Sovereign Wealth Fund Institute

The Korea Investment Corporation (KIC) views some European assets as attractive even during the current European sovereign debt crises. Middle East sovereign funds have shown lukewarm interest in direct European bank investment. Depending on individual liquidity needs, certain European governments and businesses are selling assets to raise cash, and sovereign wealth funds want to be in the position to take advantage of the valuation discounts. Korea’s SWF is stepping up their presence in Europe. They opened up an overseas office in London. Don’t expect any major direct investments in banks or in large part European banks from the KIC. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Ireland’s National Pensions Reserve Fund (NPRF) is allocating more money to domestic investments rather than overseas. This change in investment policy to invest more capital domestically stems from political and economic policy shifts. France and Italy have taken similar measures by creating strategic domestic investment funds. These strategic direct investment funds invest in companies that are deemed essential to the domestic economy. The Irish Government pulled the trigger on the creation of a Strategic Investment Fund which will be a portfolio of funds investing in select sectors of the Irish economy. Some of these areas will include infrastructure, venture capital, and financing for small and medium enterprises (SMEs). Ireland’s NTMA sought the recruitment of corporate finance advisers to identify such investments and find potential co-investors. The investments are to be sourced on a commercial basis but also be of strategic long-term significance to the Irish economy. With regards to investment in the specialized funds, the NPRF will be the cornerstone investor.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The fourth largest pension fund in the world, Korea’s National Pension Service (NPS) can now trade renminbi-denominated stocks and bonds in mainland China as a qualified foreign institutional investor (QFII). Korea’s NPS was founded in 1988 and established under the National Pension Act. In early 2006 the NPS launched an overseas investment team.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Singapore’s Temasek Holdings is stepping up investment activity in the North Asia region. It created Pavilion Capital Pte, a wholly owned company to invest in closely held companies and will focus on small and medium enterprises in China. The new entity will be run by Tow Heng Tan, its former chief investment officer and senior managing director (Investments) of Temasek Holdings covering initiatives for direct investments.. Mr. Tow Heng Tan joined Temasek Holdings in 2002 and became the chief investment officer in October 2007.

By creating this sovereign wealth enterprise, it will give Temasek additional organizational flexibility to access direct company stakes the region.

According to a statement sent out by Temasek Holdings regarding Pavilion, is that it will “complement and expand our coverage and capacity for North Asia, including China.”

In 1976, the State of Alaska amended its constitution by voter approval to create the APFC. In 1981, the actual administrative expenses were totaled at US$ 165,000. The market value at the time of June 30, 1981 was US$ 1,794,439,000.

Globally, Qatar Holding LLC has been investing in natural resource and commodity companies for quite some time. They recently picked up a significant stake in European Goldfields Limited which included funding support for the company to develop gold deposits in Greece.

Qatar Holding LLC is setting up a subsidiary called QH Indonesia to deploy $1 billion in targeting Indonesia’s raw materials and natural resources. Indonesia is centrally located near key markets such as India, China, and Australia. The sovereign wealth enterprise will be based in Jakarta. Indonesia is a heavily populated Muslim country in Southeast Asia and a major exporter of palm oil and rubber.

Nearly 85% of palm oil is produced in Indonesia and Malaysia.

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A small minority of U.S. based public investors are taking a closer look at the external CIO approach. The Alaska Permanent Fund has adopted the external CIO approach for its real return mandate. Another similar type of investment program is called absolute return management strategies. CalPERS still has an absolute return management unit, but has separated it from the public equities division. Absolute return management now reports directly under the chief investment officer of CalPERS. The overall goal of these programs is to add diversification to their portfolios and hopefully gain strategic insight from the external CIOs.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The Kuwait Investment Authority (KIA) has long been an institutional investor in the United Kingdom. In fact, the KIA has an office in London and a subsidiary called the Kuwait Investment Office which was established in 1953. Recently, the KIA reaffirmed its commitment to investing in the United Kingdom and plays a significant role in the UK financial sector.

One of the main reasons why the KIA invests in the UK is that the country has had a transparent economic policy over the financial credit crisis compared to the Eurozone. In addition, the KIA sees the UK as a relative safe haven compared to other Westernized nations.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Khazanah Nasional, a Malaysian sovereign wealth fund plans to invest directly into India in sectors such as financial services, infrastructure, and energy. India is one of the BRIC economies that had increased its economic growth tremendously this past decade. In addition, India is slowly opening up its economy to foreign investors by loosening some investment restrictions and regulations. Earlier in June, Khazanah and the Infrastructure Development Finance Company Limited (IDFC) agreed to set up a joint venture to produce a dedicated infrastructure development company that focuses on road transportation development. Khazanah would hold 80.1% of the equity share of capital in the proposed joint venture.

Khazanah Nasional is also evaluating proposals in India’s geothermal and hydroelectric business segments. In fact, much like the rest of Southeast Asia, India has strong demand for electricity and current power plants are not meeting demand.

Old Map of Tripoli

Libya has gone through a tumultuous revolution. The North African country is in the midst of jumpstarting its banking sector and trying to restart oil operations. Luckily, Libya has a sovereign wealth fund to tap for reconstruction and deep reserves of oil underground to continue to fund it. For some countries, this is why they created sovereign funds.

Sovereign wealth funds have played the roles of savior and stabilizer in the past, just look at Ireland, China, and Kuwait as great examples.

The Libyan Investment Authority (LIA) at the end of June 2011, had around US$ 64.9 billion. The new government also will have access to foreign reserves from the Central Bank of Libya. The total amount of the LIA and Central Bank of Libya’s assets is around US$170 billion.

