Sovereign wealth funds: Back to basics in 2010

By:
Dawn Cowie
Published on:

Caution and safety in numbers in 2009; Accelerating investment in Q2 continuing into 2010

It was a nail-biting year for sovereign wealth funds (SWFs) in 2009. With the price of oil, currency movements, and exposure to financials and real estate to worry about, many funds were in a state of paralysis in the first half of the year. Only $3.5 billion was invested between April and June as equity markets rallied, the lowest quarterly level since the last three months of 2004.

Even those funds that were active displayed more caution and sought safety in numbers on big deals. Collaboration between sovereign wealth funds in order to spread the risk of investments had not been seen before 2009.

In 2009 a lot less leverage was available even for acquisitions of distressed assets. Although some funds such as the Kuwait Investment Authority and Abu Dhabi Investment Authority do not use leverage to increase investment returns, others that do, such as the Qatar Investment Authority, have found it hard to come by.

"Some SWFs have used collars mostly to get leverage and protection in a declining market but they create the problem of losing upside," says Patrick Mole, a managing director in strategic equity transactions at Société Générale. In general, though, it has been back to the basics of long-term investing.

Some funds such as the China Investment Corporation also took time early in the year to hire buy-side talent, tighten their risk processes and reappraise their investment approach before re-entering the market with force in the second half.

Real estate

Industry analysts and equities experts forecast that sovereign wealth funds will continue to look for quality assets at bargain prices, particularly in the real estate sector. For example, Qatar Holding, an investment arm of the QIA, provided funding in October for the purchase of a further 8.45% equity stake in London real estate developer Canary Wharf Group by its majority owner, Songbird Estates.

However, there will also be a focus on strategic investments in natural resources and companies with a strong technology focus across a wider range of markets in 2010.

Sovereign wealth funds reported 62 deals worth $36 billion in the first nine months of 2009, exactly half the 124 deals with a value of $93 billion in the same period of 2008, according to the latest available data from management consultancy the Monitor Group.

A bumpy ride

SWF equity transactions 2008/09

Source: Monitor Group


About 70% of these investments by value were made between July and September after a slow first half of the year. However, sovereign wealth funds arguably got their timing right on financial investments the second time around, pumping $30 billion into financial services and real estate in the last three months of 2008 when prices were near rock bottom.

Large investments in financials in the first half of the year were done collaboratively. In February, Government of Singapore Investment Corporation purchased a 7.7% share of private equity firm Apax Partners with Australia’s Future Fund. The Singaporean fund was also a member of a SWF consortium with the CIC and the KIA that contributed a combined $2.8 billion to BlackRock’s accepted $6.6 billion bid for Barclays Global Investors, the bank’s fund management unit, in June.

In the second half of the year, investments in financial services gave way to engineering-related sectors such as automobiles and construction. These sectors accounted for about 40% of expenditure in the third quarter, according to data from Monitor Group.

The best deals

"The best deals are to be had in the OECD because sovereign wealth funds want access to knowledge and technology that can be transferred back to their home economies," says Victoria Barbary, a senior analyst at Monitor Group.

This quest for technology transfer could lead to riskier investments by funds as well as a continued focus on established engineering names.

"China’s fund has been investing in hedge funds, making these unarguably passive, commercial investments"

Victoria Barbary, Monitor Group

For example, GIC bought a 5.4% stake in China’s Shanda Games valued at $47 million in September when the company completed an initial public offering in the US. Investment in the renewable energy sector is also set to be an important theme for sovereign wealth funds in 2010, according to Barbary.

China’s CIC was one of the most active funds in the third quarter of 2009 and has ramped up its investment team. It has also increasingly been favouring external fund managers, potentially as a means to diversify its portfolio without attracting scrutiny as to its motives. Investment firm Oaktree Capital Management won a mandate in September to invest $1 billion on behalf of CIC. In June, the Chinese fund also said it would allocate $500 million to Blackstone Group’s fund of funds unit and $1.2 billion to be overseen by Morgan Stanley’s asset management unit.

It is fairly common for sovereign wealth funds to invest about 10% to 12% of their portfolios in alternative assets via direct investments in commodity producers and suppliers or alternative asset managers, according to Monitor’s Barbary. CIC is a relative newcomer so it has some catching up to do.

"China’s fund has been investing in hedge funds as a way of widening its spread of investments through third-party managers," she says. "Investing in hedge funds will give CIC no direct influence on company policy, making these unarguably passive, commercial investments."

Although developed markets are expected to continue to be the funds’ main focus in 2010, their beefed-up investment teams are likely to look farther afield for opportunities. One emerging markets equities head expected greater investment in Russia and Mexico, picking up on bullishness about Latin American growth.

An increased share of investment is also expected to go to Asia and continental Europe.

"Gulf sovereign wealth funds will continue to focus on assets in the US and the UK but Asia is definitely on their screens and they may be willing to diversify into continental Europe due to the performance of the euro relative to the dollar and pound," says Mole at SG.