Investment criteria and drivers
Most SWFs have historically revealed little about their investment strategies and as a result it is perhaps not surprising that our non-SWF respondents were divided on certain questions. In particular non-SWFs were divided on whether SWFs are most interested in returns, or in the strategic benefits of the assets in which they invest. This contravenes the view of SWFs, who claim to be primarily focused on economic performance. Overall it did seem that SWFs were viewed simply as commercial organisations and as long term, even passive investors, and certainly not as a threat, political or otherwise.
When asked to identify the most important investment criterion for these funds, a substantial proportion (35.5 per cent) of all respondents gave the simple answer of “the highest economic return.” A larger group (36.4 per cent), however, opted for the more complex answer of “potential strategic benefit/investment for relevant wealth fund jurisdiction.” The Middle East based SWFs, in particular, have in written responses given the impression that their investments are intended to help develop the skills needed for their newer industries such as financial services and tourism. It is easy to see therefore from the responses received why such investments are regarded by some as “strategic.” A further group of respondents, 20 per cent, said it was the desire for a “premium brand” or “market credibility.”
The variation in these results suggests SWFs may need to communicate their strategies more clearly with the investment community.
There was more of a consensus on the long term nature of SWF investments. When all respondents were asked what they regarded as the most important driver for institutions, funds or companies as investee entities seeking SWF investment a substantial portion (43 per cent) of respondents overall said that it was “longer term investment”. A further 20 per cent cited “more passive investment strategy/minimum imposed controls.”
When asked about the comparative approach of SWFs and private equity firms in relation to the term of their investments 71 per cent of SWF respondents said they regarded themselves as longer term investors than private equity firms, almost exactly the same percentage as all non-SWF respondents when they were asked directly if they thought SWF investments were longer term than traditional private equity investments. When asked to explain their answer to this question, typical views included observations that SWFs had longer “time horizons” and that they were not engaged in “active management.” Another said, “Sovereign wealth funds are investing their surplus resources to store value and to provide future returns when needed more critically than now.”
The relationship with private equity
There was also general agreement on the question of working closely with private equity. Around 70 per cent of non-SWF respondents overall believed that SWFs would increasingly co-invest with private equity funds in some way. The largest proportion (over 40 per cent) thought it would be through co-investment in deals, while the others believed SWFs would either invest in private equity managers or their funds. Respondents would perhaps have been influenced by recent high profile deals such as CIC’s decision to take a stake in Blackstone and Mubadala’s investment in Carlyle.
SWF respondents concurred with the majority, with none answering that they would operate independently from private equity. Such answers are consistent with the publicly held views of private equity organisations, notably EMPEA and the British Venture Capital Association, that SWFs are operating on a basis of friendly co-operation with their members and in some cases are even joining them.
This compatibility was underlined by answers to another question. Some 72 per cent of all respondents believed that it was the SWFs’ long term investment strategy, and consequent lack of exit pressure, in their approach to private equity investing that made them especially attractive to both investee companies and to private equity funds. Their financial capacity was pointed to as a critical element by 48 per cent.
There was much less agreement on the question of SWFs’ attitudes to risk. This again, perhaps, suggests that the SWFs may need to communicate or demonstrate their investment strategies to the investment community in this regard. Some 41 per cent of non-SWF respondents saw the funds as more risk averse than private equity, while 36 per cent saw them as less risk averse and 23 per cent judged they had a similar risk profile. Of the SWF respondents a majority (71 per cent) believed they had a similar risk profile to private equity.
It is perhaps easy to see how such a spread of responses could have arisen. The recent investments in large US and European banks, namely Citigroup, Merrill Lynch, Morgan Stanley and UBS, have come at an interesting time. Such investments can be seen as safe in that they are considered robust and established businesses and maintain sizeable balance sheets, but on the other hand the credit crunch might make them look vulnerable and more volatile investments particularly in the short term.
Geographical focus and emerging markets
SWFs are expected to maintain a wide geographical focus in their investments. North America and Western Europe were forecast to be among the most attractive regions for them in the next 12 months. Over a third of respondents singled out the US as the likely top destination for SWF funds, influenced perhaps by the recent investments in the banking sector, while nearly a quarter identified Western Europe as the leading region. Significant numbers also pointed to China as a leading potential destination.