Cash, stocks, and bonds make up 77% of LIA’s assets, with 45.5% in cash. Some of this cash will most likely be used to finance post-Gaddafi reconstruction. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

In general, current U.S. mortgage debt investments are souring for institutional investors. Last week, Fannie Mae and Freddie Mac mortgage bonds fell after the United States FHFA made clear changes in guidelines for a government-supported refinancing program. Refinancing risk is a major concern for bond investors, especially in today’s low yielding fixed-income markets. The institutional investor will lose out from the household’s gain in refinancing. Fannie Mae and Freddie Mac guarantee against default, not from prepayment loss.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The adoption of Islamic finance as a viable asset class is gaining traction among SE Asian sovereign institutional investors.  Malaysia’s Employees Provident Fund (EPF) is boosting fund allocation in Islamic bonds.  In October 2010, the fund held $650 million in sukuks.  They want to have a total allocation of $1.75 billion towards Islamic finance instruments.  Most of EPF’s Islamic finance allocation is managed by external managers.

In order for the sukuk market to be an effective hedge, the industry must grow.

Qatar Holding has actively been investing in direct company stakes in continental Europe for quite some time. Over this past year, Qatar Holding purchased direct stakes in numerous European ventures such as a Parisian football club and Spanish energy firm Iberdrola. Some European firms are starved for capital due to the European banking crisis which stems from stability issues with sovereign debt and higher mandatory capitalization levels for banks.

Sovereign investment entities like Qatar Holding have been an alternative source of capital for some of these European companies.

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The Kuwait Investment Authority (KIA) is planning to open a representative office in Beijing. This signifies Kuwait’s increasing appetite for investment opportunities in mainland China, thus tightening Sino-Kuwait economic and political relations. Already, the Kuwait Investment Authority has participated in a number of noteworthy Chinese initial public offerings and investments.

There has been broad speculation that Qatar Holding, the sovereign wealth enterprise of the Qatar Investment Authority wants to allocate more capital in gold. Not so much in gold exchange-traded funds, but rather in gold producing companies.

These types of direct investments are riskier by their very nature, but can have a greater return payout. Recently, Qatar Holding invested into European Goldfields in addition, to lending money to the firm. It is clear the sovereign wealth entity wants to be a major player in gold firm investments. Some speculation includes the creation of a dedicated gold investment vehicle.  The commodity reached a high last month, but fell recently due to current market volatility.

Max Giolitti

This interview appears in the 3Q Y2011 issue of the Sovereign Wealth Quarterly.

Q&A with Max Giolitti, Former Head of Risk Management and Asset Allocation at the Alaska Permanent Fund

1. For large institutional investors, what is your investment outlook on 2012, is it positive, negative, mixed?

In terms of asset prices it is mixed. Developed countries in particular are going through an adjustment period. From a “great moderation” standpoint this is a significant outlier event, but from a longer historical context it is not. Emerging countries will also experience the effects of the developed countries pains, but then the very definition of emerging implies greater volatility. My investment philosophy is based on three principles: value, risk and diversification.

I don’t try to predict which asset will do well in a given year but rather to build a risk and economic scenario balanced portfolio that won’t depend on making that choice correctly every time. From a tactical standpoint, I believe in risk factor tilts based on valuation.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

This past Saturday, Chinese officials from various organizations including the China Investment Corporation participated in a lengthy IMF meeting to discuss global economic and financial issues, especially regarding the stability of Europe. Over the past year, several European Governments deeply courted China to induce them to purchase their sovereign debt. The China Investment Corporation, one of China’s sovereign funds said it needs to protect its own interests first since that is what it is mandated to do. Basically, the CIC invests to make a commercial profit, not to bailout firms or governments for the sake of it.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Sovereign wealth funds are typically long-term investors; they can wait out financial storms and purchase assets when it is most opportunistic. Sovereign funds have been actively investing in the United States for decades, recently more in the past seven years. The slowdown in the U.S. economy has reinforced the message to sovereign funds to look elsewhere and diversify. Economies with high growth rates, low unemployment, favorable ownership rights, and sustainable demographics usually correlate to robust GDP growth and low political risk. The message in 2000 was to diversify globally. The message remains the same.

The answer to the title is yes. The next generation in the United States is facing a bleak financial future as unemployment among youth is substantially high and growing.

This increases political risk, lowers investors’ confidence, and will lead to contractions in GDP.

With the high levels of unemployment for young people, it has spurred them to live at home, consume fewer goods, delay marriage, and in the aggregate purchase less property. In addition, the lost generation is known for taking large amounts of student debt which places burdens on the Federal Government and consumption spending.

Sovereign wealth funds consume this data and make assumptions, granted the United States is still the largest market for investments; other countries have been gaining traction. In our belief, sovereign funds will select companies that have significant company exposure to overseas markets. What do Morgan Stanley, General Electric, and AES Corp have in common? They all have significant presences outside of the United States. Companies that rely on U.S. elastic consumption will suffer as long as unemployment, especially among the youth runs high.

Giulio Tremonti

Like other Southern European nations, Italy is suffering from severe sovereign debt issues. The Italian Ministry of Finance met with the China Investment Corporation to discuss possible scenarios. Recently, investors wanted greater returns and drove up the bond auction. Italy is trying to lower soaring interest rates and introduce austerity measures. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The Abu Dhabi Investment Authority (ADIA) has released their 2010 annual review. Some interesting notes about ADIA include that around 80% of assets are managed by external managers. An estimated 60% of assets are invested using index-replicating strategies.

