Sovereign wealth funds (SWFs) are attracting public attention as more countries open funds and invest in big-name companies and assets. This has given way to widespread concern over the influence these funds have on the global economy, attracting public attention regarding their accountability for the nature and type of investment. In this report, Asia Thinkers discusses the funds’ accountability to its investors, “the public” and their focus on profit and/or their support in building a better society.
Sovereign Wealth Fund
Sovereign wealth funds (SWFs) is money accumulated from a country’s budget surplus or public saving and is a way for countries to invest excess capital into markets or other investment to accrue wealth for the benefit of their citizens.
Since the first sovereign wealth fund “Kuwait Investment Authority” was established in 1953 to invest excess oil revenues, the last few decades have seen the size and number of sovereign wealth funds increasing dramatically. According to the SWF Institute, there are more than 91 countries with over 400 sovereign wealth funds with cumulated assets amounting to nearly $8.2 trillion in 2020. Currently, the world’s largest funds are the Norway Government Pension Plan, the Chinese Investment Authority and Abu Dhabi Investment Authority. Other funds investing globally include the Hong Kong Monetary Authority, Australia’s Future Fund, USA, “The Alaska Permanent Fund, Russian National Wealth Fund and the Indonesian Investment Fund.
The original reason for a country to establish a sovereign wealth fund was to act as a stabilizer to diversify the country’s money by investing in other areas. However, a recent trend has seen a growing number of funds turning to alternative investments, such as hedge funds, private equity and emerging assets such as cryptocurrency.
There has always been debate amongst economists over SWF’s size and potential impact on the global economy and political implications for countries. One example is the mortgage crisis of 2006-2008, where the Chinese sovereign wealth funds helped rescue struggling Western banks such as CitiGroup and Merrill Lynch. Concerns over the influence of SWFs resulted in legislation to curtail their investment in the USA. Globally, political leaders have asserted that sovereign wealth funds can pose a threat to national security, and their lack of transparency has fuelled this controversy. This debate has extended to public accountability for Sovereign funds investment decisions, often investing in high-risk emerging asset classes such as cryptocurrency and excluding socially responsible investments from their portfolio.
Some economists argue that Sovereign funds by their very nature focus on profitability and social issues should not be the concern of financial advisors. Others suggest that this traditional approach is outdated, and profit is not the only goal, suggesting that SWFs in today’s world have a responsibility and duty of care to invest in companies that bring both profit and social benefits to their investors.
Norway: A case study
A recent review suggests many funds make small investments domestically to address social issues, such as the China Investment Corporation (CIC), which is involved in poverty eradication efforts in various provinces in China and Singapore-owned SWF Temasek Holdings establishing the Temasek Foundation to deliver community programs, while the Norway SWF has made climate change and net zero emissions at the core of their investing philosophy.
The Government pension fund of Norway also known as the “Oil Fund” was established to invest in the surplus revenues of Norway’s petroleum sector. Norway’s sovereign-wealth fund holds over $1.2 trillion in assets, making it the largest of the world’s funds. The focus is to push the thousands of companies in its portfolio to reach net-zero emissions by 2050. The move is part of a larger climate action plan in accordance with the Paris Agreement. Norway’s sovereign-wealth fund has announced that it aims to have every company in its vast portfolio of 9000 companies in 70 countries reach net-zero greenhouse gas emissions by the Paris Agreement target date of 2050.
”Our goal is to be the world’s leading investor in terms of how climate risk is managed,” said Nicolai Tangen, the fund’s CEO, “Our long-term return will depend on how the companies in our portfolio manage the transition to a zero emissions society.” The fund’s push for net-zero targets came after the Norwegian government publicly urged the fund to adopt zero-emission goals.
Photo: Global Citizen
Legitimacy and Accountability
A critical review by financial analysts reveals a general lack of Government regulation of SWFs. Such a trend is prominent in either oil-rich monarchies, e.g., Kuwait, Abu Dhabi, and Qatar; autocracies, e.g. Russia and China; and democracies dominated by a single political party, e.g. Singapore and Malaysia. A UK Economist commented to Asia Thinkers that “it is becoming increasingly important that Sovereign funds must not only demonstrate transparency as to the risk but also be transparent as to the investment objectives. The 1 Malaysian Development Berhad (1MDB) scandal illustrates the lack of transparency and accountability allowing the use of the Malaysian SWF as a vehicle for corruption and abuse.”
The Norwegian sovereign wealth fund’s approach and leadership on governance and stewardship illustrates how highly influential it can be in establishing management of the funds’ direction and accountability, ensuring companies in the fund reach the goal of net-zero emissions of greenhouse gases. Wilhelm Mohn, global head of corporate governance at Norwegian SWF explains: “The corporate governance function is responsible for developing the fund’s position and expectations when it comes to governance and sustainability matters and implementation. Big decisions are anchored in the Norwegian parliament, and there is scrutiny on the funds’ strategic direction as well as results.” He further commented “that the SWFs transparency and accountability were key. It was very important that the funds’ intentions had the broadest possible support in Norway as well as political support in Parliament and that the fund was managed in a way where there was consensus from the Norwegian population”.
Accountability for High-Risk Investments
Sovereign wealth and pension funds continue to search for profits by investing in alternative emerging assets such as Cryptocurrency despite the risks and apparently without any public mandate. A Hong Kong banker commented to Asia Thinkers that “sovereign funds have traditionally been accountable only for profit and have started to invest outside the traditional asset class especially investing heavily in emerging assets such as cryptocurrency and blockchain to obtain greater profits, be it at a higher risk. But as numerous government authorities have pointed out this is an unregulated environment containing regulatory uncertainty. As one US financial advisor stated, “How any pension plan could ever justify investing in cryptocurrencies that are likely to be deemed unregistered securities or exchanges is beyond the pale.”
