Sovereign Wealth Funds are state-owned investment vehicles that control a portfolio consisting of national and international financial assets. The capital that these institutions manage is essential for the economies as it allows them to mitigate economic shocks; safeguard the wealth of future generations; make key investments for the country’s development; pay pensions; or maximize the profitability of a percentage of the country’s international reserves – generally the surplus over the level deemed optimal - which are usually managed following a capital preservation approach.
What’s the actual volume that they manage?
Currently, SWFs are estimated to manage approximately $7 trillion, almost twice the amount managed in 2007. By way of reference, the total volume of reserves managed by central banks is approximately $13 trillion.
How did they reach this level of assets?
The world’s largest SWFs have two ways of amassing their massive level of reserves. First, as a result of significant trade surpluses, and, second, through commodity exports, especially oil. In the first group we find SWFs and monetary authorities from Asian countries such as China, Singapore, Korea and Malaysia, while the second group is integrated by funds from the countries of the Arabian Peninsula , Norway and Russia, to name a few.
In what assets do they invest?
Investments in sovereign funds can be classified into two large groups. On the one hand, direct investments in capital markets in publicly traded instruments such as bonds (sovereign, corporate and financial) and shares. This type of investments goes virtually unnoticed by the public, but actually accounts for the largest portion of SWFs investments. Indeed, it is estimated that 35% of the assets wealth funds manage are invested in bonds and another 35% in shares. Some of these investments follow stock indexes and are therefore capable of holding a highly diversified exposure both in terms of countries and sectors.
For instance, Norway's Government Pension Fund Global or GPFG, the largest SWF in the world, holds a sizeable debt and share investment portfolio in Spain, which, at the end of 2015 stood at about €15.8 billion in approximately 120 different securities.
The other large group of investments are direct investments in companies and assets (real-estate, private equity, company acquisition) which account for nearly 30% of the assets they manage. This percentage is poised for future growth, based on the fact that it has been on the rise since 2007, when they accounted for barely 15% of their assets. These investments do get more media coverage.
What characterizes sovereign funds vs other types of investors?
Sovereign funds are long-term investors, i.e. they can make investment decisions considering much longer time frames (beyond economic cycles), and this allows them to adopt counter-cyclical positions.
Sovereign funds are known as “real money” investors, because their funds do not come from leverage (deleveraged funds) or from liabilities with third parties (unlike the pension funds, which are subject to pension-related liabilities).
Sovereign funds can also invest in illiquid assets, because they do not have to meet any financial obligations.
What are the sector’s most representative forums?
The IFSWF (International Forum of Sovereign Wealth Funds) is the forum par excellence. Its first meeting was held in 2007 and established the governance, accountability and transparency fundamentals for the investments they made.
CROSAPF (Co-Investment Roundtable of Sovereign and Pension Funds) is the co-investment forum that will hold its third meeting this year, in Azerbaijan. This forum provides the ideal framework to explore investment opportunities with the private sector.
How are these funds being affected by falling commodity prices?
The drop in commodity prices has caused some sovereign wealth funds to decrease their level of investment. This is leading to an optimization of the investment portfolios and some borrowing to fund some acquisitions that before would have been funded through equity. Looking forward, it will be interesting to see how their investment portfolios evolve.
How do financial institutions help sovereign wealth funds manage their reserves?
Sovereign funds need to rely on financial institutions to perform their functions. BBVA, for instance, has teams exclusively devoted to offering coverage to public sector customers, including sovereign funds.
Through these units, BBVA offers a series of intermediation mechanisms to sovereign wealth funds, including the purchase-sale of bonds and shares, time deposits, mandates for outsourcing the management of a portion of their reserves, hedging instruments, funding and a broad range of M&A products.
In this line of support, BBVA organizes a yearly seminar for public sector issuers and investors. During this seminar, sovereign funds have the opportunity to go over some of the current financial topics and share their needs, making it easier for BBVA to figure out ways to help them meet their investment strategy goals.