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Sleeping Giants: The Rise of Sovereign Wealth Funds

For decades, sovereign wealth funds (SWFs) have preferred to remain in the shadows. Little was known about them and their nature as long-term passive investors helped keep it this way. In recent years, however, the nature of SWFs has begun to evolve. Alongside accumulating a large and growing pool of capital, the profile of sovereign wealth has been boosted by high-profile investments in disruptive technology giants, such as Uber and WeWork; a growing appetite to develop their own internal operations; and the close relationship between SWFs and national governments. In this post, I will outline three ways in which SWFs are becoming increasingly serious and influential players in the asset management space.

What Are SWFs?

SWFs are best understood as the investment arm of national governments. They are traditionally associated with resource-rich nations that are looking to diversify their wealth, so it is no surprise that many of the largest funds are in resource-rich regions such as the Persian Gulf States and the Asia-Pacific. The assets under management (AUM) represented by the top 15 funds—excluding public pensions—has grown at an annualized rate of 6.6% a year since 2012 to US$6.8 trillion. Countries from both the emerging markets and the developed markets are increasingly keen to establish their own SWFs. Recent countries to set up their own SWF were Mexico (2015) and Turkey (2016), while Israel and Romania are both close to launching their SWFs imminently. In August, the European Union proposed the idea of a 100 billion euro fund to support strategic sectors. As the number and value of SWFs increase, so has their ability to affect and guide the wider asset management industry.  

Technology and Data

As the digital transformation of the asset management industry as well as the wider economy continues, SWFs are keen get on the front foot. Aite Group’s analysis of SWF’s spending costs on technology and data shows that in 2018, the total spend by the top 15 SWFs is estimated at US$682 million, and this is expected to rise to US$850 million by 2021. The gradual shift toward internal investment management within SWFs is fueling demand for more sophisticated in-house technological innovation such as look-through capability that allows fund managers to identify exposures at any level of ownership. There is also a growing appetite within the SWF space for fintech investments with startups, such as the financial affiliate of Chinese e-commerce giant Alibaba Ant Financial, Indonesian e-commerce marketplace Bukalapak, and Berlin-based mobile banking company N26, all receiving significant investment from SWFs. Through their investments and internal developments, SWFs are fueling both the supply and demand for an increasingly digitized investment management industry.

ESG

With environmental, social, and governance (ESG) considerations featuring more and more prominently in the investment strategy of buy-side firms, the formidable investment clout of SWFs makes them a key player in the future of ESG. In July 2018, six SWFs  that collectively represent US$3 trillion committed to only invest in companies that account for climate risk in their business strategies. SWFs are also significant investors in the green bond market. Earlier in 2019, Hong Kong raised US$1 billion through its first sovereign green bond issuance, with 41% of orders going to SWFs, supranationals, and central banks, as noted in this article. Perhaps most famously, the world’s largest SWF in Norway has divested from oil, gas, and coal companies. This represents US$13 billion worth of divestment from listed fossil fuel companies and a legal mandate to instead invest up to US$20 billion directly in renewable energy projects as noted here. With ESG high on the asset management industry’s agenda, the increasing investment clout and responsiveness to ESG concerns makes sovereign wealth an increasingly important player in the asset management space.

Protectionism

In theory, while SWFs are supposed to diversify wealth away from local exposure, in practice, their close relationship with national governments can often breed protectionist tendencies and a more regional asset management approach. In the current age of global trade tensions and a stubborn suspicion of international finance, many SWFs (particularly the newer ones) have been encouraged to invest in local companies and to develop nearby regions. As far back as the mid-2000s, Chinese and Emirati bids for U.S. companies worth tens of billions of dollars fell through, explicitly due to U.S. concerns over political interference and national security. While U.S./China tensions are in the spotlight today, there are rising protectionist instincts rising across the globe: from Brexit to NAFTA, to TPP, to the current South Korea/Japan standoff. Through their relationship with national governments and growing tendency to take a regional approach to their investments, SWFs are becoming key players in the current international investment climate.

Conclusion

The growing stature of SWFs make sovereign wealth a growing and serious force to be reckoned with in the asset management industry. Through their ESG strategies, use and investment in technology, and their unique relationship with national governments, SWFs are increasingly unable to avoid the scrutiny they have long evaded. For further reading, the Institutional Securities &Investments team at Aite Group published a report in September 2019 examining in detail the rise of sovereign wealth and its implications for the wider asset management industry. This report is based on a detailed analysis of the publicly available annual reports of the top 15 SWFs and Aite Group interviews with two large SWFs.