Publications March 2009

Sovereign Wealth Funds Report, Q1

The Changing Landscape for Sovereign Wealth Funds

After a period during which sovereign wealth funds ('SWFs') continuously made headlines by their involvement in a number of high-profile investments in Western companies and, in particular, major U.S., Swiss and U.K. banks, the recent decline in comparable transactions has raised the question to what extent SWFs will continue to be active in the international markets in light of heavy losses across the board. In this report, we look at the impact of the current financial crisis on SWFs and examine the continued efforts to expand their portfolios while shifting their focus and priorities.

Market Size and Growth

A recently published report by International Financial Services London ('IFSL') estimates that assets under management of SWFs worldwide increased by 18% in 2008, to reach a total of $3.9 trillion. While this growth rate is projected to drop over the coming years due to the fall in commodity prices in particular the fall in the price of oil as well as the global economic downturn in general, IFSL believes that SWFs remain likely to double in size to approximately $8 trillion by 2015.

These figures suggest that the losses suffered by certain SWFs since the beginning of the financial crisis may have been subsequently offset by the continued influx of capital from various funding sources, including from Central Bank reserves in Asia and the Middle East, and from current account surpluses in many emerging markets, such as China and Russia.

Investment Trends

In terms of investment activity, SWFs from Asia have traditionally been among the most active investors of all SWFs, accounting for 66% of such transactions reported since 1995 followed by SWFs from the Middle East. Over the past 10-15 years, a majority of SWFs have targeted investments in North American and European companies. Specifically, investments in the financial sector have been the most prominent, reaching a total of $92 billion, or 77.4% of all SWF investments, in the last 2 years.

Despite the high level of investment in recent years, current trends indicate that SWF investments in North American and European financial companies have reached their peak. SWFs appear to have shifted their investment focus towards increasing portfolio diversification and targeting domestic markets.

Portfolio Diversification

Many of the SWF investments in the financial sector were large, single investments undertaken by a small number of SWFs. The heavy losses incurred over the last year by these SWFs with respect to some of these investments, coupled with the continued unpredictability of the global financial markets, have exposed the need for SWFs to achieve more balanced portfolios in order to help limit their overall risk exposure.
For example, after experiencing significant losses on some of its investments in the financial sector, China has shifted its overseas investment focus from the financial sector to natural resources. Similarly, Singapore's Temasek, under the lead of its recently appointed chief executive, Charles 'Chip' Goodyear, is expected to refocus its investment efforts on the top performing commodities. Other SWFs have adopted more risk-averse strategies, including the reduction of equity investment allocations in favor of investments in U.S. Treasury securities, gold, cash and fixed-income deposits.

Domestic Investments

The increased political pressure applied by domestic stakeholders to SWFs after their recent losses has caused a new trend to emerge among SWFs. SWFs, in response to this political pressure, are now placing an increased emphasis on injecting liquidity into the domestic markets in order to help revive local economies.

Recently, both the Corporation and the Authority have bought shares in their respective domestic banks, while France's strategic investment fund has already made a number of investments in domestic companies in an effort to bolster their finances.

The Way Forward

Depending on their exposure and ability to adapt to new market conditions, SWFs have been affected by the current financial crisis in different ways. In spite of the recent shifts in their investment focus, however, SWFs are still expected to return to the Western markets as they become propelled by strong growth, incentivized by internationally agreed principles on transparency and governance, supported by guidelines for open investment policies in recipient countries, and attracted by falling asset prices in these markets.