Sovereign Wealth Funds – Role Model For Private Investors?

Receive $2,000 each Christmas from your government’s investment fund? Sounds great and is true if you live in Alaska.

Although Sovereign Wealth Funds (SWF) seem to be a recent phenomenon, they have been around for decades. One of the first, the Kuwait Investment Authority, established in 1953, before Kuwait’s independence from the United Kingdom, played a major role after the First Gulf War 1990. Since the fund was managed in London, UK, the Iraqi invaders had not been able to gain access to its funds. After the war was over, the Kuwait Investment Authority stepped in with its great financial power as a savior for the Kuwaiti people in the reconstruction period of the country’s economy.

The most recent development in the field of government wealth management was in relation to Afghanistan. On June 24th, The New York Times published an article indicating that the resources of Afghanistan were worth nearly $1 trillion, based on American government officials’ calculations. Later that day, Ashby Monk from the SWF project at the University of Oxford suggested creating a SWF straight away in order to hold and manage the revenue for future generations.

Currently SWFs have $4 trillion assets under management, which approximately equals the total assets under management of both hedge funds and private equity. This figure is expected to increase to about $12 trillion by 2015.

Since the turn of the millennium, the influence of SWFs on the world economy has rapidly increased. In particular, rising prices for oil and other natural resources have fueled the build up of such funds. The benefits and the threats of this development and the SWF phenomenon itself are the subject of intense discussion by the general public as well as in expert and academic circles. Benefits became obvious during the peak of the global financial crisis: government-owned funds appeared as white knights, acquiring large stakes in global banks. Middle Eastern and Asian SWFs invested in sum $60 bn into Credit Suisse, Barclays, Citigroup, UBS, Morgan Stanley, Merill Lynch and Deutsche Bank. But some western governments fear the increasing accumulation of investments in their domestic companies and the political power that might accrue to the SWFs as a result. Main concerns are that foreign governments might suddenly acquire direct influence over global markets through their SWFs and could target particularly military suppliers and other high-tech industries.

There is a lot of research going on in this field of sovereign wealth management but since SWFs have rather low levels of disclosure, especially the Middle East, it is difficult to draw meaningful conclusions. A recent research paper by Rolando Avendano and others investigated the political bias of SWFs in comparison to mutual funds. The results showed that SWFs tend to invest in different types of firms. For instance, the investment targets have higher price-earnings-ratios but lower price-to-book-ratios, higher dividend yield and much higher sales growth. Also the beta from the Capital Asset Pricing Model, indicating the overall risk of the investment in a certain stock is 20% lower. It seems that SWFs invest overall more conservatively and with a long-term investment horizon as opposed to many trading oriented mutual funds.

But what can private investors learn from Sovereign Wealth Funds?

For private investors it is by definition not possible to invest in SWFs. What private investors can do is to learn from the investment strategies of SWFs in so far as their level of disclosure allows. For instance when SWFs started to take large stakes in banks during the peak of the financial crisis, private investors could simply invest in a financial sector or banking index fund. A more conservative way to profit would be to invest in the same blue chips, for instance in stocks of the Dow Jones Global Titans index which includes the largest public companies in the world.

Interestingly, over the last months there has been a very intense debate in Norway whether the Petroleum SWF (managing Norway’s proceeds from oil) should switch to a passive investment model. A report by professors from Yale, London Business School and Columbia found strong evidence that the active style of the Norwegian SWF has hardly added value compared to the market index. The report recommended essentially a switch – at least in part – to a passive model. The management team of the SWF, from Norges Bank, were shocked and wrote a long rebuttal defending their active style in fund management. Of course, most managers from Norges Bank would lose their jobs, should the fund be switched to a passive model.

Overall, we think that SWFs present some good learnings for investors:

• Think long-term – investment in companies and stocks must be long-term decisions as the market may be exposed to strong short-term fluctuations.
  

• Be conservative – think about quality in your investment decisions.
  

• Take opportunities and invest in clearly undervalued companies, for instance, when other investors are panicking or running out of cash.
  

• Be open to passive investing, as most active asset managers will never beat the market benchmark over extended time periods.