Sovereign Wealth Funds:

A new (old) force in the capital markets

Praful Anchaliya Sabina Islam Sahil Jain Vijay Krishna

Sovereign Wealth

Fund

Financial vechiles owned by states

which hold, manage or administer public

funds.

Invest in wide range of assets.

Managed independently of

other state financial

institution

Have significant proportion of investment

abroad

Invest in diverse set of financial asset class in

pursuit of economic returns

Sources of Funds

Surplus funds of oil producing nations(e.g. UAE, Saudi Arabia, Russia, Venezuela)• ADIA-Abu Dhabi

Investment authority

• KIA-Kuwait investment authority

Surplus funds from the sale of copper, diamonds, or minerals• Chile• Botswana

Others with dedicated central bank funds.(large export revenues)• CIC-China

investment corporation

• GIC- government of Singapore investment

• Norway-government pension fund – global

Are all SWF’s same???• No

• Use of earnings from export commodities and revenue receipts.

• Use of foreign exchange reserve.

Comparison of SWF with others

Sovereign wealth fund

State owned enterprise

Public pension fund

Asset owner ship government Primarily government

Pension members

Primary purpose varied Varied Fund defined benefit obligations

Funding source commodity./ non commodity

Government/corporate earnings

Pension contributions

Government control

total Significant insignificant

disclosure varied varied transparent

Investor class growth

high steady steady

Existence of SWF’s

• SWF has been existent in the markets since decades

• KUWAIT INVESTMENT BOARD -1950

• Abu Dhabi Investment authority – 1976

• Saudi Arabia monetary authority – 1952

• Tamasek holdings – 1974

• Government of Singapore investment corporation –

1981

• China investment corporation – 2007

Trends in SWF• Traditionally, long-term, passive approach to investing

– Therefore, no-widespread public attention

• Recently, – more active investment approach by co-investing in M & A

deals

E.g.: Barclays Taemasek-China Development Bank

– Commitment of money to private equity for diversification

E.g.: CIC purchased 10% stake in US private equity firm for $3 billion in 2007

Market Size• Based on market estimates, assets under management by SWFs may currently

amount to over USD 3.1 tr

• In terms of size, therefore, SWFs are a more significant industry than hedge funds, but – for the moment – are far smaller than most other types of institutional investors

• Relative weight in global capital markets: however, may well change in the years to come given the growth dynamics behind state funds, especially in emerging economies, as the volume of funds disposable for SWF investments may increase substantially in future

• International reserves has been steadily increasing over past five years

• This has particularly been the case in many emerging economies which benefited from oil revenues, such as oil-exporting countries in the Middle East or Latin America, or rising competitiveness and improving balances of payments vis-à-vis established industrialised economies, especially China, South Korea or Taiwan

Changing Flows and Market Opportunities

• Most SWFs enjoy considerable freedom in their investment decisions and are expected to maximise performance

• In their asset management, SWFs are likely to behave similarly to investment, pension, hedge or private equity funds, seeking to diversify across a wide range of asset classes in different countries

• Over coming five years: In quantitative terms, future SWF asset allocation could lead to a gross capital inflow of over USD 1 tr into global equity markets and USD 1.5 tr into global debt markets

Geo Economic Implications of SWF.

• To protect domestic currencies and banks from crisis• Broad range of investments opportunities• Implication to government and business• Lower taxes, better public works, strong state run

business• Capital inflows are positive

ISSUE OF TRANSPERENCY• Lack of transparency!!• Objectives not stated clearly• Lack of guidelines on ethical standards & investment

policies.• No information about returns & people behind the

investment.

Principles drafted for SWF• SWF investment decisions should be based on

commercial grounds and should not hold geopolitical goals of the controlling government.

• Greater information disclosure by SWF’s about fund size, investment objective , institutional arrangements & financial information-asset allocation,benchmarks and returns.

• Strong governance structure , internal controls

• Respect host country rules.

The Deal for Merrill Lynch

15th JAN 2008-$6.6 billion dollars-KIA+Korean investment Corporation & Mizuho Corporate Bank.

$ 5 billion dollars – TEMASEK

$1.2 billion dollars Davis Selected Advisers.

Deal Insight

Was the above deal terms appealing?

Was the deal in favor of ML?

Average ML dividend Yield 1.4% , but promising a 9% dividend yield isn't that too much?

Were these funds the right kind of investors?

Stock price movementJan 2006 – April 2008High-97.5$Low-39.9$Average- 74.2$On announcement – 53.9$After announcementHigh -21.8Low – 4.15Current – 21.05

Security issued- Non Voting mandatory convertible , preferred stockDividend-9%Reference stock price-$52.40Conversion premium-17%Maturity – 2.75 yearsLiquidation preference – $100,000 per share

Recent investments• Singapore’s GIC: £4.8 billion stake in UBS• Saudi group: £800+ million in UBS• ADIA: £3.75 billion in Citigroup• Singapore’s Temasek: £2.5 billion in Merrill Lynch• China Investment Corp: £2.5 billion in Morgan Stanley• China’s Citic Fund: £500 million in Bear Stearns

Conclusion• Global reach for companies.• Reduction in financial market uncertainty• Build trust in recipient countries.• Stabilization of markets• Transparency in financial and investment objectives,

asset allocation and rate of returns.• Diversified investment for companies.