ADIA also prefers to use separate accounts or in the UK, segregated accounts.

The report also gives details about the structural changes and procedures Sheikh Ahmed bin Zayed Al Nehayan implemented such as in asset allocation and risk management. According to the annual review, no more than 45% may be invested in developed equities.

Their asset allocation range into private equity is between 2 to 8% and 5 to 10% in real estate.

A range of 60 to 85% is targeted to invest in North America and Europe.

From 12/31/2010

Link: ADIA Reports

Nearly 80% of ADIA’s assets are managed externally, with 60% invested in index-replicating strategies. The Abu Dhabi Investment Authority is reorganizing its external equities team. At the top, the department will be divided into two sections, indexed-fund strategies (beta) and active management (alpha). One of ADIA’s primary goals for the restructuring was to simplify how they manage relations with external equity fund managers based on strategy. Indexed fund managers are usually monitored on how close they track a particular index or benchmark. On the other side of the spectrum, active managers are usually monitored by their various strategies, holdings, and risk profile.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Telstra has been a large component of the Australian Future Fund’s investment portfolio for a very long time.  Recently, in mid-August the Future Fund completed its portfolio rebalancing for holdings in Telstra.  Telstra is an Australian media and telecommunications company.  The Future Fund has reduced their holdings in the Australian firm down to 0.8% or around 100 million shares.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

According to the press release, “The State Investment Council (NMSIC) today announced record returns of 22.5% for the fiscal year ending June 30, 2011.  The investment returns helped grow the total funds managed by the NMSIC more than $2.5 billion year-over-year, and placed it in the top third among peer funds of more than $1 billion.

“The State Investment Council was well positioned for the bull market we experienced for much of the year,” said State Investment Officer Steve Moise. “The Council is also working diligently to diversify its assets, and create a balanced portfolio of quality investments that will be less vulnerable to the volatility we have seen recently on Wall Street.”

The Council in July voted to take steps to reduce overall exposure to the public equities (stock) market from a target of 60% to 46%.  New long-term investment targets include increased allocations to core real estate and real return assets such as timber and infrastructure.

The 22.5% investment performance for the year marks the highest returns experienced by the permanent funds since the legislature voted to allow greater exposure to the stock market back in the late 1980s.  The previous investment returns peak of 21.5% came in 1998, in the middle of the internet “dot-com” stock bubble.

For the fiscal year ending June 30, the Permanent Funds were valued at $15.35 billion.  The Funds also distributed $763 million over the past 12 months.  Permanent Fund distributions continue to be a vital source of revenue for New Mexico, directly benefitting public schools and universities, and reducing the tax burden on our citizens.

Read more: New Mexico State Investment Council

Yngve Slyngstad

In the aggregate, a growing number of sovereign wealth funds are allocating more to public equities, less in fixed income. This adds a bit of volatility to their portfolios but at the same time, some funds have achieved impressive gains in certain years. Norway’s Government Pension Fund Global has made significant strides in allocating to public equity in markets such as Europe and the United States.

Yngve Slyngstad, the head of Norway’s sovereign wealth fund confirmed that the downgrade rating the United States received had no effect on the way the fund views investments in the country.

During the financial crisis, Norway’s Government Pension Fund Global had exposure to Fannie Mae and Freddie Mac. S&P gave many mortgage CDOs strong ratings at that point in time.

During a news conference regarding 2Q fund results last Friday, Yngve Slyngstad expressed, “The US debt downgrade had no effect on our portfolio or our thinking.”

According to the press release, “the Future Fund’s return for the financial year ending 30 June 2011 (excluding the Fund’s Telstra holding) was 12.4%. Over the three years ending 30 June 2011 the return was 6.0% per annum. Since the first contribution to the Future Fund, a little over five years ago on 5 May 2006, the Fund has generated a return of 5.2% per annum. The return for the last quarter of the financial year was 0.6%.

The Future Fund’s Telstra portfolio returned 2.9% over the year and 2.7% for the quarter. Reflecting the long-term investment mandate for the Future Fund, the Board of Guardians will continue to focus on performance over rolling ten year periods using rolling five year
periods to gauge progress.

Mr David Murray, Chair of the Board of Guardians, said that the positive returns of 2010/11 reflected the careful construction of the portfolio since the Fund’s inception in May 2006.

“We have witnessed an extremely difficult global economic environment over the last few years and this is continuing to present challenges,” said Mr Murray.

“The Board remains focussed on prudently building a diverse portfolio that is capable of generating good returns in positive environments but provides some protection in weaker markets.”

“The portfolio’s positioning, and our dynamic approach to building and adjusting the portfolio, has helped generate solid performance for the Fund since inception and positions it appropriately for its long term mandate.”

“The reduction in the holding of Telstra shares has continued in line with the Board’s longstated strategy to reduce the holding in an orderly way over the medium term and without untoward market impact.”"

Read more: Future Fund Press Release

Sovereign funds have had a strong comeback in public equities this year; however, those gains are at risk. Funds like Norway’s Oil Fund, the Alaska Permanent Fund, and the Abu Dhabi Investment Authority are greatly affected by global public equity performance. Sovereign wealth funds are long term investors that can weather the storm, but by no means are investment staff at these governmental funds not worried. Short-term performance puts tremendous pressure and strain on investment committees and boards. External fund managers for sovereign funds are on tight watch on how they perform in these challenging markets.

Funds exposed to passive investment strategies in U.S. markets are at most risk.

