Once seen as pariahs of international markets threatening national strategic assets and now hailed as white knights to wobbling banks, Sovereign Wealth Funds (SWFs) have been on a rollercoaster ride in the past year. However, while their standing may have improved, SWFs are now nursing billion-euro paper losses. Faced with increasing public pressure at home to account for those losses and political demands that they should help prop up flagging domestic economies, many are now reviewing their investment strategies to protect their long-term interests.

According to the California-based independent Sovereign Wealth Fund Institute, SWFs manage an estimated $3.91trn (€2.86trn) in assets, with about 46% in the hands of Middle Eastern governments and 35% held by Asian governments. While most funds are rather secretive about their investments, a few have officially acknowledged the huge losses sustained following the worldwide dive in stock market valuations and as a result of investments in financial institutions that went sour: Singapore’s Temasek Holdings’ portfolio has lost about 31% in value or about €27bn, while the Government of Singapore Investment Corporation’s (GIC) assets have dropped 25% from their peak and the Kuwait Investment Authority is down €22.5bn. Even the world’s largest SWF — the Abu Dhabi Investment Authority — has not been spared, possibly losing €92bn last year, bringing its portfolio at the end of 2008 down to an estimated €240bn, according to the Council on Foreign Relations (CFR), an independent think-tank. 


Timing, it appears, is everything. According to CFR’s Brad Setser, China may have lost €60bn on €120bn worth of overseas equity holdings. The State Administration of Foreign Exchange (SAFE), which manages almost €1.46trn of reserves, began making huge bets on global stocks in early 2007, and continued, analysts believe, until the collapse of Fannie Mae and Freddie Mac in July 2008, despite the prior warning signs of the subprime crisis.


For some the mantra is now once bitten, twice shy; a recent survey by Financial Dynamics International showed that SWFs are now adopting a more cautious approach, particularly when it comes to bailing out distressed firms. Instead, they’re likely to hold onto their cash and wait for markets to bottom out before making more significant investments. “When the market fell, we went into UBS and Citi. But we went in too early,” remarked Lee Kuan Yew, chairman of Singapore’s GIC at a banking conference in early March.


Tjun Tang, partner and managing director of the Boston Consulting Group in Hong Kong, believes there is a new dynamic at work in terms of the management of these funds: “Though they have traditionally been long-term investors, their time horizon seems to have shortened dramatically. Now if they make an investment and it comes under significant short-term volatility, they’re under much more pressure from stakeholders at home, such as the government, national economic think-tanks and the public. What this means, is that a number of funds are more likely to wait to see an uptick in the market before stepping in rather than trying to invest at the bottom of the cycle.” 


Kirby Daley, senior strategist at brokerage Newedge Group in Hong Kong, believes SWFs will turn to investment strategies that reflect the new economic and geo-political environment. “I think we will see some varied responses by SWFs to the coming global economic environment. The new environment will be one where protectionism, resource procurement and capital preservation will be themes that SWFs will consider more than they did over the past two years.”


Tang agrees: “There are some common themes about what SWFs are looking to do. Firstly, looking at how such national funds can support their domestic economies, either through fiscal stimulus, financing new infrastructure or recapitalising domestic institutions. There is also a strong theme around physical assets, as a hedge against their consuming needs for commodities.”


Such changes are already happening: Russia’s National Wealth Fund recently invested €4.76bn in the domestic stock market, and placed €4.7bn on deposit at state bank VEB; China Investment Corporation, the Chinese government’s SWF, recently raised its stake in the country’s three largest state-owned banks (Industrial and Commercial Bank of China, Bank of China, and China Construction Bank); and SWFs in Qatar and Kuwait have started buying shares of their country’s listed banks to bolster confidence. 


Rachel Ziemba, RGE Monitor’s lead analyst for oil exporting economies, says several SWFs have also started to increase their exposure to commodities “both through futures and through direct purchases in commodity-related equities such as oil, gas, mining companies.” 


Temasek set up oil and gas exploration and production subsidiary Orchard Energy last year, with a view to secure some energy supply, while China’s SAFE took a 1.8% stake in French oil giant Total.


Amrita Sen, analyst at Barclays Capital in London and co-author of a recent report on SWFs and their strategy towards commodities, believes that some will invest in commodities as they are likely to offer stronger rates of growth for now. She notes that commodities can be a hedge against inflation, and the asset class has the advantage of showing little correlation with stocks and bonds.


“Surveys suggest SWFs may now have $10bn–$20bn [€7.3bn–€14.6bn] in commodities and oil, but this is underweight, by most measures, and could rise rapidly to hundreds of billions of dollars. Though the current direct SWF exposure to commodities is limited, we expect this to increase over the next few years,” she says.


However, Edwin Truman, a senior fellow at the Peterson Institute for International Economics, warns that it would be “unwise” for funds that are fuelled by commodity earnings to invest in commodities, stating: “They would not be diversifying.” 


Ziemba believes SWFs from oil producing countries will take a different approach to commodity investment to non-oil SWFs: “Asian funds might find investing in commodities a good way to diversify from other sources of incomes. But for oil funds, investing in commodities would be a form of doubling down, increasing their exposure to energy prices. But they could invest in agriculture to offset the fact they are net importers.” 


A third investment theme for some SWFs could be the commercial property market. CB Richard Ellis has predicted SWFs could potentially invest as much as €53bn over the next seven years in that sector, bringing the sector weighting to 7% of their total assets.


“Favoured future destinations are expected to include Japan, the UK and other countries with currencies that are not held in the SWF’s foreign reserves,” stated Michael Haddock, CBRE’s director of EMEA Research in a recent report.