Governments Helping Each Other?

One of the suggestions that is being mooted with increasing frequency against the backdrop of the Euro-zone’s (once again) deteriorating debt woes is that foreign sovereign investors should ride to the rescue of these fiscally challenged countries. One of the most obvious vehicles for the purpose are the so-called sovereign wealth funds (SWFs), which are really a somewhat ill-defined grouping of government-controlled funds typically funded from sovereign revenues. This change in Western attitudes marks a quantum leap from the widespread criticism until recently of sovereign investors as non-transparent and potentially unpredictable in as much as many critics thought them to be driven by political motivations. But, as so often before, beggars cannot be choosers. Many European economies now find themselves in a precarious situation whereas SWFs are among the largest pools of investible capital – thought to total close to $4trn – and they have at various stages during the crisis shown their potential to serve as a force for good by providing critical funding and boosting overall confidence. But also SWFs have in many cases responded to the previous criticism by shedding more light on their structure and behavior.

But what is the basis of bringing the two sides together in a mutually beneficial fashion? The crisis has had profound implications for the investment behavior of many SWFs. Faced with significant losses on most investments and economic pressures at home, the initial response of many SWFs was to turn in ward. For instance the Kuwait Investment Authority playing an important role in alleviating economic stress points through its acquisition of a stake in the troubled Gulf Bank as well as investments on the Stock Exchange. The Qatari Investment Authority acquired 20 per cent stakes in Qatari banks in order bolster confidence in the banking sector. In Saudi Arabia, SAMA drew down its foreign reserves from a peak of $448bn to $386bn between late 2008 and September 2009. Since then, however, many SWFs have increasingly turned their attention outside of the region, in large part because of the value opportunities created by sharp market corrections. In particular, the fundshave increased their allocations to equities, commodities, real estate, and infrastructure, as well as other alternatives such as private equity and hedge funds. Foreign investments rose sharply to 86 per cent of total deal value in 1H10. The primary focus was on developed-market equities with the advanced OECD economies accounting for three-quarters of SWF spending ($16.3bn) and nearly half of the number of deals.

The renewed foreign interest by many SWFs has not gone unnoticed and is being actively encouraged. At a time of crisis, SWF investments can serve not only as a mechanism for disposing of assets under distress but also as a way of re-establishing or underscoring economic credibility. Chinese and Norwegian support for Greece has been critically important in assuaging investor concerns about the country’s economic situation. The long-term profile of SWFs potentially enables them to overlook short-term volatility provided their assessment of the recovery prospects is positive. But SWF support can be a double-edged sword. Suggestions earlier this month by some SWFs that they were losing their interest in peripheral Euro-zone debt caused considerable investor anxiety. This reversal was clearly triggered by recent indications of a diminished EU appetite for unconditional bail-outs with the recent EU summit calling on investors to assume a greater proportion of the losses caused by default-type situations. In particular, the Russian National Welfare Fund announced that it had removed Ireland and Spain from the list of permitted countries while the Norwegian Pension Fund also expressed caution over Spain. It is generally agreed that this reassessment contributed to the latest increase in the borrowing costs facing the more vulnerable Euro-zone nations. Any retreat by likely to increase the pressure on the European Central Bank to engage in bond purchases.

Expectations of SWF support have become increasingly intense in some of the peripheral Euro-zone countries. While market corrections have in some instances created attractive long-term value opportunities, the SWFs – as guardians of national wealth – have every reason to tread with caution. Many of them suffered significant losses at the early stages of the crisis by failing to anticipate the severity of the downturn. But even now, some critical conditions are not always present to support substantial SWF investment. The appetite for major deals still frequently continues to be curbed by a home bias, something that a renewed relapse in the global economy would undoubtedly further reinforce. At the same time, investments are curbed both by available investable funds and often formal guidelines on asset allocation. In spite of a major reversal in attitudes, SWFs are likely to be deterred also by political factors, not least the residual public hostility to sales to foreign entities, something that can easily intensify when the volume of transactions increases or they come to involve sensitive assets. The risks of this are potentially significantly increased by the clear shift towards protectionism in the public mood in many countries. Finally, SWFs naturally wish to and should seek value. Unrealistic pricing, especially against the backdrop of continued uncertainty, should rightly deter them. But SWF investments can also serve as a way of bringing valuations to more realistic levels in return for the security provided by a certain buyer, as complicated as this often may be.

Ultimately, renewed SWF activism should not be seen as a panacea but deserved to be recognized as a positive force. Every effort should be made to turn this into a win-win situation for all concerned. One component of rectifying the global imbalances, however, controversial, will have to involve the acquisition of Western assets by emerging market surplus nations. SWFs can play an important and positive role in this process by boosting confidence, encouraging the emergence of market-clearing prices, and ensuring that the process is conducted in an economically rational way. Quite contrary to the political allegations, most SWFs are mature, experienced investors with a particular fiduciary duty as guardians of national wealth. In most cases, their interests are likely to be significant aligned with the countries and governments now calling them to the rescue. Supporting and managing this process can help reduce stress points in the global economy while supporting the important tradition of free trade and investment that has served as a the guarantor of global prosperity in recent decades. But just as much as many feared politically motivated investments in the past, they should not encourage the politically inspired abandonment of economic criteria in the current situation. Making Euro-zone investments attractive will have to involve serious reform. Investment in the absence of such reform be of little benefit to anyone.

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