On Monday, U.S. stocks have fallen sharply and analysts predict this will be a horrible week for equities. Sovereign wealth funds such as the China Investment Corporation were not caught off hand by Standard and Poor’s downgrade on the United States.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Sovereign wealth funds and other governmental investors will likely continue to hold positions in U.S. treasuries, at least in the short-run. Last Friday, Standard & Poor’s downgraded the United States, while Moody’s and Fitch Ratings affirmed their AAA status for the United States. This downgrade is unlikely to cause any mandatory sell-off of treasuries or massive dump by central banks, governmental pension funds, and sovereign funds since treasuries remain the most liquid asset. At this point in time, the United States is not facing the exact same dilemma that Greece is currently dealing with.

Around the globe, government officials publicly did not state there would be a massive sell off of treasuries from their respective countries.

From a practicality stance, treasuries remain safe as other major Western nations with sovereign debt issues are in similar or worse shape than the United States.

Asian countries are major holders of U.S. treasuries, especially China and Japan. Unlike Japan, in China there is a strong growing consensus from government officials of the need for the United States to curb its addiction on borrowing.

South Korea’s vice finance minister, Yim Jong Yong, told reporters in Gwacheon, “Our faith in U.S. Treasuries has not changed,” after a meeting with counterparts from the central bank and financial agencies.

Major Foreign Holdings of U.S. Treasury Securities in Billions – End of Period

Source – U.S. Treasury

* Includes Channel Islands and Isle of Man
**Oil exporters include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria.

With all things being said, many countries with non-commodity sovereign funds have large allocations to treasuries. For central banks, this is a result to prevent the unwanted appreciation in their currency against the U.S. dollar. If their currencies appreciate over the U.S. dollar it would hurt their export competiveness. Already, Japan has indicated they are willing to intervene again after selling currency on August 4th. Asian central banks are not thrilled about the American downgrade, but they are willing to hold out.

China possesses nearly $3.2 trillion in foreign exchange reserves, mostly in U.S. dollar assets. U.S. treasuries are one of the most actively traded financial instruments on the planet and most liquid. Unwarranted volatility and market uncertainty would weaken the already fragile stability of the international financial system. A short term crisis has been averted; however it seems that Russia and China are not totally pleased. Basically, confidence has not been fully restored. In fact, a prominent Chinese rating agency, Dagong Global Credit Rating Company, has already downgraded the United States from A+ to A.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Mike Burns

The Alaska Permanent Fund is now at US$40 billion. They had a return of 20.6% in fiscal year 2011, which is the third highest in their history. The greatest contributor of return came from their stock portfolio. Within stocks, the U.S. portfolio performed the best at 33.4%. The public equity portfolio makes up half of the Alaska’s permanent fund total value.

“We’re very pleased with the Fund’s performance this year – it’s been an outstanding year and we enjoy the chance to report such good news,” said Michael Burns, CEO. “But at the same time it’s important to remember that the Board of Trustees and the staff do not chase returns. Our goal is a positive rate of return over the long term, and that’s our focus when we build a portfolio that doesn’t change in response to short-term market conditions.”[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Park Alpha, the consulting arm of the Sovereign Wealth Fund Institute, is offering SWF common equity ownership reports. These unique reports are offered by subscription or via on-demand order basis. For sovereign wealth funds and other institutional investors, they can see the amount of SWF ownership in a common equity position. The reports are also useful for investor targeting and investor relations.

Sample Reports

• BP – July 2011
• Visa Inc – July2011

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About Park Alpha
We are the consulting arm of the Sovereign Wealth Fund Institute. We are not a brokerage or 3rd party marketer. www.parkalpha.com

It is true that most sovereign wealth funds and global institutional investors have a high allocation to U.S. dollar assets. This has been the story for the past half century. Second, it has been a difficult time for the U.S. dollar this past decade. With the bailout of financial institutions, mounting federal and state governmental deficits, QE2, high unemployment, two wars, and now the possibility of a block in the augmentation of the debt ceiling, American currency is increasingly being watched like a hawk from foreign governmental investors. In addition, as skilled and unskilled labor prices are priced more efficient in emerging markets versus the United States, it will place a continued drag on the U.S. dollar.

Lastly, the United States cannot exclusively rely on wealth creation from the appreciation of financial and real estate assets over the long haul. Sovereign wealth funds painfully recognize this and learned their lesson from the bankruptcies of Fannie Mae and Freddie Mac.

In the aggregate, sovereign wealth funds are somewhat confident in American multinational businesses. From looking at direct sovereign investments in U.S. equities and U.S oriented external fund manager mandates, we can see the United States is still a viable destination for investment. Furthermore, we see a trend in investing in multinationals, where those companies’ incomes are not solely coming from the United States.

Not all sovereign funds and central banks are confident in the US government’s handling of currency and fiscal policy. In fact the Chinese government warns of excessive risks of U.S. assets, as the dollar keeps falling versus other currencies. The loose monetary policy is stimulating global inflation and asset bubbles, especially in commodities like silver. In November 2010, Russia and China renounced the U.S. dollar in terms of using their own currencies in bilateral trade.

It is true the United States has taken the position of an expansionary monetary and fiscal policy to encourage economic growth; however these economic policies come at a price, which includes higher interest payments and more debt. The Qatar Investment Authority sees the U.S. dollar’s weakness as a driver of its investment policy. Even if the United States can pull off some real economic growth, it will be hindered by incoming inflation.

