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Post-financial crisis outlook: What's ahead for sovereign wealth funds?

Despite bleeding from the financial crisis, sovereign wealth funds - the mighty government-controlled investment entities - have been quite active in recent weeks, with some making noticeable investments in global projects and others gearing up to clinch future deals.

The most recent move by a sovereign wealth fund came July 28, when Aabar Investments, controlled by International Petroleum Investment Co., which is owned by the government of Abu Dhabi, agreed to pump $900 million into Virgin Galactic, a British commercial space travel venture.

Aabar earlier invested $1.8 billion in Daimler AG, the German manufacturer of Mercedes-Benz cars. It has also invested in Tesla, the California-based electric car manufacturer.

Aabar's deals coincide with moves by several other sovereign wealth funds:

*Khazanah invested $25 million as part of a $108 million financing in Small Bone Innovations Inc., a U.S. specialized orthopedics company;

*China Investment Corp. announced on June 2 a $2.2 billion investment in U.S. banking giant Morgan Stanley. On July 3, it made a $1.5 billion investment in Teck Resources, a mining company in Vancouver, B.C. It took a stake worth $365 million in the UK-based Diageo plc, an alcoholic beverage company.

Meanwhile, the Libyan Investment Authority and Italian aerospace and defense company Finmeccanica have agreed to form a joint venture to invest in Africa and the Middle East in aerospace, electronics, transportation and energy.

"This cooperation is an example of LIA’s consistent and continued investment in solid strategic investments and alliances globally, as a long-term investor," said Mustafa Zarti, deputy chief executive, the Libyan Investment Authority. Finmeccanica and the Libyan Investment Authority share the view that the Middle East and Africa "will offer significant investment opportunities."

These moves contrast with the picture earlier this year when several sovereign wealth funds reported hefty losses.

The Alberta Heritage Fund’s fair value was CDN$14 billion at March 31, down $3 billion from the previous year. A plunge in world equity markets and the credit crisis primarily caused the 18.1 per cent decline in the fund net assets.

Singapore's Temasek Holdings put its loss at 31 percent to $81 billion between March and November 2008.

Kuwait's sovereign wealth fund lost about $31 billion, and Abu Dhabi Investment Authority, $125 billion.

Last week, Bahrain's Mumtalakat Holding reported losing $184 million last year, with total assets plunging by 7.6 percent.

No doubt, these debacles somewhat crushed sovereign wealth funds' appetite for risky investments, inducing them to trim their investment time
horizons to deal with market uncertainties. Additionally, funds floated by oil-producing countries have changed their return expectations and postponed some investments.

Going forward, sovereign wealth funds are unlikely to be aggressive investors as they were during the past two years, unless they can grab assets at fire-sale prices. They now appear to be moving toward creating stabilization funds to support their own economies from the shocks of falling commodity prices and export earnings. 

In fact, Bahrain's sovereign wealth fund made it clear in May that it would focus on its domestic investments. The  Kuwait Investment Authority and Qatar Investment Authority have also made key investments in domestic equities.

Kazakhstan’s sovereign wealth fund, Samruk-Kazyna, plans to buy gold, copper and iron assets that would benefit companies such as London-listed KazakhGold Group, Kazakhmys, Eurasian Natural Resources Corp. and Toronto- listed Alhambra Corp. Singapore’s Temasek, CIC and Brazil’s sovereign wealth fund are expected to follow suit.

Gulf asset management policies now favor domestic and emerging market economies over Western economies, according to Oxford Analytica, a private research organization in Oxford, England. While the attention to their domestic economies may decrease once the economic downturn eases, portfolio diversification and investment in emerging markets are likely to grow in prominence among regional funds.

Arab SWFs have pulled back somewhat from global markets as the value of their investments has fallen and have focused more on domestic economies. Gulf investors have also expressed interest in future development plans in their home countries. With more than 50 per cent of the population under age 24 years, the Gulf nations desperately want to create jobs.

Early August, Dubai World suspended several of its planned projects. "Dubai World has put on hold a number of projects until the market improves, including some tourism projects in Africa and elsewhere," a Dubai World spokesperson said in a statement.

With the formation of Dubai World Africa, it had planned to invest more than $1.5 billion over five years.

The International Monetary Fund recently observed that some sovereign wealth funds are seeking indirect hedges to offset falling commodity prices. Such a step would change the asset allocation strategy in the sovereign funds' portfolios, leading them to invest in new sectors, new regions and new asset classes.

Natural resources, especially mining, would benefit from such moves, because they have low exposure to sovereign wealth funds now. Currently, banks and financials have the highest exposure, even after the market bloodbath, followed by real estate and energy.

The energy sector, however, would be relatively low priority for some funds, because several large fund sponsors already have an exposure to the sector through investments or their own economies. This sector may get preference from sovereign wealth funds of non-oil producing countries, such as Korea and Singapore, and industrial nations, such as China and Japan.

Despite all the talk about adjustments and pullbacks, some dismiss the possibility of dramatic changes in sovereign fund investment practices.

"Sovereign wealth funds are heterogeneous," said Andrew Ang, a professor at Columbia University Business School in New York. "It's hard to say one policy is going to apply to all the funds. You might see some changes in funds that had a very high holding in financials" and that are small, such as  Temasek, which manages $85 billion. But larger ones, such as the $326 billion Norway Government Pension Fund, are unlikely to change much their investment strategies.

In fact, he noted, Norway went ahead with its plan to boost its position from 40 percent to 60 percent in equities despite the market meltdown. However, he said, generally speaking sovereign wealth funds, pension funds and endowments "will need to re-evaluate their illiquid assets," including hedge funds and private equity funds in light of the credit crunch.

Still, Ang said, their appetite for foreign investments is unlikely to diminish. "I'd hope actually they would continue to be very large providers of capital to the financial world," although they would work under "regulatory and government uncertainties" in the post-financial crisis environment.

Oxford Analytica holds similar views: "Although financial markets have collapsed, oil prices have dropped, and global imbalances are unwinding, countries around the world remain interested in setting up new sovereign wealth funds. Seven new ones are expected to be created during 2009. While no longer making headlines as in 2007, they will maintain a powerful role in global financial markets."

Source: The Capital Express (