Some sovereign wealth funds have announced in recent months that they plan to expand their investments in emerging economies after being burned by the downturn in the developed world. Africa, which has been overlooked until now, may be one of the big beneficiaries.
As defined by the International Monetary Fund (IMF), sovereign wealth funds (SWFs) are “special purpose investment funds or arrangements that are owned by the general government. Created by the government for macroeconomic purposes, SWFs hold, manage or administer assets to achieve financial objectives, and employ a set of investment strategies that include investing in foreign financial assets.”
SWFs represent an enormous pool of funds in search of long-term investment opportunities, with $5000bn in assets in March 2012, according to Michael Maduell, president of the Las Vegas-based private research and consulting group Sovereign Wealth Fund Institute. And despite the economic turmoil brought about by the recessions in Europe and the US in recent years, total SWF assets rose by $500bn, or 15%, between 2011 and 2012, according to Preqin, a leading source of information for the alternative assets industry. Indeed, the assets held by SWFs dwarf the estimated total held by hedge funds ($2000bn) and private equity ($744.2bn).
The first SWF was created by Kuwait in 1953. Since 2005, a trickle has become a stream. India is among several countries said to be considering the creation of an SWF; its fund would be used to buy coal assets abroad. Small countries sometimes create an SWF as a savings fund to boost their credit ratings, Mr Maduell notes. Currently his organisation lists 60 SWFs worldwide.
SWFs receive their initial funding from balance of payments surpluses, foreign currency operations, proceeds of privatisations, revenues from commodity exports, or other sources. They range in size from Goliaths such as the Abu Dhabi Investment Authority with assets of $627bn, to Equatorial Guinea’s Fund for Future Generations with just $80m. Some funds do not disclose their assets.
The investment approach of an SWF is determined partly by the strategic purpose it is designed to fulfil, and partly by a set of principles that guide the type of investments it makes. The Norwegian Government Pension Fund (NGPF), for example, is required to be completely transparent and disclose the value of the assets it owns, says Elroy Dimson, emeritus professor at the London Business School, who chairs the fund’s strategy council.
Though it is the world’s second largest SWF with assets of $611bn, Mr Dimson says one reason the fund does not invest in private equity is because its value is difficult to quantify. The fund also seeks to invest in an ethical and socially responsible manner.
In March, the NGPF announced an adjustment to its investment strategy that reduces the share of Europe to 40% from 54%, while raising the emerging market share from 6% to 10%. “This increase reflects the fact that the world’s economic centre of gravity is gradually moving toward emerging markets,” a statement said.
This is a significant shift, according to an analysis by Valeria Miceli of the Universita Cattolica in Milan and co-author of the book Sovereign Wealth Funds: A Complete Guide to State-owned Investment Funds. Ms Miceli reviewed 2740 large deals completed between 1990 and 2010 by 29 of the 52 existing SWFs. She found 60% of acquisitions were in advanced economies. Deal value was even more concentrated: $395bn – or 70% – in the developed world, and just $170bn in emerging or developing countries.
Ms Miceli says her analysis shows the volume of deals involving emerging economies has increased over time. However, most deals in this category reflected activity in Asia, and, more specifically, China.
In April 2008, then World Bank director Robert B Zoellick called on SWFs to allocate just 1% of their then $3000bn in assets – or $30bn – to Africa. His appeal appeared to fall on deaf ears. “I don’t see any significant interest in Africa, but there is a more pronounced interest in the Middle East/north Africa region, even if it is not as significant as in Asia,” says Ms Miceli.
One exception is the $5bn China Africa Development Fund. However, it invests only in Chinese enterprises that set up operations in Africa or plan to invest there. It is specifically intended to “embody the Chinese government’s diplomatic and economic policies towards Africa”, while investing based on “market economy principles”.
The neglect of Africa seems about to change, however. Institutional investors see Africa as holding the greatest overall investment potential of all frontier markets globally, and many plan to increase their asset allocations there within five years – in some cases by at least 5% of their fund’s value, according to a 2012 report by Invest AD, a subsidiary of Abu Dhabi Investment Council, and the Economist Intelligence Unit. In most cases, they would start from nothing.