Sovereign wealth funds across the board are looking at sectors that have a hedge against the American economy. One sector is commodities, which some favorite types include oil, natural gas, gold, silver, and agriculture. In particular, Middle Eastern sovereign wealth funds see it as a win-win, especially in agriculture, since those countries are in dire need of sustaining food supplies. In addition, over the long term as the population of India and China grow and their tastes and preferences alter for more prepared foods, food prices will rise. The Qatar Investment Authority, Kuwait Investment Authority, and even Temasek Holdings have been active investors in food companies.

What is saving the dollar is that there are very little alternatives to it. The euro and Japanese yen have their own issues, precious metals can bubble up, and other currencies lack liquidity.

Chinese state media reports that Temasek Holdings has no intention of reducing its position in the Agricultural Bank of China. Temasek Holdings, Kuwait Investment Authority, Qatar Investment Authority, and other governmental investors were cornerstone investors in Agricultural Bank of China’s $21 billion initial public offering. The bank is China’s third largest lender and they made a net profit of 45.8 billion yuan in the first half of 2010. Profits are rising for this bank by the growth in fee & commission income and widening net interest margin.

Temasek Holdings recently sold large stakes in the Bank of China Ltd and China Construction Bank Corp. Temasek Holdings wanted to manage exposure to the Chinese banking system, especially after Moody’s cautioned of a potential ratings downgrade for Chinese banks.

Bank Stats

This interview appears in the 2Q Y2011 issue of the Sovereign Wealth Quarterly.

ISRAFIL MAMMADOV IS CHIEF INVESTMENT OFFICER OF THE STATE OIL FUND OF THE REPUBLIC OF AZERBAIJAN (SOFAZ). Currently, SOFAZ ranks a 10 in the Linaburg-Maduell Transparency Index.

1. Is the current global market providing a positive investment environment for SOFAZ, and what type of changes would you like to see?

Similar to other investors whose portfolios consist mainly or entirely of fixed-income securities, SOFAZ suffers from the current low-yield environment in the financial markets. Therefore, SOFAZ reduces duration and favors higher coupon bonds in order to avoid negative return. Moreover, credit spreads remain wide and there are still some good values in lower credit rating securities. SOFAZ takes advantage of these opportunities by shifting towards lower credit rating securities. Additionally, considering the current environment in some emerging markets and southern European countries, SOFAZ also benefits from the current investment opportunities in these markets.

It goes without saying that, the best possible way to benefit from the current environment would be the introduction of equities and alternative investments to current portfolio, which SOFAZ is planning to start investing in soon.

2. Will 2010 go down in history books as a good year or bad year for sovereign wealth funds, and why? How did 2010 impact SOFAZ?

In general, 2010 has been a good year with significant upward trends in SWFs’ assets under management. SWFs gained positive returns from their investment portfolios, even though these returns were comparatively lower than 2009 levels. Recovery in global financial markets continued with a slow pace in 2010.

2010 has also witnessed post-crisis tendencies, one of which was the shift of geographical focus of investments. High level of unemployment and economic slack faced in developed countries has made investments unattractive in these countries. On the contrary, investments in the emerging markets have seen significant rise during the course of 2010. Another tendency was a shift towards equities and alternatives, since fixed-income markets have not provided high returns over 2010 due to low yields and high volatility of prices. However, the opposite is true for equities, which demonstrated decent level of growth (5-7%).

SOFAZ investment portfolio faced 1% return in 2010 – the lowest return since inception. This level of return is characterized by several reasons. Firstly, it was due to the ultra-low yield environment dominating the market. Another reason is that a large portion the investment portfolio consisted of short-term maturity bonds. Finally, unexpected sovereign debt crisis observed in some European economies also contributed to the level of returns of the SOFAZ investment portfolio in 2010. From the beginning of 2010, SOFAZ started investing in securities with lower credit rating, in order to increase returns without taking high interest rate risks, as well as to diversify its investment portfolio.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The press release states, “Temasek Holdings (Private) Limited (Temasek) today released its annual performance review, Temasek Review 2011 – Building for Tomorrow.

Covering the financial year ended 31 March 2011, Temasek Review 2011 reports a record year end portfolio value of S$193 billion, up from S$186 billion in the previous year.

Temasek continued its 2002 strategy of steady and active international investment, particularly in Asia, to reshape its portfolio for sustainable long term returns.

Mr S Dhanabalan, Chairman of Temasek Holdings, said, “While Asia rebounded swiftly in 2010, the USA and European economies continued to face uncertainties. Rising debt burdens, inflation risks, and political upheaval in the Middle East, tested the resilience of the global economic recovery. Against this backdrop, Temasek continued its steady investment and divestment pace, ending the year with a net cash position, in anticipation of opportunities ahead.”

For Temasek, investments made after 31 March 2002, when it began shifting its portfolio weight towards Asia, delivered annualised returns of 21% over the last nine years, or over 5.5 times returns for the period. The portfolio of earlier vintage investments made before 31 March 2002 , comprising mostly Singapore-based investments, delivered creditable annualised returns of 11% over the last nine years, or under 2.7 times.

From the shareholder perspective, Total Return to Temasek’s Shareholder (TSR) for the year was a modest 4.60%. This is based on the value of the overall portfolio, including cash and cash equivalents in the overall Temasek portfolio, as well as dividends to the shareholder and net of any capital injection from the shareholder.

Five-year and 10-year TSRs were steady at 7% and 9% respectively, while the 20-year and 30-year TSRs were 15% and 14% respectively. Since its inception in 1974, Temasek has delivered a healthy 17% compounded annual return.

Group net profit was S$13 billion, more than doubled from S$5 billion a year ago, due to higher contributions from Temasek investment activities and improved profits from its portfolio companies.

