Sudip Bandyopadhyay

Defining which funds are sovereign wealth funds (SWF) is tricky at best. A relatively strict definition is employed by Monitor Group, which defines SWF’s as investment funds that:

1. Are owned directly by a sovereign government.

2. Are managed independently of other state financial institutions.

3. Do not have predominant explicit pension obligations.

4. Invest in a diverse set of financial asset classes in pursuit of economic returns.

5. Have made a significant proportion of their investments internationally.

This definition would exclude Saudi Arabian Investment Authority (SAMA) for example, as it is a central bank. However, many analysts do include SAMA among the SWFs because its foreign assets are invested in a much more diverse portfolio than most central banks. The Norwegian Government Pension Fund – Global is also included in the SWF group despite the name, because it functions as an endowment fund, and has no explicit pension liability stream.

Although sovereign wealth funds (SWF) pursue higher risk-adjusted returns than traditional central banks, through a diversified portfolio of assets, their appetite for risk does vary. More conservative funds include Saudi Arabian Investment Authority (SAMA), the Russian funds, and Kuwait’s General Reserve Fund. These tend to focus on fixed income securities and deposits, with a relatively small equity exposure. Most of the larger SWFs, including Abu Dhabi Investment Authority (ADIA), Norway’s Government Pension Fund – Global and Government of Singapore Investment Corporation are largely passive investors, managing diversified portfolio seeking higher returns than the conservative funds. Their portfolios include a substantial proportion of equities, as well as exposure to private equity and other asset classes, such as real estate.

During the last few years there has been huge concern & skepticism over investments by SWFs in foreign assets.Although the US has moderated its stance on acquisitions by Middle Eastern Investors and sovereign wealth funds (SWF) post-financial crisis, some European countries, including France and Germany, remain wary of foreign SWFs buying stakes in what are seen to be ‘strategic’ assets and sectors of the economy. Late last year, France announced the creation of its own state-owned fund to support companies of national strategic importance, and Germany passed legislation allowing the government to review an prohibit a non-European Union company from acquiring more than 25 per cent of the voting rights in a German company.

To a large extent, this simply reflects the lack of information about how these funds are managed and what their investment objectives and strategies are. Since the furore over the DP World deal in 2006, SWFs have made efforts to improve their transparency, disclosure and general public relations efforts. At a meeting hosted by the International Monetary Fund (IMF) in May 2008, SWFs clarified that they have always invested “on the basis of economic and financial risk and return related considerations”, allaying fears of political motivations behind SWF acquisitions in the West. An International Working Group of SWFs, led by Abu Dhabi Investment Authority (ADIA) and the IMF, was also established to put in writing a series of ‘best practices and principles’ that SWFs would strive to adopt voluntarily to improve their transparency and governance. This code of conduct was published later last year and is known as the Santiago Principles. Essentially, the Santiago address the need for greater accountability and disclosure of objective and fund strategies; a sound legal framework for the funds to operate within; improved governance structures and processes to ensure risk management and accountability; and prudent investment practices based on financial and economic risk and return.

Although increased transparency has benefits both for the SWFs and the recipient countries, there can be a cost in terms of the fund’s flexibility, which could compromise the SWFs returns – Norway’s oil fund, one of the most transparent, has on average achieved an annual return about 4 per cent since it was established, compared with an estimated average annual return of about 10 per cent for ADIA. Nevertheless, there is evidence that many funds are making efforts to implement the Santiago Principles, particularly those relating to disclosure of investment objectives and strategies. Temasek recently revised its charter, downplaying its links to government policy or strategic interests, while China Investment Corporation published its first annual report in July 2009. SWFs are also becoming involved in joint ventures, both with each other and with third parties, allaying fears in recipient countries of political motivation in investment decisions transaction.