By Mary Campell, Senior Reporter -- The first thing to know about sovereign wealth funds (SWFs) is that it’s hard to know anything about sovereign wealth funds. Even basic information – how many there are and what assets they manage – is subject to some speculation. But one thing everyone – particularly hedge fund managers – does know about SWFs is that they make attractive potential investors.
Don Steinbrugge’s best guess – and his guess is better informed than most – is that there are “at least 40 or 50” SWFs out there (“with new ones popping up all the time”) and they manage between $3 trillion and $4 trillion in assets.
Steinbrugge, CEO of Agecroft Partners, a Virginia-based hedge fund consulting and third party marketing firm, told FINalternatives that an investment by a SWF can be a very big deal for a hedge fund:
“If one of the very large ones hires your organization, it could be a very large mandate – you know, it’s not unheard of to get a mandate of $500 million or even $1 billion.”
Definition and History
The independent California-based SWF Institute defines a sovereign wealth fund as “a state-owned investment fund composed of financial assets such as stocks, bonds, real estate or other financial instruments funded by foreign exchange assets.” According to Steinbrugge, there are “three primary buckets” from which those foreign exchange assets come: oil – like the Alaska Permanent Fund or the Abu Dhabi Investment Authority (ADIA), commodities, and government surplus. (In fact, the latest figures from the SWF Institute show oil and gas are the source of 60% of total SWF funding.)
The thought behind such funds, says Steinbrugge, is that “these are assets that are not going to be needed in the short term, and, as a result, the objective of these funds in general tends to be to generate high-risk adjusted returns with a long-term focus as opposed to currency reserves that are very short-term oriented.”
Although SWFs have been around for years – the Kuwait Investment Authority (KIA), for example, was established in 1953 – their total size had increased markedly over the past 10-15 year. In 1990, SWFs managed assets worth about $500 billion; today, as mentioned, the total is $3 trillion to $4 trillion; and by 2012, that total is expected to hit $10 trillion.
What’s interesting, says Steinbrugge, is that “if you look at the top 20 [SWFs], 10 of them didn’t exist 10 years ago.”
In terms of size, he says, there are “a fair number of sovereign wealth funds that are well below a billion dollars; you also have a number that are well above $100 billion.”
At the high end of the spectrum are funds like ADIA, which the SWF Institute lists as the largest SWF in the world, with an estimated $672 billion in assets; followed by Norway’s Government Pension Fund (Global), with assets of $445 billion; and Saudi Arabia’s SAMA Foreign Holdings, with estimated assets of $432 billion.
That ‘estimated’ brings us back to our opening contention: that it’s hard to know a lot about SWFs. Take assets, for instance:
“The exact dollar amount is only an estimate,” says Steinbrugge, “And the reason it’s only an estimate is because there are significant differences in transparency between various sovereign wealth funds. For example, if you take the Alaska Permanent Fund, they’re very transparent about what their assets are, what they’re investing in, what managers they’re investing in.” On the other hand, “If you take the Iran Oil Stabilization Fund, they’ll tell you absolutely nothing.”
The SWF Institute uses something called the Linaburg-Maduell Transparency Index to rate funds on a scale of 1 to 10 (where 1 indicates a low degree of transparency and 10 is high). The ratings of the top funds mentioned early vary wildly: the ADIA has a 3 rating, the Norwegian Pension Fund a perfect 10, and the SAMA Foreign Holdings fund a 2. (The Iran Oil Stabilization Fund gets a 1 – the lowest possible rating – while the Alaska Permanent Fund also receives a 10).
The veil of secrecy may be lifting, however. ADIA published its first ever annual review in March 2010, revealing that over 80% of its assets are managed by external managers, with private equity benchmarked at between 2-8% of the total portfolio.
Steinbrugge says he believes SWF transparency is an issue that the government regulatory authorities in various countries are looking into:
“I know there is a lot of pressure on sovereign wealth funds to reveal what they’re invested in and I don’t think the concern is necessarily how much is put in hedge funds or private industry or stocks or bonds – it’s more in reference to investments in strategic industries…those affecting national security.”
“You obviously wouldn’t want a sovereign wealth fund buying one of the leading defense contractors in your country. Or, you wouldn’t want a sovereign wealth fund buying your oil companies, just to throw out a couple of examples.”
Interest to Hedge Funds
Sovereign wealth funds currently account for 5% to 10% of hedge fund investments, says Steinbrugge. (To put things in perspective: even if the lower-end, $3 trillion estimate for SWF assets is correct, it’s still double the $1.5 trillion controlled by hedge funds as of early 2008).
That represents about 6% to 7% of total SWF assets. Funds with a hedge fund allocation, says Steinbrugge, tend to be the ones that have been around a long time – or the largest ones.
“The reason for that is, the ones that have been around a long time are fairly experienced, investment savvy, have built up pretty big research teams and feel comfortable in diversified alternatives. As far as new funds...there’s a strong trend towards an increase in their allocations to hedge funds.”
Steinbrugge says SWFs tend to follow a three-step process, when it comes to hedge fund investment. The first step is investing in funds of funds. Then, “once they get comfortable,” they begin to go direct which, in the beginning, usually means buying “a lot of the well-known, brand name hedge funds.” The third step, once they get “very comfortable” is to focus on alpha. At that point, he says, they may begin to invest in more medium-sized funds.
But this process is by no means carved in stone, as Steinbrugge is quick to point out, offering the example of a large new fund, the Chinese Investment Corporation (founded in 2007, now with estimated assets of $288.8 billion), which skipped the ‘fund of funds’ step completely. “They went out and hired a very experienced person to help them go direct, a guy by the name of Felix Chee who used to head up the endowment at the University of Toronto and was very influential in U of T beginning to go direct.”
China has established a number of very large funds over the past decade (besides the Chinese Investment Corporation, there’s the SAFE Investment Company, with estimated assets of $347.1 billion, according to the SWF Institute, and the National Security Fund, with $146.5 billion). As a result, China is challenging the Middle East, which once dominated this space.
When it comes to hedge fund investments, Steinbrugge says these funds are leaning toward the United States and Europe, chiefly because this is where most brand name hedge funds are located.
The SWF market is growing faster than endowments and foundations or pension funds, he says, and sovereign wealth funds tend to be “fairly stable, long-term oriented investors,” both of which make them attractive to hedge fund managers.
So what should hedge fund managers hoping to attract SWFs as clients be prepared for?
Steinbrugge offers a few tips:
“I think one of the things they need to be prepared for is a long due diligence period because sovereign wealth funds are very thorough in their due diligence. And I think, for the very large sovereign wealth funds, you need to be prepared to show a fair amount of transparency.”
“I think the sovereign wealth funds are focused on liquidity and for the very largest sovereign wealth funds, there could be push-back on fees.”
But for an investment worth a potential $1 billion, maybe a little push-back is worth it.