Sovereign Wealth Funds Asset Allocation in the Wake of the Global Financial Crisis Eliot Kalter President, E M Strategies Senior Fellow, The Fletcher School EKalter@EMStrategies.com June 2009
Sovereign Wealth Funds Assets Under Management Factors Driving Growth of SWFs Investment Objectives and Asset Allocation Global Financial Stress Test The Fletcher School s SWF Initiative: Key International Issues in the Wake of Financial Crisis Increased Asset Allocation to EM and LATAM Reinforced by Global Crisis
Assets Under Management
The Largest SWFs
SWF Market Share by Country
Assets Under Management by Institutional Investor SWFs hold a relatively small proportion of institutional investors asset
Assets Under Management by Institutional Investor Estimates of SWF asset holdings vary due to lack of transparency Source: JP Morgan USD billion % of total SWF assets Total SWF assets 2,998 3,737 100 Of which: Top ten SWFs 2,367 3,034 79 81 Commodity funds 1,900 2,504 63-67 East Asia 999 1,139 30 33 Middle East 1,168 1,730 39 46 Europe & Central Asia 637 17 21 Africa 82 114 ~3 Americas 114-119 3-4 Memo items Official reserves** 7,155 Hedge funds and private equity 2,800 Private pension, insurance and mutual 74,900 funds Global financial assets 190,000
Cou ntry Name/Purpose Source Date The number of countries with SWFs is growing rapidly Russia Savings Fund for Future Generations Natural Resources 2008 Chile Pension Reserve Fund 2008 Libya Libya Investment Authority Natural Resources 2007 China China Investment Corporation 2007 Trinidad and Tobago Heritage and Reserve Stabilization Fund Natural Resources 2007 Australia Future Fund Fiscal Surplus 2006 Chile Economic and Social Stabilization Fund Natural Resources 2006 Mauritania National Fund for Hydrocarbon Revenues Natural Resources 2006 Korea Korea Investment Corporation 2005 Source: Eliot Kalter, Center for Emerging Market Enterprises at the Fletcher School (based on information from the IMF, Peterson Institute and RGE Monitor Qatar Qatar Investment Authority Natural Resources 2005 Timor-Leste Investment Fund Natural Resources 2005 Venezuela National Development Fund (PDVSA) Natural Resource 2005 Sao Tome and Principe National Oil Account National Resources 2004 Russia Oil Stabilization Fund Natural Resources 2004 UAE-Dubai Isithmar Natural Resources 2003 UAE-Abu Dhabi Mubadala Development Company Natural Resources 2002 Sudan Oil Revenue Stabilization Account National Resources 2002 New Zealand Superannuation Fund Fiscal Surpluses 2001
Algeria Revenue Regulation Fund Natural Resources 2000 Azerbaijan State Oil Fund Natural Resource 2000 Mexico Oil Income Stabilization Fund Natural Resources 2000 Kazakhstan National Oil Stabilization Fund Natural Resource 2000 Iran F/x Reserve Fund; Oil Stabilization Fund Natural Resources 2000 Venezuela Macroeconomic Stabilization Fund Natural Resource 1998 Botswana Pula Fund Natural Resource 1997 Hong Kong Exchange Fund 1997 Malaysia Khazanah Nasional Fiscal Surplus 1993 Norway Brunei Government Pension Fund-Global/ Long term fund for future generations Brunei Investment Authority/General Reserve Fund Natural Resources 1990 Natural Resources 1983 Singapore Government Investment Corporation (GIC) F/x Reserves 1981 Oman State General Reserve Fund Natural Resources 1980 Canada-Alberta Alberta Heritage Savings Trust Fund Natural Resources 1976 USA-Alaska Alaska Permanent Reserve Fund Natural Resources 1976 UAE-Abu Dhabi Investment Authority (ADIA) Natural Resources 1974 Singapore Temasek Holdings Fiscal Surplus 1974 Kiribati Revenue Equalization Reserve Fund 1956 Kuwait Kuwait Investment Authority (KIA) Natural Resources 1953 Source: Center for Emerging Market Enterprises at the Fletcher School (based on information from the IM, Peterson Institute and RGE Monitor).