Investing for Sustainable Returns
Temasek remains anchored in Asia as part of its strategy to build its portfolio for resilience and sustainable long term risk adjusted returns.

During the year, Temasek maintained its steady pace of investments and divestments, with S$13 billion of investments and S$9 billion of divestments. It supported the recapitalisations of its portfolio companies, and stepped up its investments in the energy and resources sector, as well as in non-Asia growth economies such as Latin America. Temasek closed the year with net cash.

China remained Temasek’s largest investment destination. Additional investments included over S$3 billion in the rights issues of China Construction Bank and Bank of China.

In India, Temasek invested S$280 million in GMR Energy, giving it a significant exposure to the growing Indian power sector.

In Singapore, Temasek invested over S$100 million in Hutchison Port Holdings Trust, the first container port business trust listed on the Singapore Exchange.

Investments in the energy and resources sectors during the year included an initial S$500 million in Odebrecht Oil & Gas, a leading Brazilian upstream services provider for the oil industry, and S$700 million in Chesapeake Energy Corporation, the second-largest producer of natural gas in the USA.

In Mexico, in partnership with Impulsora Mexicana de Desarrollos Inmobiliarios, Temasek committed over S$100 million to pursue land banking opportunities with its first joint investment in Supra Terra.

Divestments during the year included Temasek’s stakes in Fraser and Neave, Hana Financial Group and Fortescue Metals Group.

Temasek ended the year with an underlying portfolio exposure of 77% to Asia, including 32% in Singapore. Latin America and other growth regions were a growing 3%, while mature economies of Australia & New Zealand and North America & Europe comprised a steady 20%.

The portfolio mix is balanced 45:55 between growth regions and mature economies.

Ms Ho Ching, Executive Director and CEO of Temasek explained, “We will continue to invest in the transforming economies of Asia and Latin America. At the same time, we remain open and ready to participate in opportunities in mature markets such as our recent investments in the USA.”

Financing Framework
The annual Temasek Review, Temasek Bonds and credit ratings are public markers of Temasek’s credit quality. They are also an integral part of the Temasek commitment to anchor Temasek’s institutional framework for financial discipline over the long term, foster good governance, and expand its stakeholder base.

Starting with its maiden 10-year Temasek Bond in 2005, Temasek has issued additional Temasek Bonds over the last two years to build out its debt maturity curve, including a groundbreaking 40-year Singapore Dollar Temasek Bond in late 2010. To date, Temasek has issued S$10 billion of triple-A rated Temasek Bonds in Singapore dollars, US dollars and British pounds sterling, with an average debt maturity of 16 years.

In February 2011, Temasek established a US$5 billion Euro-commercial Paper (ECP) Programme to cover the short end of its debt maturity curve. The Temasek ECP Programme has been assigned the highest short term ratings of A-1+ by S&P and P-1 by Moody’s.

Both the Temasek Bond and ECP Programmes form the major building blocks in its financing framework.

Contributing to the Community
As a responsible corporate citizen, Temasek is committed to the wider communities through its philanthropic support and endowment gifts for building people, as well as building the capacity and capability of communities around Asia, and rebuilding lives.

Temasek launched two philanthropic foundations in August 2010, following strong returns in excess of its risk-adjusted hurdles in the previous financial year that ended 31 March 2009, The Temasek Education Foundation supports educational causes in Singapore, while the Temasek International Foundation promotes and advances international scholarship and fellowship in the broader global community.

Looking Ahead
Temasek remains optimistic on the longer term outlook in Asia and other growth economies, despite medium term inflationary and structural risks, compounded by global imbalances.

Mr S Dhanabalan explained, “According to a recent McKinsey Global Institute report, mid-sized cities in growing markets are projected to deliver almost 40% of global growth by 2025. We continue to see the rising middle income populations driving rapid urbanisation and housing demands. Innovation will spur demand for new services, which could also lead to attractive investment opportunities.”

Temasek’s four investment themes of transforming economies; growing middle income populations; deepening comparative advantages; and emerging champions; will continue to guide its investments in the decade ahead as it strives to deliver sustainable long term value to its shareholder.

Ms Ho Ching elaborated, “Our strategy is to continue to invest and divest at a steady pace; stay liquid; shape a resilient portfolio and yet maintain the full flexibility to shift our portfolio mix, if and when necessary. Institutionally, we are committed to do things today for the long term. We are here to build a better tomorrow for our future generations. Directionally, we would like to further expand our stakeholder base to include co-investors and retail investors over time.””

Read more: Temasek Holdings

In the aggregate, Chinese bank stocks have fallen ever since Moody’s Investors Services released information that Chinese banks might have higher than expected exposure to local government debt.  There is tremendous concern that Chinese lenders will be incapable to absorb losses on defaults; however, a Chinese government plan to clean up the problem could alleviate the situation.  [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Across the globe, monetary authorities are diversifying into equities and different currency assets. Just recently, the Hong Kong Monetary Authority (HKMA) has started investing in fixed income and equities in the Chinese market. In November 2010, they were granted a Qualified Institutional Investor license.

The HKMA manages an exchange fund which the majority is held in American dollar and euro assets. The fund is now looking at diversifying into yuan assets. They have been given a US$ 300 million quota to invest in mainland China public markets.

Norway’s sovereign fund is prodded by some for its conservatism in investments. The sovereign fund takes small stakes by indexing companies across the globe, with a significant allocation to Europe and the Americas. Over the years, the wealth fund actively pushed to diversify from bonds to equities, and now real estate.