Despite the fall from the grace of cryptocurrencies, it would appear sovereign investors are still looking at exposure to the sector and continue to pump in millions in a bid to increase risk in their profile in the hope of long-term higher yield. Singaporean state-owned investors GIC and Temasek have been leading the way, having made a number of large-scale investments in this area.
In January 2022 Temasek and Canadian pension fund OTPP participated in fundraising by cryptocurrency exchange FTX US, which competes with leading crypto exchanges Coinbase and Binance. November 2022 saw the collapse of FTX once the second-largest cryptocurrency exchange, where at least $1bn in investor assets appeared to be missing resulting in FTX filing for bankruptcy. While the loss was negligible in terms of the Singapore fund’s overall portfolio, questions are being raised over diligence in the decision to expose the fund to a highly volatile commodity, using pensioners’ money.
The Singapore Government took immediate action .”Temasek’s investment loss of $275 million in the collapse of cryptocurrency exchange FTX was disappointing and damaging for Singapore and the losses Singapore’s sovereign wealth fund suffered were being taken seriously.” said Deputy Prime Minister and Finance Minister Lawrence Wong. The Finance Minister further commented that “Temasek recognizes this and has issued a comprehensive statement to explain its due diligence process and the circumstances leading to its investment in FTX,” adding that an internal review is being conducted to study what went wrong with the FTX deal and how to improve the risk management process.”
“The International Monetary Fund” reports that sovereign wealth funds have a higher degree of risk than traditional investment portfolios, holding large stakes in the often-volatile emerging markets and assets. The original reason for a country to establish a sovereign wealth fund was to act as a stabilizer to diversify the country’s money by investing in other areas such as property, infrastructure, company startups and commodities However, a recent trend has seen the majority of funds to a greater or lesser degree, turn to alternative and more risky investments, such as hedge funds, private equity and emerging assets such as cryptocurrency. With the collapse of alternative investments in 2022 led by the cryptocurrency collapse and bankruptcy of the FTX crypto exchange, major sovereign funds lost millions including the Australian Future funds, Australian retirement fund, Canada’s CDPQ, the Ontario Teachers’ Pension Plan, and at least 15 US pension funds including the Houston Firefighters Relief and Retirement Fund, Alaska Retirement Management Board California Public Employees Retirement System, Delaware Public Employees Retirement System and the New Mexico retirement board.
There have also been heavy falls in stock and bond markets over the last year, caused partially by raising interest rates and the Ukraine war cutting the combined value of the world’s sovereign wealth and public pension funds for the first time ever, Overall sovereign funds lost 1 trillion in 2022 due to world fundamental forces affecting growth. According said Stephen Jen, global head of currency research at Morgan Stanley. “We are now taking seriously the possibility that some SWFs may be forced to sharply slow down their pace of purchases of risky assets or, in extreme cases, liquidate parts of their portfolio in the coming year or so.” He estimates SWFs may have seen paper losses in the order of 25 per cent this year as global stock markets and other alternative asset markets declined. His report, which analysed 455 state-owned investors with a combined $32 trillion in assets, found that Denmark’s ATP had had the toughest year anywhere with an estimated 45% plunge. With Norway’s sovereign wealth fund reporting a record loss of 1.64 trillion for the whole of 2022, citing “very unusual” market conditions. Other reports indicate that despite the losses SWFs continue to invest. The Global SWF report said 2022 saw the re-emergence of the mega deals − investments of more than US$1 billion − with average deals by sovereign wealth funds back up to levels not seen since 2016.
Asia Thinkers posed the following questions to a Hong Kong financial analyst: Sovereign wealth funds have grown extensively over the last few years and are now a major player in the world economy.
Should SWFs be focused just on profit to increase the wealth of an individual country or with escalating global social and environmental issues, is there a responsibility to support and manage investments which can help to drive social change eg education, clean water, climate change?
Comment: This is quite a complicated issue. I personally believe that SWFs have a responsibility firstly to their shareholder to make a profit but this is not incompatible with investing in Environmental, Social Corporate Governance (ESG). From my understanding, SWF’s around the world have very different preferences to the ESG issue. In Europe, the ESG focus is very big whereas in Asia (and some of the US state-controlled funds) investing with an ESG mindset is not so important. Today more than $20 trillion, or a quarter of all professionally managed assets worldwide, follow ESG strategies.
Our view as a firm is that the world has just gone through the first attempt of ESG investing which isn’t a particularly refined approach and is heavily politically driven (I certainly wouldn’t want politicians telling me which companies to invest in!). I think we are slowly moving into an ESG ‘2.0’ phase of investing which will take a more sensible approach to these issues rather than trying to facilitate various interested parties transition to their view on being Carbon Neutral when we are finding out the world still will require fossil fuels for the foreseeable future.
Generally, the ESG solutions available have a heavy focus on the ‘E’ which translates to an overweight in technology and an underweight in energy (exactly the opposite of where you would want to be positioned last year). We are aware that the larger institutions (big insurance companies etc) are asking for a far more discerning approach to their ESG allocations and asking for managers to run customized solutions that cater to their ESG preferences, which can include issues with clean water as well as carbon emissions.
Should SWFs invest in emerging asset classes such as cryptocurrency, which have a greater risk of Loss and be more transparent and accountable as to the nature of investments to the parliament/public?
Comment: In answer to your second question about transparency I think the answer is very much yes, it is essentially public money, so accountability on performance is important. That’s not to say that an SWF should not invest in more speculative assets that carry a greater risk-reward premium, but the people making the decisions on how to allocate capital should be held accountable for the performance against a clearly defined set of objectives.