Sovereign Wealth Funds: The Next 10 Years

Ten years ago, I penned an article (see reprinted text here) in which I examined the phenomenon of large and increasingly active government-owned investment funds. While many of them had existed for decades, there was literally nothing available in the academic or practitioner literature on this phenomenon – not even an agreed term! So after some deliberation, I chose to call them “Sovereign Wealth Funds”. The timing of my article was opportune, in that the pace of activity in this particular segment was picking up dramatically, and the new name – and especially its 3-letter acronym SWF – seemed to fill a need: new funds were being set up all over the world, assets under management were growing fast, and increasingly the role these institutions were playing in markets was being studied and discussed by policymakers, academics and market practitioners alike.

What followed over the next decade was nothing short of spectacular.  In my 2005 paper, I identified 22 SWFs with an estimated US$ 895 billion under management. Today, according to Global Public Investor (a survey published in 2014 by OMFIF, see www.omfif.org), there are at least 80 funds which can be termed SWFs with an estimated asset size of just over US$ 6 trillion. Although one can legitimately contest whether certain funds should be included on this list or whether the size estimate might perhaps be a bit too aggressive, what is not in dispute is the fact that over the last 10 years SWFs have dramatically increased in both size and scope: even on most conservative estimates, they appear to have at least doubled in number and quintupled in asset size.

Perhaps more importantly, SWFs are now treated as a distinct and unique class of institutional investors: there is a whole new industry providing dedicated services, specialist research and professional publications all focusing on SWFs. The funds themselves have come together to establish the International Forum of Sovereign Wealth Funds (IFSWF), which helped strengthen their legitimacy and provided a platform for representing their views and advocating their interests. And perceptions in recipient countries have, for the most part, shifted decisively from suspicious distrust to constructive engagement.

But what does the future hold? As I contemplate the spectacular developments in the SWF industry over the previous decade, I cannot help trying to imagine how it might change over the next 10 years. At the risk of making a fool of myself in 2025, I will go out on a limb and make 6 specific predictions, starting with high-conviction forecasts, moving through lower probability views, and finishing with an outright speculative prognostication. However, as my level of conviction in each subsequent forecast declines, my estimate of the impact it would have, if it actually materialised, goes up – think of it as a positively-skewed right-tail risk.

Prediction #1: The Canada Model of investment management will win

Since late 2011, there has been a fascinating debate about the pros and cons of three different and distinct models of long-term institutional fund management: the Norway Model, which broadly speaking pursues orthodox asset management against established benchmarks in traditional asset classes, the Canada Model, which leans more towards absolute return strategies and is more often managed in-house, and the Yale Model, which relies heavily on alternative investments and hiring specialist external managers.  My prediction is that, in ten years’ time, the Norwegian model will have fully converged on the Canada model, while the Yale model will be used only by funds of certain size – certainly not the largest SWFs in the hundreds of billions of dollars.

Prediction #2: SWFs (and other long-term investors) will reshape global macro and volatility trading

Long-term institutional investors, including SWFs, have always had very limited presence in the global macro and volatility trading space, and for good reason: (1) both areas are quite complicated and require talent and expertise which is expensive and not easy to attract to work in a relatively low-paid, usually conservative and often bureaucratic environment; (2) both areas are usually viewed as short-term trading orientated, and as such, irrelevant to a long-term investor. However, this is about to change – and in a big way. I recently edited two books, which have received some acclaim, on both of these topics. And my main conclusion is that SWFs and other long-term institutional investors are about to discover these strategies. And when they do, they will revolutionise both industries: just imagine what happens when you take the skills, experience and analytical mind-set of a top-notch global macro or volatility specialist, lift it out of the short-term oriented, highly leveraged hedge fund and put it in the context of a very large, unleveraged and unconstrained long-term institutional investor. The implications of this are truly staggering!

Prediction #3: SWFs (and other long-term investors) will reshape the Venture Capital industry and the market for heritage assets

During the last 10-15 years, there has been an increasing tendency among SWFs and other long-term investors to allocate a larger portion of their portfolios to less liquid assets traded in private markets. The funds have become increasingly familiar with private equity, real estate, infrastructure, hedge funds and commodities, and some have even ventured into such esoteric areas as catastrophe bonds, life settlements and music rights. But two areas have so far remained largely outside this broad move: early stage venture capital (VC) and heritage assets (or art investments). I predict that in 10 years’ time, some SWFs – and this is certainly not an area for everyone! – will have moved massively into these 2 areas, and by doing so, will have reshaped them completely. While I still haven’t had a chance to look more closely at VC, recently I have completed two papers discussing the rationale and the mechanics of SWF investment in long-term heritage assets (forthcoming this summer in Bocconi University’s Sovereign Investment Lab annual report and ESADEgeo SWF annual report).

Prediction #4: IFSWF will become the equivalent of the BIS for the SWF community

The Bank for International Settlements (BIS) is widely known as the “central bankers’ central bank”. While I’m not suggesting that the IFSWF will become an “SWF for other SWFs”, I do envisage it effectively offering the same three core services to the SWF community that BIS does for central banks: (1) providing a platform for regular and confidential discussions between the world’s SWF chief executives and senior investment professionals; (2) generating research across multiple areas of policymaking and asset management directly relevant to the SWF community; (3) providing asset management and on-the-job training services to new SWFs and those SWFs which seek to expand into new and more esoteric areas. While this looks like a tall order for the IFSWF as it currently stands, 10 years is a long enough time horizon to achieve these ambitious goals.

Prediction #5: At least one African SWF will become as respected as GIC or ADIA

From my 20 years in global financial markets, I can attest that there are two SWFs which are always hugely respected by market practitioners as being at the “top of their game” – GIC, the Government Investment Corporation of Singapore and ADIA, the Abu Dhabi Investment Authority. These institutions are considered to be as sophisticated, smart and market-savvy as the best hedge funds and private equity houses anywhere in the world. I predict that, in 10 years’ time, Africa will have at least one SWF which will be as sophisticated and which will command as much respect and attention amongst market participants. Today, there are three potential contenders: the SWFs of Botswana, Angola and Nigeria;  the first of these is comparatively small but long established, well run and well respected, while the latter two have the potential to become very major funds indeed given good governance. But there are multiple new African SWFs being set up (or being considered) at the time of writing, and I think at least one of these will have the potential to surprise us 10 years from now.

Prediction #6: A new nationwide SWF will be set up in a major developed country (e.g. the USA, the UK, Germany, Japan, or Switzerland)

None of these countries currently have a nationwide (or federal) SWF, but I can see both the potential and the rationale for any one (or all) of them to do so. This prediction is clearly speculative, and it is certainly not based on any inside knowledge of any discussions within these countries, but if even one of them were to decide to set up a full-fledged SWF, I predict that it would be a game-changer domestically, and that it would have hugely significant implications internationally – a US or UK fund would be able to call upon the market expertise of the world’s two premier financial centres, while Japan, Switzerland and especially Germany look set fair to generate large and persistent current account surpluses for which an SWF might be a very logical development.

Watch this space!

Andrew Rozanov is an Associate Fellow of Chatham House and a  guest writer for Laburnum Consulting Ltd