Market Views: The merits of setting up a SWF in Asia
Sovereign wealth funds in Asia are more than just big-ticket investors and can perform other functions to the benefit of their respective countries.
Macau recently announced its intention to establish one to diversify away from its gambling-and entertainment-focused economy, optimise its existing reserves management system and enhance its returns by “adopting commercial and market-oriented investment management models”.
A number of Asian countries, however, including Taiwan and Japan, currently do not have a SWF to invest on the nation’s behalf.
In Taiwan’s case, though, there is the National Development Fund (NDF), a quasi-SWF that helps support certain government policy objectives, such as in the development of the biomedical and green energy sectors.
Judging the investment performance and governance of SWFs against a single set of benchmarks or criteria is difficult, as each has its own unique mission.
AsianInvestor asked five industry professionals to share their insights as to the role SWFs should play and how their investment performance should be assessed.
The following extracts have been edited for brevity and clarity.
Benno Klingenberg-Timm, head of Asia Pacific sovereign clients
UBS Asset Management
The establishment of a SWF is not necessarily a prerequisite for investing foreign exchange reserves effectively. However, the experience of Singapore or China shows that when a country establishes a SWF, diversification of foreign reserves becomes more efficient and the return on accumulated wealth is higher.
SWFs provide several benefits, including: a) the ability to attract talent and skills at competitive market rates. This helps to broaden the ability of the SWF to invest effectively; b) the establishment of a "centre of excellence" that could potentially benefit the whole country [with increased] knowledge around global capital markets and financial expertise; c) a higher return on accumulated wealth thanks to a broadening of the investment universe.
SWFs can have multiple goals including: a) stabilisation; b) saving for future generations; c) local development. A SWF can have one or multiple goals.
Each one of these goals has different investment objectives. In the case of stabilisation, the investment goal is to protect the capital and maintain a high degree of liquidity. In the case of savings, the investment goal is to maximise returns and liquidity is less important. When a SWF has a domestic development mandate, the goal is not only about returns -- economic and social indicators such as [the country's] GDP growth, employment and the support of domestic industries and infrastructures become just as important too.
The investment performance of a SWF is generally assessed against a benchmark which reflects the investment guidelines of the fund. The most recent trend among well-established SWFs has been the introduction of a so-called reference portfolio. This is a very simple benchmark expressed in terms of listed equity and fixed income only (generally 70% equity and 30% fixed income).
The SWF is required to beat the reference portfolio through diversification across a wider range of asset classes including alternative asset classes and active management.
Garry Hawker, Singapore-based partner and director of strategic research for growth markets
Mercer
The motivating factors for the establishment of a SWF vary, including the stabilisation of fiscal revenues, principally due to commodity price fluctuations and inter-generational saving from what are deemed, perhaps, to be excess foreign exchange reserves.
... While SWFs focused on inter-generational saving often do not have a clearly defined purpose, such considerations might be more important for a mature economy like Japan.
SWFs are not a homogeneous group and therefore the investment performance should be compared relative to each fund’s specific objectives and purpose.
A stabilisation fund with a very conservative investment strategy cannot be [directly] compared with a government-owned investment company that is essentially an equity investor. But both are regarded as SWFs.
As such, SWFs could be compared based on how they are performing in terms of achieving their objectives and purposes, although such comparisons will look beyond just investment performance.
Jayne Bok, head of investments for Asia
Willis Towers Watson
Setting up a SWF is not a trivial exercise. The decision needs to be made in light of the source of wealth, the purpose of the fund, including how it relates to a country’s future spending, and its sustainability relative to that purpose.
Most countries that have set up sovereign funds have done so in their growth phase, essentially saving current surplus wealth for a rainy day when they foresee a depletion or reduction in the main driver of that wealth.
Performance for any fund should be relative to the fund’s stated purpose, objectives and time horizon. There is a fairly wide variance in target asset allocations across sovereign funds, which in turn reflects a range of different objectives and/or return targets. For instance, the objectives of a stabilisation fund versu a development fund versus a capital maximisation fund will be completely different.
There will be other qualitative and non-financial factors for assessment too, such as certain social goals or responsibilities ...
Taiwan and Japan are mature markets with ageing populations. Whilst these countries don’t have a sovereign fund in the traditional sense, they do have large public pension funds that are active in global markets and share many of the same characteristics as sovereign funds.
Cyrille Urfer, head of sovereign wealth funds and institutional clients for Middle East business development
Unigestion
The growing importance of SWFs in the global economy and financial markets is undeniable. The strategic benefits of SWFs will continue to fuel their ascending influence as countries such as Taiwan and Japan, among others, debate whether to enter this space.
... Governments have to deal with [ageing] demographic dynamics causing strain on pension plans, exacerbated by low or even negative yields, huge investment [requirements] in infrastructure, as well as energy transition costs paving the way to less carbon-intensive economy.
The complex and sometimes conflicting investment objectives underlying these [long-term] challenges requires a dedicated sovereign entity with a focused management team, sense of purpose and strong governance processes to deliver coveted long-term outcomes. For countries that have accumulated reserves, it is reasonable for them to try to invest according to long-term timescales.
The reserves and the patient capital nature of SWFs constitute a competitive advantage and certainly a more effective way of handling public money. Governments generally mandate SWFs to manage strategic holdings (Tamasek), build up savings for future generations [and] invest in foreign assets for capacity and diversification purposes (Abu Dhabi Investment Authority) or ... [invest] in economic and human capital to improve the competitive position of the country or national companies.
The creation of more target-purposed funds with less generic and clear mandates, such as the Ghana Infrastructure Investment Fund, increases accountability and eases somewhat the assessment of results and contribution to society. Nowadays, SWFs play a transformational role for government initiatives in driving sustainable goals.
Josef Pilger, global pensions leader
Ernst & Young
Asia-Pacific is home to some of the world’s fastest ageing populations and will soon become the world’s top global retirement and asset management market. This region collectively will require up to US$300 trillion in retirement assets, in addition to healthcare and health infrastructure, to ensure sufficient long-term savings and retirement income to support this ageing population.
Countries with established SWFs are going to be better placed to support the future economic impact of an ageing population. SWFs contribute to both the capital markets and long-term savings required to support future pension infrastructure needs and play a role in supporting the delivery of predictable retirement outcomes.
Younger nations such as Singapore and Australia have demonstrated the region’s potential to accumulate significant retirement assets while building some of the world’s most successful markets ...
In less developed markets, these funds can act as anchor investors to increase trust if foreign private capital is required for co-investments.
Those markets yet to establish their own SWF should consider using long-term, impact and inclusive capitalism practices when establishing [one. They should also] measure the fund’s success [based on its] quantitative investment returns as well as broader impact on national and citizen values.