Norway’s SWF has also taken bets where other investors feared, such as Greek sovereign debt. Greek sovereign debt proved to be a bit risky for them; therefore, they cut their debt position in it in the first quarter.

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With the increased risk profile of sovereign bonds and other fixed income instruments, many central banks are rethinking their asset allocation for reserves. In addition, government bonds have yielded historic lows in recent months. A decade ago, a majority of central banks wouldn’t even contemplate investing reserves in equities, besides central banks like the Saudi Arabian Monetary Agency.

By the end of 2011, the Bank of Israel plans to invest a portion of its reserves in the stock market. The investments will be based on indexing rather than active equity management. Beta strategies are becoming widely accepted by conservative investors such as central banks.

Another bit of news is that the Bank of Israel plans to utilize external managers for this equity pilot program.

The Bank of Israel has around US$ 77 billion in reserves. There has been no formal announcement on what percent will be allocated to equities in the future.

Hedge funds have bounced back from the doldrums of the financial crisis. The global hedge fund industry is yearning for capital inflows. With this in mind, it is becoming increasingly vital for hedge funds to understand how sovereign wealth funds operate. Major equity management and investment consulting firms have already developed so-called sovereign wealth fund account teams to handle the extra needs of them.

Not all sovereign funds invest in hedge funds or have a desire to. Newly created sovereign funds or funds that require vast amounts of liquidity shy away from these types of alternatives. As sovereign funds grow in asset size and have the ability to take on more portfolio risk, they usually see hedge funds as a possible asset class.

Hedge funds must come to a realization that receiving money from a SWF is far different than a typical high net worth client, pension fund, or insurance company. If a sovereign fund loses money being managed by a traditional fund manager with a clear defined strategy, it is easier to sell the loss story to the public. Hedge funds bear a risk connotation to them. The media and American political class has done a fantastic job on enhancing that risky black box image of hedge funds. This leads to a possible conclusion that sovereign funds that require less public accountability are also more likely to invest in hedge funds.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Brazil seems to be the Latin American darling of the Middle East. Over the past few years, Brazil has been improving its macroeconomic stability and building up significant foreign reserves. Brazil was one of the first emerging market economies to recover from the financial crisis. The Government of Brazil even created a sovereign fund. In early May 2011, the Mubadala Development Company expressed interest in possibly investing in Brazilian industries such as mining, energy, aluminum, agribusiness, and logistics.

Mubadala believes that emerging markets like Brazil, India, and China will yield the best risk-rewards in growth over time.

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The Government of Singapore Investment Corporation and the Australand Property Group have created a logistics joint venture called Australand Logistics.  The real estate joint venture will invest in industrial assets and will have a target investment size of AUD$450 million.  The initial term of the JV is 5 years and is expected use very little to no debt in its strategy.  The initial portfolio holds six completed assets and two properties under development in Australia.  The total value of completion is around AUD$220 million.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Owned by the Province of Alberta, the Alberta Investment Management Corporation (AIMCo) manages investments for the Alberta Heritage Fund, public pensions, and other governmental funds.  They have been an active investor in several prolific direct investing strategies.  In the next twelve months, the crown corporation could spend as much as C$700 million (US$ 720 million) in private equity type purchases.  These would mostly likely be mid-market type transactions.  AIMCo has spent a tremendous amount of internal resources and time beefing up their private equity / direct investment team.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Georgia is a country with ripe agricultural land and located strategically by the Black Sea. The country’s soil and climate has made farming a very productive sector for the overall domestic economy. Crops such as corn, wheat, hazelnuts, citrus fruits, and grapes are dominant. Hassad Food, the sovereign wealth enterprise of the Qatar Investment Authority is on the lookout for agricultural investments. They recently made a visit to meet with the Finance Minister of Georgia. In addition, they also discussed about Qatari Diar’s possible investment in developing hotel properties in the country.

It might be a strategically convincing idea to partner with Qatar, as Georgia imports nearly all its required materials for gas and oil products.

Please view Park Alpha’s latest report on Global Utilities by the Numbers – May 2011. The report calculates and tabulates financial and investment data for select publicly-traded global utility companies.

Download Here

Park Alpha is the consulting arm of the SWFI.

Several Chinese renewable companies are grabbing the attention of sovereign funds. Sovereign funds understand that energy and technology are key drivers for stock performance and they want exposure to this industry. In fact, many of these Chinese companies are taking advantage of the current IPO market in Hong Kong for Chinese securities.

Energy efficiency and renewable energy generation are two key areas within the renewable energy sector that have attracted the interest of SWFs. Huaneng Renewables Corp. is planning to IPO and has secured US$ 335 million from nine cornerstone investors. This includes $60 million from the China Investment Corporation and $50 million from Temasek Holdings. Huaneng Renewables Corporation is the wind power unit of China Huaneng Group. The firm had planned to IPO in December, but decided to postpone due to market volatility. Earlier, Singapore’s GIC invested in Nobao Renewable Energy Holdings Ltd. Nobao Renewable Energy uses proprietary technology that utilizes energy stored in the ground to provide heating, cooling, and hot water to buildings. Investing in the renewable energy sector is not a new occurrence, but has picked up after the middle of 2010. In 2009 the CIC, through its sovereign wealth enterprise Chengdong Investment Corporation backed GCL-Poly Energy Holdings Limited. They ended up closing the joint venture between the organizations.

