility, however, is that economic recovery, and especially a recovery in the demand for commodities, results in SWFs becoming “super strong”. It is in this final scenario where the Santiago Principles, and the permanent forum, will play a significant role in reconciling the concerns of inbound nations with the demands of investors. As it currently stands, achieving such a role still requires a considerable amount of work.

Oliver Cornock is regional editor of the Oxford Business Group


p/s photo: Rita Rudani

1 comment:

see said...

they've got so much resources yet they don't proper due diligence? duh!