“Africa’s emerging middle class is catching investors’ eyes, ahead of commodities and natural resources,” the report stated. Furthermore, investors were more concerned about technical market concerns than about political and economic stability in countries of interest.
Invest AD has raised $40m for its Emerging Africa Fund. It will invest in 10 African countries, principally in Nigeria, Egypt and Morocco, with a primary focus on banks and telecoms and a smaller investment in other sectors. In 2010, along with Japan’s SBI Holdings, it created a $75m Africa fund and invested in the initial public offering of Rwanda’s Bank of Kigali.
Despite these hopeful signs, some experts do not expect a radical shift in investment patterns. “What SWFs should be doing is diversifying globally,” says Mr Dimson. “The unanswered question is, should they have a normal market capitalisation weight in developing markets, or should it be more or less?”
One factor weighing against funds investing more heavily in some developing countries is that the supply of ‘free-float’ equity – shares that are easily traded in the market – can be quite limited, says Mr Dimson. For example, about 90% of the equity in some Chinese companies is owned by the state and not available to the private sector. In other countries, where companies may predominantly be held in family ownership, the free-float might grow, which could eventually lead to more opportunities for funds to invest, if the family chooses to sell.
There is also a sense of uncertainty about buying the bonds of developing countries because of the fear that countries with fiscal problems will keep issuing bonds to cover shortfalls, posing a danger for investors in the event of default, says Mr Dimson.
The kind of investments SWFs make also depends on their strategic and investment goals.
Stabilisation funds, which are used to hold liquid assets and buffer the rise and fall of prices of a country's commodities, generally prefer safe assets. Others, such as pension reserve funds, reserve investment corporations and saving funds, have “a very limited demand” for safe assets, according to the IMF’s 2012 Global Financial Stability Report. The IMF estimates SWFs hold $500bn to $600bn of countries’ sovereign debt, far less than banks, insurance companies and pension funds.
In recent years, SWFs have focused heavily on investments in the financial sector (including real estate), manufacturing, energy and utilities, information technology and telecommunications, according to Ms Miceli. The number of SWFs investing in infrastructure has risen 16% since 2011, to 56% of all SWFs, according to Preqin. Infrastructure as an asset class has become increasingly attractive, due to its long-term nature, stable returns and low risks – perhaps because of the shocks caused by the financial crisis.
Two new websites, Zanpato.com and Sokoni.com, aim to match investors with infrastructure projects in need of them. Zanpato has a global reach. Several SWFs have signed up as members, says co-founder Ryan Orr, executive director of Stanford University’s Collaboratory for Research on Global Projects. Sokoni, which is being developed with assistance from the African Development Bank, serves that continent.
Still, there can be problems with investment in infrastructure, which has disappointed some investors in the past. “A lot of people think it makes sense if you pay the right price. But many infrastructure investments are not listed, so you don’t know if you paid a fair market price or overpaid,” says Mr Dimson. “In principle, infrastructure offers an inflation-protected income stream – but you could wind up owning a road that nobody drives on.”
SWFs generally prefer to invest in developed infrastructure in developed markets with an existing cash flow, instead of in projects starting from scratch in the developing world, says Mr Maduell. “Their ideal sweet spot is a minority stake in a plan with a private partner.”
The caution shown by SWFs is often mirrored in recipient economies. Some fear the motives of SWFs may be political or strategic, rather than purely financial. That some of the biggest SWFs are based in countries with limited democracy does not help. To overcome these fears and improve the image of SWFs, 23 countries have joined the International Forum of Sovereign Wealth Funds, which promotes a set of best practices called the Santiago Principles.
In a speech in London in 2011, David Murray, honorary chair of the forum, dismissed such concerns as “both theoretically unsound and practically unsubstantiated”. He added: “SWFs have demonstrated their commitment to accepted standards of governance and accountability and that they operate as investors with economic and financial objectives.”