EM country current account surpluses and oil exporters drive the expansion of Sovereign Wealth Funds Factors Driving Growth of Sovereign Wealth Funds International reserves reached levels beyond those needed to buffer external vulnerabilities in many EM countries Reserve accumulation must be sterilized to be non-inflationary; Domestic cost of sterilization greater than return on central bank investments SWFs do not face same investment restrictions as central banks Growth of SWFs also driven by need to insulate economy from volatile commodity prices, share wealth across generations and fund priority projects
Asian manufacturers and oil-exporting countries have accumulated large current account balances, reflecting high commodity prices and favorable balance of trade (cumulative balances in billions of U.S. dollars) Emerging Asia Oil Exporting Countries 1800 2500 1600 1400 2000 1200 1000 1500 800 China 1000 600 400 500 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2000 2001 2002 2003 2004 2005 2006 2007 0 Source: IMF, World Economic Outlook.
20 18 16 14 12 10 8 6 4 2 that has translated into a large accumulation of foreign exchange reserves (in months of imports) Emerging Asia 3 months of import cover China Oil Exporting Countries 3 months of import cover 14 12 10 8 6 4 2 0 1997 1999 2001 2003 2005 2007 1997 1999 2001 2003 2005 2007 0 Source: IMF, World Economic Outlook.
Foreign exchange reserves are at unprecedented levels across the globe China Japan Russia India Korea Euro Area Brazil Singapore Hong Kong Algeria Malaysia Mexico Thailand Libya Turkey Foreign Reserves in 2008 (in USD billions) 0 500 1,000 1,500 2,000 Source: IMF, International Financial Statistics (reserves excl. gold).
EM country surpluses will continue in medium term Global Savings, Investment and Current Accounts
Investment Objectives and Asset Allocation SWFs have fewer limitations with longer investment horizons
SWFs Not a Homogenous Group Stabilization Funds Insulate Budget/Economy (e.g. Chile, Kazakhstan, Azerbaijan, Algeria, and Venezuela) Savings Funds Intergenerational Transfer (e.g. Kuwait, Qatar, U.S. Alaska) Reserve Investment Corporations Part of Reserves; Increasing Returns (e.g. Korea) Development Funds Socio-Economic Objectives Contingent Pension Reserve Funds Finance Unspecified Contingent Pension Liabilities of Government (Australia, New Zealand).
Investment Strategies of SWFs Based on Dominant Objectives Conservative investment style; more fixed income focused than others Stabilization funds: natural resource exporting countries to insulate the economy from volatile commodity prices Reserve investment corporations: established to reduce the negative cost-of-carry of holding reserves or to pursue investment policies Moderate to aggressive investment style: diversified portfolio of international assets; as assets grow a higher proportion to private equity Savings funds: while newer oil funds predominantly focus on stabilization objectives, the recent increase in oil prices has added emphasis to savings objectives, intended to share wealth across generations Development funds: allocate resources for funding priority socioeconomic projects, such as infrastructure Pension reserve funds: identified pension and/or contingent-type liabilities on the government s balance sheet
Portfolios Reflect Investment Horizons and Purpose
Asset allocation to private equity increases as SWFs grow Source: Preqin
SWF Private Equity Transactions by Number and Value Private equity transactions continued to increase in 2008 despite crisis
Rapidly Shifting Asset Allocations EM countries transforming to powerful investors with varying structure, transparency and accountability Global asset allocation is shifting rapidly While there are regional differences, SWF share longer time horizons and higher risk/return appetites Increasing allocations to private equity, real estate, alternative investments Increasing allocations to EM countries, including to meet public policy objectives
Implications for Investment Decisions Implications of sovereign wealth funds asset allocation strategy: Emphasis on access to information/analysis about SWF shifting allocation and joint investment strategies Increased importance of regional managers to offset information gaps Positive impact on return/risk of global private equity and negative impact on long-term global fixed income investments Positive impact on EM investment, equities and fixed income EM currencies with SWFs or recipient of SWFs to appreciate over the medium-term
