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WorldOctober 1 2013

Emerging markets look to SWFs for stability

A new generation of sovereign wealth funds – from resource-rich economies in Africa and Latin America – has emerged over the past few years. While these new funds are still relatively small, their impact could be sizable if they enable their source countries to secure stable economic growth and mitigate future risks associated with the booms and busts of the commodity cycle.
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While they prefer to remain under the radar, the rapid proliferation of sovereign wealth funds (SWFs) over the past decade has attracted a great deal of attention, with their number effectively doubling and assets under management currently standing at an estimated $5000bn to $6000bn. This growth is showing no sign of slowing, with US fund manager Invesco forecasting that global SWF assets could continue to grow to between $12,000bn and $15,000bn by 2017.

Roughly half of existing SWFs belong to non-commodity production countries, such as China and France, but, in the past couple of years, the majority of the new funds have come from resource-rich regions such as Africa and Latin America. According to a report published by JPMorgan Asset Management in June 2013, Africa has been witnessing the most rapid establishment of new SWFs, driven mainly by the amassing of commodity revenues and foreign exchange reserves. 

The report notes that over the past two years, 15 African countries have either established SWFs or earmarked plans for the possible development of a sovereign fund.

While blessed with an abundance of natural resources, an over-reliance on them has often thwarted the development and diversification of resource-rich developing countries – a situation further complicated by the fact that the inflow of resource revenues leads to a rapid appreciation of the country’s currency, otherwise known as 'Dutch disease'. The global financial crisis and associated commodity price volatility further highlighted the vulnerability of resource-dependent economies.

As part of their efforts to mitigate future risks associated with the booms and busts of the commodity cycle, African governments are turning to SWFs as a vehicle through which to generate returns on excess capital and preserve funds for future generations. Since mid-2011, Angola, Nigeria and Ghana have all launched new investment vehicles for their surplus oil money. Mozambique, Sierra Leone and Tanzania, also buoyed by new hydrocarbon discoveries, have expressed a desire to follow suit.

Angola's example

Angola, which was forced to take a $1.3bn loan from the International Monetary Authority (IMF) when oil prices fell at the onset of the financial crisis, started operating its $5bn Fundo Soberano de Angola (FSDEA) fund in October 2012, which it hopes will reduce its dependence on crude oil revenues – currently comprising about 45% of the country's output.

In June 2013, FSDEA appointed José Filomeno dos Santos, son of the incumbent president Jose Eduardo dos Santos, as its chairman, and unveiled an investment policy that targets three key criteria: preservation of capital, maximisation of returns over the long term and infrastructure development.

Half of the fund’s investments will be focused on fixed-income instruments and cash, issued by sovereign agencies, supranational institutions, large companies with investment-grade credit ratings, financial institutions and, additionally, in equities issued within the G-7 countries. The remainder of the funds will be allocated to alternative investments, including, but not limited to, emerging markets, high yield, commodities, agriculture and mining, infrastructure, property, Brazil, Russia, India and China and frontier market stocks, assets and depreciated opportunities.

FSDEA is also focusing investments on the infrastructure and hospitality sectors because of the significant job and wealth creation opportunities they offer across sub-Saharan Africa. It is committing 7.5% of the funds towards socially responsible projects to improve education and off-the-grid access to clean water, healthcare and energy. 

“When looking at the strategy of the fund, we asked ourselves two key questions: will it stimulate growth for Angola and will it stimulate wealth? There is a growing consciousness among African countries [for the need to] diversify away from being solely resource-dependent countries into [creating] a broader economic structure in the future,” says Mr dos Santos, the fund's chairman.

“The governments are aware that they need bodies to stimulate investment in areas that benefit the country, but where the private sector isn’t prepared to take the first step. SWFs are prepared to take this step as we have a broader approach to investment whereby we aren’t just fixated on financial returns – we also want to see the social benefit to society.”

Stabilising effect

In a similar move to that of Angola's, Nigeria’s $1bn SWF – the Nigeria Sovereign Investment Authority (NSIA) – is allocating up to 10% of its funds to a social infrastructure fund, which is due to be launched in early 2014.

“We have a pipeline of projects for this part of the fund, which range from agriculture to healthcare to social housing to schemes that help drive new business ventures for entrepreneurs,” says Uche Orji, the chief executive of NSIA, which was established in June 2012. “This doesn’t mean we will not earn a return on these investments, but it does mean that we are prepared to earn less than the benchmark rates we have on other investments. However, we are doing lots of work internally to develop the strategy because the last thing we want is for people to assume that it is a grant scheme or some sort of philanthropy. The objective of the fund is to build returns above inflation.”