The China Investment Corporation sees tremendous potential to invest in Russia and has already done so. The CIC and Harvard University were among a crop of new investors who purchased a 10% stake in Bank VTB OAO. Russia is planning a wave of privatizations to open up its markets and increase foreign capital investment. Moscow wants to challenge London, as a global financial center and is undertaking several initiatives to do so. It also wants to appeal to private equity investors.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

In November 2007, the Emirates Investment Authority (EIA) was created by Emiri decree. They are the United Arab Emirates’s federal sovereign wealth fund. The sovereign fund has characteristics of a strategic development sovereign wealth fund, similar to that of the Mubadala Development Company and Bahrain’s Mumtalakat Company. This marks a stark contrast in style to the Abu Dhabi Investment Authority. The sovereign entity is even debating whether to raise debt to enable more acquisitions.

The EIA controls positions in several UAE firms such as Etisalat (Emirates Telecommunications Group) and du.  Etisalat operates in over 18 countries and services over 100 million customers in Asia, the Middle East, and Africa.  The EIA holds around 60% in Etisalat.  In terms of direct investments, they are allocated towards telecommunications; however, they see possibilities of jumping more into financial services, education, food production companies, and healthcare. The EIA does not only invest in just direct stakes in companies. They are also active in bonds and private equity funds.

Asian sovereign funds have been active in investing in Latin American natural resources. The Korea Investment Corporation, Canada’s Ontario Teachers’ Pension Plan (OTPP), and another investor are planning to invest in Manabi Holding SA. Manabi Holding SA is a Brazilian special purpose company that manages steel assets and iron ore exploration.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

According to an interview by Reuters, Gita Wirjawan, Chairman of the Badan Koordinasi Penanaman Modal (BKPM), says the China Investment Corporation is planning to offer $4 billion in infrastructure project loans. The BKPM is an investment board that coordinates business between businesses and government. Its aim is to increase foreign direct investment in Indonesia. Another goal is for the agency to improve the lives of its citizens by creating domestic jobs. The types of Indonesian infrastructure projects were not specified. Indonesia is an Asian emerging economy with a growing middle class in desperate need of infrastructure. If the proper infrastructure is not built in a timely fashion, it can harm economic growth and decrease country competitiveness.

Most sovereign wealth funds prefer to invest in developed infrastructure in Western economies. Developed infrastructure is less risky and cash flows do not vary as much as infrastructure projects. In addition, regulation and government transparency are key planks for SWFs to plunk down significant amounts of capital. Indonesia is at an economic crossroads. The country is aiming to build over 20,000 km of roads and provide at least 15,000 MW through power plants in the next few years. Indonesia is also ripe with natural resources in oil and gas. Lastly, Indonesia is fortunate enough to be able to reap the benefits of hydroelectric power, a renewable source of energy that contributes to an overall low carbon economy.

Kuwait is strengthening its economic position in Egypt. The Kuwait Investment Authority (KIA) is planning to set up a sovereign wealth enterprise to invest US$ 1 billion in Egypt’s stock market. This is a significant symbol of confidence in the Egyptian capital markets after the overthrow of Hosni Mubarak. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

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Tony Tan

The press release states, “GIC officially opened its India office in the city of Mumbai on 31 March 2011. This is GIC’s eighth overseas office outside Singapore. GIC’s India office will be headed by Mr Kishore Gotety. The office will be made up of more than 10 investment and asset management professionals. The team aims to foster close relationships with key Indian partners who share GIC’s values as a responsible and long-term investor.

GIC Deputy Chairman and Executive Director, Dr Tony Tan, said, ‘GIC has been amongst the earliest institutional investors in emerging Asian markets. In India, GIC has been investing across the public and private markets since the early 1990s. The setting up of the India office demonstrates GIC’s commitment to secure a larger role in the Indian growth story.’”

Read more: GIC Press Release

Spain has struggled to stabilize their banking sector through the lasting effects of the global financial crisis. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

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By Alexia Wai-Chun Tye

Guest Contributor

France’s Fonds Stratégique d’Investissement (FSI) generated creditable results for 2010, reinforcing its raison d’être as France’s answer to the sovereign wealth fund model, albeit with a distinct national development mandate focusing solely on French domestic markets.  [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The views, opinions, positions or strategies expressed by guest contributors and those providing comments are theirs alone, and do not necessarily reflect the views, opinions, positions or strategies of the Sovereign Wealth Fund Institute or any employee thereof.

Yngve Slyngstad

“In a year marked by the European sovereign debt crisis and fears of an economic slowdown in Europe, the fund posted its fifth-highest result ever,” says Yngve Slyngstad, chief executive officer of Norges Bank Investment Management (NBIM), which manages the fund.

The fund’s equity holdings returned 13.3 percent in 2010, measured in international currency, while fixed-income investments returned 4.1 percent. The overall return was 1.1 percentage points higher than the return on the fund’s benchmark indices.

“Globally, stocks and bonds gained last year, helped by improving company profits, low interest rates and stimulus measures from the European Central Bank, the Bank of Japan and the US Federal Reserve,” Slyngstad says. “The fund also benefitted from its long-term approach, as large equity purchases during the financial crisis in 2008 and in the first half of 2009 yielded solid returns. The value of our fixed-income investments also continued to recover after steep price drops two years earlier.”

The fund’s best-performing stock sector was basic materials, followed by the industrial and consumer goods sectors. The biggest-gaining stock investments, measured in krone returns, were food company Nestlé, Apple and oil producer Royal Dutch Shell. The weakest performers were Banco Santander of Spain, oil company BP and Banco Bilbao Vizcaya Argentaria of Spain.”

Read more: Norges Bank

This interview appears in the 1Q Y2011 issue of the Sovereign Wealth Quarterly.

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