A growing role for Sovereign Wealth Funds
The financial crisis and ongoing shift of economic power from west to east is changing the environment for sovereign-wealth funds (SWFs), the government-run investment vehicles that manage state-owned assets. At the same time, the world is seeing ever more of what I called in 2007 “the rise of state capitalism.” In the five years since I used that term in the Financial Times, the role of the state in global economic and financial policy has clearly deepened. This has implications for SWFs, which are both contributors to and products of this global rebalancing.
Since 2007, the assets controlled by SWFs have risen from around $2.2 trillion to more than $5 trillion, with the major funds coming from the same “super seven” players: Abu Dhabi (United Arab Emirates), Norway, China, Kuwait, Russia, and two funds from Singapore. In addition, recent years have seen Qatar’s fund grow significantly in size; it crossed the $100 billion threshold in 2011.
Before the financial crisis, there was increasing suspicion of SWFs. They were seen as opaque and as being driven more by strategic than commercial needs. As a result, there was growing unease in the West about how these massive pools of capital might be deployed, and also about the potential risks that might follow from greater foreign-state influence on important national assets. One example was the outcry over the attempt by China’s CNOOC to buy a stake in a US oil firm, Unocal.
Then the financial crisis hit, bringing about a shift in the world’s thinking regarding sovereign funds. It led to them being seen in a more favorable light. SWFs provided a much-needed source of finance during the crisis, as a number of them injected money into Western financial firms.
At the same time, the funds worked with governments and international organizations to establish new principles on transparency, which have guided their conduct since 2008.
These voluntary guidelines, known as the Santiago Principles, sought to address worries over their transparency and accountability, aiming to differentiate SWFs from state-owned enterprises. Add in the relative scarcity of long-term investment capital in the West, and recipient nations are now more welcoming of foreign sovereign money.
The financial crisis also strengthened the arguments in favor of states playing a strong role in the economy. In the West, governments have bailed out banks, while globally the free-market “Washington consensus” has lost out to the rising momentum of the state-influenced “Beijing consensus.”
Since the crisis, SWFs have also become an increasingly important factor in economic development in emerging markets. SWFs are not donors; they are asset managers whose role is to seek strong and stable financial returns. And yet, global currents have led them to diversify away from the dollar, without necessarily selling the dollar assets. They are placing a rising proportion of new reserves in other currencies by investing in emerging-market assets.
One place they have put their money is in infrastructure. The long-term investment horizon of SWFs makes them ideal financiers of large infrastructure projects. Asia, for instance, needs $8 trillion over the next ten years to finance infrastructure projects. No surprise, then, that Asia, along with Africa and Latin America, has been a key destination for sovereign funds in recent years—an important dimension of ever-expanding “south-south” trade and investment. A number of sovereign funds, including those from China and the Middle East, are also allocating more funds to domestic infrastructure. Such investments are strategically beneficial for their own countries and commercially attractive for themselves, given the low risk and stable returns. In short, SWFs are extending the reach of state capitalism, with the funds playing the role of development-finance institutions.
This shift is already visible. In 2010, about 14 percent of all SWF investments were in infrastructure, according to the Sovereign Wealth Fund Institute, and that figure has probably risen since.
Preqin, a London-based research group, estimates that 56 percent of SWFs are investing in infrastructure, up 16 percent over 2011, with Abu Dhabi alone allocating more than $30 billion to this asset class. In addition, in 2012, both Angola and Nigeria created SWFs ($5 billion and $1 billion, respectively) in which to place some of their oil revenues, with the specific goal of investing a large portion in infrastructure. These funds have ambitions that go beyond immediate returns; instead, they seek to create the conditions for long-term sustainable economic growth. You could call them sovereign development funds.
Established SWFs are also investing more in infrastructure; the financial crisis has made liquidity less of a priority and long-term returns more appealing. Singapore’s Temasek, for example, established Singbridge in 2009 to develop sustainable Asian infrastructure, including stakes in the Tianjin Eco-City and Sino-Singapore Guangzhou Knowledge City. Temasek is also investing in power projects in India and Vietnam. Malaysia’s SWF has created a special-purpose vehicle to work with the Indian government in financing highway construction. There have also been major investments in the developed world; Britain’s chancellor, George Osborne, has even gone to China to encourage it to invest in UK infrastructure projects, and Abu Dhabi’s fund has bought a major British water company.
SWFs are likely to continue to grow, even though their reputations are mixed and the questions about their strategic intentions and opaque governance remain. But the critics need to recognize that SWFs are also a new and important element in innovative finance that is, quite literally, bringing power (and water and roads) to the people.