Emerging markets in general, especially Asia and the Middle East, were also thought likely to be prominent. A high proportion both of respondents overall (around 56 per cent) and most SWF replies (over 70 per cent) believed that more than 25 per cent of total investments made by the sovereign funds would be made in emerging markets over the next 12 months.
An initiative by the International Finance Corporation could encourage this trend further. Some initial discussions have considered how SWFs could provide capital for a “super fund” for investments in Africa. The IFC said that SWFs may welcome an opportunity to invest at arm’s length.
This likely flow of fun ds into emerging markets has been identified as an important trend by financial services analysts. A report by Morgan Stanley said that SWFs would target “best-in-class cash generative players”, especially banks and financial services companies with exposure to Asia and emerging markets.
The financial services sector indeed is an important area for some of the larger SWFs. Temasek has, according to the Morgan Stanley report, 38 per cent of its portfolio invested in financial services. "The strategic angle of partnering with players who can develop domestic capital markets is also critical. Moreover valuations and the need by some financial institutions to raise fresh equity is creating a new range of opportunities," the report commented.
Respondents concurred that financial services would likely draw the most investment from SWFs over the next 12 months. Nearly half of non-SWF respondents agreed it would be the leading sector for SWF investment.
The other focus areas are forecast to be infrastructure, which most respondents agreed would be one of the top sectors, and energy, especially oil and gas. SWF respondents also agreed these sectors would attract most investment.
Transparency and disclosure
Transparency is now the most contentious issue facing SWFs. More than 80 per cent of respondents overall said they believed there was a need for more information from SWFs. Nearly half said it should take the form of a voluntary code of best practice while a third said a formal, multi-jurisdictional system enforceable by law should be considered.
This mood is in line with recent moves towards introducing disclosure requirements for private equity and hedge funds, so perhaps SWFs are not being singled out, especially in the UK. The Hedge Fund Working Group under Sir Andrew Large has published a report this year on voluntary standards for hedge funds, and Sir David Walker headed a working group which issued disclosure guidelines for private equity firms last year.
A majority (63 per cent) of non-SWF respondents accepted that the imposition of disclosure requirements would discourage investment by SWFs. But SWFs themselves were not so sure, with some 71 per cent saying it would depend on the nature of those requirements.
In a separate question addressed to all respondents according to 60.6 per cent of respondents, the lack of transparency rules are likely to result in governments restricting investments by the funds. This suggests that more disclosure would help to ward off protectionist moves.
The question of transparency will need to be confronted soon, although our respondents were divided on the question of how the issue would be resolved. Nearly 44 per cent thought SWFs would not accept a voluntary code of conduct in the next 12 months, while 28 per cent thought they would. Appendix 1 to this survey shows a timeline for proposal guidelines/codes of conduct for SWFs that have been under consideration by certain institutions.
Responses in this survey indicated that not all SWFs will be deterred from investing by codes of conduct. The debate about transparency needs to be seen in the context of other, stronger imperatives. When asked for the most influential factor determining the number of deals over the next 12 months, few SWF respondents (14 per cent) cited transparency requirements. The deeper global “credit crunch” was seen as more important, with nearly half of respondents overall citing it as the most influential factor. Indeed regulators and markets around the world acknowledge that SWFs will have an important role in alleviating the effects of the liquidity crisis.
SWFs themselves have shown they are willing to take on such a role. CIC, for instance, a $200 billion fund, recently announced it was allocating a larger proportion of its funds for overseas investment, raising the amount by over 30 per cent to $90 billion. CIC invested in both Blackstone and in Morgan Stanley last year, and the potential for a fruitful relationship with private equity was underlined when it expressed an interest in investing further in private equity managers.
While the taking of majority stakes in Western companies will be difficult to foresee for both regulatory and strategic reasons, there are precedents for SWFs taking control. Temasek, for example, and Malaysia’s Khazanah both acquired banks in Indonesia following the Asian financial crisis in the late 1990s.
In summary, with the amount of investment monies at their disposal, SWFs are developing into increasingly important investors across the globe. This survey shows that the private equity industy, financial institutions and corporates, despite some concerns about SWF transparency, generally welcome them as they are recognised as commercial, not political, organisations which have an active and influential role to play in the modern investment community.