Global Financial Stress Test Global Indicators: Advanced countries hit harder than EM countries Growing contribution to world growth of EM countries
Relative strength of Latin America Indicators of Financial Stress in EM Countries WEO: Spring 2009
Relative strength of Latin America Indicators of Financial Stress in EM Countries Source: IMF WEO Spring 2009
Key International Issues Facing SWFs in the Wake of Global Financial Crisis The Fletcher School s Sovereign Wealth Fund Initiative The Fletcher School at Tufts University and its Center for Emerging Market Enterprises (CEME) has created the SWF Initiative (SWFI) The SWFI offers an informal environment for SWFs to have open discussion on key issues that they face, without pressures of enforcement The SWFI focuses on critical issues such as risk management, asset allocation, transparency and accountability Emphasis on: Reaching better understandings among SWFs Process for reaching goals compatible with national and international interests
SWFI is discussing with SWFs: In the wake of the global financial crisis Key International Issues SWFs face discriminatory restrictions Recipient country discriminatory restrictions on SWFs are of great concern and affect the general availability of capital Mission and global focus under pressure The current global downturn is creating pressure on management to participate locally and regionally in ways that may be outside of their mandates, organizational skill sets and core competencies The global financial system and future global financial architecture in question Confidence in the global financial system has been tested by the global crisis; SWFs are rethinking what is required and what role they may play individually and/or collectively to reshape a new global investment regime
Key International issues Impact of Global Financial Crisis on Asset Allocation to Emerging Markets The global financial crisis has reinforced the secular shift of financial and economic power away from the traditional centers of the US and Western Europe and towards emerging markets A gradual shift of asset allocation to emerging market debt and equity is being reinforced The financial crisis has ridded investors of the perception that developed markets in the West are less risky and more secure than emerging markets Asset allocation to Latin America is expected to increase from low levels while Asia should see significant increases
Increased Asset Allocation to EM and LATAM Reinforced by Global Crisis Value of SWF Deals by Location of Target: OECD vs. Emerging Markets
SWF Activity in EM Private Equity Markets A number of SWFs began investing in private equity during 2008 and a few are expected to make maiden allocations to the asset class over the course of 2009 China Investment Corporation (CIC) made its first investment in a private equity fund in April 2008, committing $3.2 billion to a buyout fund managed by JC Flowers & Co. Other sovereign wealth funds have increased their allocations to private equity in order to take advantage of favorable pricing as a result of the recent turmoil in the financial markets. One such example is Australia s Future Fund, which increased its allocation to the asset class in order to take advantage of dislocation in the markets.
SWF Activity in LATAM EM Private Equity Markets (continued) Another sovereign wealth fund that started investing in private equity during 2008 was Korea Investment Corporation (KIC), which adopted a more aggressive approach to its investments generally, and this included a debut allocation to private equity. Temasek Holdings CEO Ho Ching stated recently that the $134bn portfolio is rotating out of developed world assets and into developing, with potentially positive implications for LatAm. The fund is looking to maintain exposure to rest of Asia at 40%, keep Singapore at about 30%, cut OECD to 20% and add exposure to other geographies such as Latin America, Russia and Africa of up to 10%. It also framed our decision to open new offices in Mexico and Brazil last year, says Ho
SWF Share of Alternative Assets in Total Alternative Sector Low AuM estimate 2007 2012 8-10% alternative allocation 15% alternative allocation 20% alternative allocation Average 6.0% 10.4% 13.9% 12.1% High AuM estimate 7.5% 12.5% 16.6% 14.5% Average 6.7% 11.4% 15.2% 13.3% Source: JP Morgan
Endowment Portfolios Provide a Guide for SWF Asset Allocation Endowment Funds* Asset Allocation, 2007 Source: NACUBO, 2008
Sovereign Wealth Funds Asset Allocation in the Wake of the Global Financial Crisis Eliot Kalter President, E M Strategies Senior Fellow, The Fletcher School EKalter@EMStrategies.com June 2009