Basic HTML Version
24
Types of SWFs and Objectives
There is often a tendency to categorize
different types of government investment funds
(“GIFs”), including SWFs, Pension Funds and the
Reserve Management arms of Central Banks, as
Sovereign Wealth Funds. However, despite the
moniker, there are distinct differences in these
GIFs’ investment strategies and mandates. SWFs
have the freedom to engage in less conservative
investment strategies, as compared to Pension
Fund and Central Bank investors, because,
as mentioned, in general SWFs neither fund
liabilities nor pay dividends.
This is not to say that Pension Funds and Central
Banks have not or will not look to expand their
investments in public equities and alternatives.
In fact, as they accumulate reserves that are
either large relative to any potential near-term
funding requirements or, conversely, insufficient,
these institutions are likely to explore
investment strategies that generate higher
returns. The Canadian pension funds, as a group,
have already been market leaders in adopting
diversified investment strategies. On the other
hand, take, for example, Japan-based pension
funds, which have historically invested the
majority of their assets in Japan Government
Bonds (“JGBs”) and, to a lesser extent, in
domestic equities. These pension funds are
now looking to expand their asset allocation
strategies as their annual returns are not fully
funding their pension liabilities. As such, they
are beginning to consider a more aggressive
investing approach to improve overall returns.
While this will take time to fully implement, the
goal of diversifying and enhancing returns will
remain top-of-mind for most of these investors.
Focusing purely on SWFs, one has to be aware
of their differing objectives in order to fully
understand their overall asset allocation
framework. SWFs can be divided into three
major categories – Future Generation Funds,
Development Funds and Stabilization Funds.
Most of the world’s SWFs see their primary
objective as “Future Generation Funds,” which
are meant to provide a “rainy day” fund for
future generations of a given country. This
objective, in particular, is a large focus of SWFs
that derive their funding from commodity
exports, as they want to help minimize the
impact of depleting reserve bases of their
commodity resources. “Stabilization Funds”
are meant to support the domestic economies
from any unfavorable events, whether they
are dislocations in budgets or domestic capital
markets. As an example, SWFs of the major
Gulf countries expended significant sums to
support their domestic financial institutions and
capital markets following the financial crisis in
2008. In general, most SWFs in the Middle East
function as a combination of Future Generation
and Stabilization Funds. Finally, some funds,
especially those located in countries and regions
where domestic infrastructure development and
job creation is a priority, but is constrained by
a lack of foreign direct investment, also serve
as Development Funds. In essence, they hope
to serve as catalysts for much-needed local
development. An example of this is the Nigeria
Sovereign Investment Authority (“NSIA”), which
was established in 2011, and has each of the
above three objectives as part of its charter.
Investment Strategy
One of the major distinctions in how SWFs
invest is whether they rely on outsourced
asset managers for their investments or have
internal staff to pursue their investments
directly. With a couple of exceptions, most of the
long-established SWFs have gravitated towards
investing more of their assets directly, in part
to enhance their fee-adjusted returns. Similarly,
whereas most of the recently-established SWFs
began investing primarily through external
managers, in recent years they have expanded
their internal teams and have grown increasingly
more comfortable investing directly. Norges,
the largest SWF by AUM today, invests the vast
majority of its assets directly in the fixed income,
equity and real estate markets, whereas GIC
Private Ltd. primarily uses external managers
for its alternative investments portfolio. Abu
Dhabi Investment Authority, on the other hand,
pursues an index-replication strategy for 55%+
of its portfolio. In contrast, according to their
annual reports, China Investment Corporation
and Korea Investment Corporation use external
managers for approximately two-thirds and one-
third of their portfolios, respectively. We believe
that, over time, we will see an increasing trend
on the part of SWFs to manage their assets
directly; and those who continue to use external
managers for parts of their asset allocation will
reduce the number of managers that they use.
One indicator of this is the number of SWFs that
are opening offices in major investment centers
and hiring professional staff to pursue regional
investment activity.
One of
the major
distinctions
in how SWFs
invest is
whether
they rely on
outsourced
asset
managers
for their
investments
or have
internal
staff to
pursue their
investments
directly.