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Sovereign Wealth Funds: Learn from the Best!

Advocacy Consultant
Oct 15, 2017 2:30 PM 5 min read
Editorial

Mobike is a tech startup trying to cash in on the new “bike-sharing” craze in China. Since June, the 2-year old company has raised over $300m in funding, including an undisclosed but substantial amount from Temasek Holdings. Temasek has also invested in Airbnb, the American online hospitality marketplace, and Chinese e-commerce giant Alibaba. Temasek however is not a typical investment fund. It is completely owned by Singapore Government’s Ministry of Finance. Financiers esoterically label such institutions, increasingly seen as directing the course of global trade and investment, as Sovereign Wealth Funds (SWFs).

 

A SWF represents a state-owned pool of capital mostly invested in foreign equities, debt, real estate, and commodities. Akin to private equity and hedge funds, SWFs generally prefer riskier assets yielding high returns and hence operate with a very targeted mandate in comparison to the nation’s central bank holdings. They are known to maintain a low leverage on their balance sheets.

 

Countries approach SWFs differently when it comes to defining their legal and institutional structure. For instance, the Kuwait Investment Authority was established as a stand-alone legal entity with reasonable autonomy. Other countries may want to exert greater control by instituting them in the form of state-owned corporations operating at an arms-length basis, such as in case of Temasek. Yet another model is where the SWF owned by the Central Bank while the underlying assets are managed by a fund manager, as in Norway.

 

Historically, SWFs originated from the need of resource rich nations to park their surplus cash which accumulated over years of favorable market conditions. Over time they evolved to serve other functions such as insulating the economy from volatility, soaking up excess liquidity from the financial system, and creating savings buffers for future generations. The first SWF ever was the Kuwait Investment Authority established in 1953, funded by petrodollars. The Norwegian Pension Fund, again oil-money backed, is currently the largest SWF in the world, valued close to $1tr – about the size of the Mexican economy.

 

SWFs are financial behemoths expected to manage more than $15tr of assets by end of this decade. With significant stakes in major companies world-wide, they hold the capability to swing global markets and distort trade. The Norwegian Pension Fund alone, for instance, owns 1% of all stocks and bonds in the world and has a market cap greater than that Exxon, Shell, and Chevron combined. Their notorious lack of transparency and proximity to national governments often raises questions from regulators and analysts on their geo-political agenda, if any.

 

Overseas investments by SWFs have been often viewed with suspicion, as illustrated by the 1988 Exon-Florio Amendment which empowered the President of the United States to block any foreign investment deemed to jeopardize the country’s national security. The EU has so far restrained from passing such sweeping legislation for fear of sparking off international protectionism, but has nonetheless expressed concerns over potential national security risks.

 

The said skepticism was partially balanced when SWFs served as important stabilizing agents during the global financial crisis. They pumped in over $60bn into beleaguered banking giants such as Citicorp, Merrill Lynch, and Morgan Stanley to keep them afloat and provided much needed liquidity at a time when trust in financial institutions was at its lowest. Their search for higher returns pushes SWFs to take an activist stance, thus releasing value from underperforming companies they invest in.

 

The Developing World Catches On

 

Once the preserve of rich nations, the emerging world started experimenting with SWFs post 2000. They flipped the outward-looking model of traditional SWFs by treating them as Special Purpose Vehicles (SPVs) to attract foreign capital inwards. Though this brings in much-needed investment capital, such new-age SWFs do not always allow the concerned nation to reap their full “geo-political benefits”.

 

NIIF - India’s Own Sovereign Wealth Fund

 

The Government of India took its first tentative steps by floating the National Infrastructure Investment Fund (NIIF) in December 2015. Launched amidst much fanfare, the proposal was to create a corpus of INR40,000cr, half of which was supposed to come from private entities while the other half from the Government itself. The NIIF was envisioned as a body that would accelerate investments into India’s sagging infrastructure sector and revive hundreds of stalled projects.

 

However, progress has been slow. The FY17-18 budget allocation was capped at a relatively modest INR1,000cr. The reality struck hard when in June this year a RTI query revealed there have been practically zero contributions to the fund almost 2 years post incorporation. Though there have been talks since then of potential injections from foreign funds (courtesy Canadian pension funds etc.), mobilizing domestic capital continues to elude.

 

India can greatly gain from a Western style outward-looking SWF which deploys a bulk of our domestic capital into overseas assets. It will help the government in diversifying its revenue base, balance our fiscal deficit, and potentially reduce the tax burden of citizens. By acquiring stakes in oil and gold companies (comprising 30% of our current import bill), India would be able to cushion itself against fluctuations in the prices of important commodities that it imports.

 

Also, what is stopping us from creating a SWF with a mandate to invest into start-ups, besides the usual suspects of listed equities and credit? More than 30% of Temasek’s S$240bn portfolio taps into unlisted equities such as Didi Chuxing and China Internet Plus, besides the earlier mentioned Airbnb and Alibaba. Saudi Arabia's public investment fund invested $3.5bn in Uber this year and the Qatar Investment Authority backed Flipkart as early as 2014. Releasing domestic capital from public-sector managed pools such as Life Insurance Corporation of India (LIC) and Employees' Provident Fund (EPF) is also an idea worth considering.

 

To gain context, only 1% of LIC's policyholder-backed investments amount to a significant $2.8bn, comparable to the current annual VC inflows into India. Start-up capital being long-term can be a natural match for life insurance liabilities. With zero debt on its balance sheet, LIC has the flexibility of raising regulatory capital and provision for the "riskier" portfolio, i.e. there are no shortage of ways to execute. With India hoping to play an increasingly important role on the global stage, SWFs can add much needed financial muscle to complement our political and strategic ambitions. That is the only way to unleash our true potential.