The headquarters of China Investment Corporation, the country’s sovereign wealth fund. © REUTERS
Few creations are as emblematic of peak globalisation as the sovereign wealth fund.
The term, coined in 2005 – though the name could be retrospectively applied to funds that were set up much longer ago – refers to vehicles set up by states with the chief aim of investing surplus cash in the longer-term interest of their citizens.
While not exclusively, many of the vehicles set up during this period were in East Asian economies in the throes of an export boom, or those in the Middle East that were rich in commodities.
The growth of funds’ prominence as an investor class speaks of a time in which countries with vast amounts of new-found wealth could invest in assets overseas for the purposes of maximising returns with little chance of rebuttal from foreign governments.
Sovereign wealth funds remain a big investor class – four funds are now thought to have assets worth more than $1tn and several others have hundreds of billions. But with globalisation under attack, are funds set to see their influence curtailed?
It seems likely that the funds will no longer be so flush with cash. Malan Rietveld, a former colleague of Alphaville’s and adviser to a number of SWFs, thinks that the economic forces that made funds so wealthy are – in the current era – dissipating:
In the late-90s through to the great financial crisis, you had two major sources of sovereign wealth: commodities, mostly oil, and Asian central bank currency management, which was an element of those countries’ trade policy and export-driven growth models. You also had steadily rising commodity prices, coupled with new producers coming only, who all shared a desire to avoid the mistakes of earlier commodity boom-busy cycles – notably, the 1970s and 80s, when windfalls were largely squandered through wasteful spending and low-quality domestic investments.
Part of the “globalist mindset” that SWFs both exhibit and reflect involved having highly diversified portfolios, which generated income streams from financial markets around the world. Today there are definitely some countries that have moved towards a more resource nationalist perspective. One implication may be that there’s less money for sovereign wealth funds – particularly for their diversified global allocations, which is compounded by the current slump in commodity prices and thus revenue.
On the second source of wealth, the accumulation of foreign exchange reserves was a byproduct of exports –– when the dollars flowed in, it was necessary to buy them with the local currency in order to keep the local currency weak. So you has a massive build-up of reserves in places like China and Korea. It’s unclear if and how that model will be pursued in a post-Covid global economy – particularly if there is a prolonged slump in global trade. That golden era of sovereign wealth funds was very much a byproduct and reflecting of a more globalist mindset. That mindset has been in retreat since the GFC and will almost certainly suffer further setbacks in the post-Covid economic order.
World trade is clearly now facing steeper hurdles and a more tense political climate than it was in the early noughties. A lot of those tensions focus on some of the East Asian economies that have benefited from an influx of sovereign wealth. Notably China.
The already delicate relations between China and the US have taken a turn for the worse following the pandemic. The imposition of the National Security Law on Hong Kong has also drawn the ire of other states, including the UK, which said this week that it will ban Huawei from its 5G network. While SWFs such as the China Investment Corporation may well be a million miles away from Huawei in the sense that they are driven by profit motives, the tension between Beijing and much of the West might make foreign governments think twice before taking their cash. As Gary Smith, a managing director at Sovereign Focus, puts it here:
In the current climate it is unlikely that a state-owned investment vehicle will be able to achieve a better overall assessment than that of the sovereign nation that owns it. This will make it difficult for the China Investment Corporation (CIC) to be viewed more favourably than Huawei, especially in nations such as the US, despite the fact that CIC is a recognised SWF with an established institutional architecture. Regulators may fear that in a situation of stress, the goalposts may be shifted, and both CIC and Huawei would become equally answerable to Beijing.
To be sure, those fears are not entirely new. Around the time of the global financial crisis, funds worked with the International Monetary Fund to sign up to a voluntary code of conduct – the so-called Santiago Principles – to temper concerns that funds were taking stakes in big banks and important infrastructure for political reasons. For some, that move to appease Western governments by pledging through the Santiago Principles to invest in similar ways to Western private fund managers represented an opportunity missed. Via Stanford University’s Ashby Monk:
The problem I had with the IMF process that delivered the Santiago Principles is that we pushed sovereign funds to be western, which the west said the needed to keep markets open. But the western form of institutional investment, with its strict interpretation of fiduciary duty, has led to increasing short-termism and unchecked externalities. So while the Santiago Principles may have succeeded in keeping markets open, they also represent to me a lost a chance to re-make our system of capital allocation to be more long-term and sustainable. Because SWFs are the ultimate long term investor – they could have led the world in ESG integration, which is something we’re still struggling with today.
We think he has a point. Indeed it’s somewhat ironic that, by enabling the widening of the gulf between the 1 per cent and everyone else through their investment model, funds themselves helped exacerbate tensions over globalisation. Tensions that, as Smith mentions, now threaten to tie their hands in investment decisions.
But we’d argue that while we can see China’s sovereign wealth fund running into the sort of problems that Smith describes – and perhaps Korea too, it lying on the fault lines of the Sino-US conflict – other funds might find the situation little changed. Large SWFs such as Norway’s oil fund and the Abu Dhabi Investment Authority will face far less pressure. Indeed with the West likely to be pretty skint post Covid-19, they might end up with little choice but to take cash offered by (more benign) foreign governments.
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