Although modest in global terms, NSIA ranks as the third largest SWF in sub-Saharan Africa, after Botswana ($6.9bn) and Angola, and it was set up to invest funds accumulated from excess crude savings. As Africa’s biggest oil producer, Nigeria relies on crude exports for more than 90% of foreign income and about 80% of government revenue, making the domestic revenues very vulnerable to any swings in oil prices.

NSIA comprises three funds: the future generations fund and the infrastructure fund, which will each account for 32.5% of total holdings, and the stabilisation fund, which will receive 20% of savings. The remaining $150m is not currently allocated to any of the funds, but will be used for opportunities as and when they arise across each of the three funds.

Teaming up

In June 2013, NSIA signed two memoranda of understanding (MoUs). One was with Lagos-based Africa Finance Corporation, to work together on infrastructure transactions, and the other was with US energy giant General Electric (GE) to co-develop and finance infrastructure projects in the healthcare, aviation, transportation and power sectors in Nigeria.

“We chose GE because its overall commitment to Nigeria has been ongoing – even before I joined NSIA. We’re hoping to have transactions on the ground that we’re funding in the fourth quarter of 2013, and we expect to sign about five MoUs in total but I don’t expect them to be as broad in scale as the one with GE,” says Mr Orji. “Our biggest challenge is working out whether we have both the right asset allocation and the right managers, especially in a volatile environment such as this."

GE will contribute 15% in equity in its investment projects, while NSIA, through its Nigeria Infrastructure Fund (NIF), is currently evaluating 15 infrastructure projects to invest in through credible public-private partnerships.

The other co-investors comprise other SWFs and some private equity investors, and NSIA will charge for the use of the commercial infrastructure projects that it builds, with most infrastructure funds around the world earning on average returns of 6% to 7%, according to Mr Orji.

Latam looks forward

After Africa, JPMorgan predicts that Latin America will record the second strongest regional growth in terms of the number of new SWFs established in the coming years. In December 2008, Brazil established its first SWF – the $11.3bn non-commodity Fundo Soberano do Brasil, while in May 2012, Panama established a $1.25bn SWF. The Fundo de Ahorro de Panama (FAP) will derive a large share of its funds from the expansion of the Panama Canal that is due to be completed in 2014.

“The main funding for the FAP will be derived from the fact that once the revenue the canal generates exceeds 3.5% of Panama’s gross domestic product, that excess capital will be allocated to the fund,” says Abdiel Santiago, secretary of the FAP.

Panama ranked as Latin America’s fastest growing economy in 2011 – with annual growth of 10.6% – with revenue from its 80-kilometre waterway standing at $3bn in 2011 and expected to double by 2025.      

“The main reason for setting up the FAP was to serve as a stabilisation fund in case the economy [weakens],” says Mr Santiago. ”We want it to serve as a mechanism to counterbalance any systemic risks and natural disasters, but most importantly to preserve capital for future Panamanians.”

The FAP approved a seven-member board in December 2012, and is now working hand in hand with the Panamanian government to draw up a broad investment strategy that is expected to be approved at some point in 2013.

Iran's hopes

Iran is another commodity-rich country that hopes its recently established fund – the National Development Fund of Iran (NDFI), which was set up in 2011 – will help it avoid the Dutch disease phenomenon. NDFI’s funds currently stand at $52bn.

“The ultimate goal of the fund is to act as the engine for sustainable economic development in Iran,” says Mohammad Reza Farzin, president of the NDFI. “The NDFI is mandated with saving the future generation's share of fossil fuel resources. So, our investments are focused on achieving moderate returns through low-risk activities in foreign capital and monetary markets, as well as domestic projects (through agent banks), in line with our masterplan. We are looking at long-term assets and fixed-income securities. I’m confident that the fund’s resources will grow to more than $58bn by the end of 2013,” says Mr Farzin.

The Iranian parliament has approved a plan whereby during this Iranian year (starting March 21, 2013), 26% of all revenues from the export of oil, gas, gas condensates and oil products are transferred to the NDFI.

Conflicting interests

It is hoped that these new SWFs will help developing countries to preserve capital that can safeguard their economies in times of need. Despite decades of crude production, most of them have never built up savings funds.

Nigeria’s existing savings account, known as the Excess Crude Account, grew to more than $20bn in 2007, but had fallen to $4bn in 2011, after being frequently raided by the government. Today, it stands at roughly $6bn. In 2012, the country's finance minister, Ngozi Okonjo-Iweala, said that she wanted the SWF to grow by $1bn a year. But her wish is expected to meet resistance from state governors, many of whom are concerned about how this new allocation of national revenues will eat into their funding pots. 

“I would be surprised if there wasn’t a challenge and I don’t expect these issues to disappear,” says the fund's chief executive, Mr Orji. “It is hard to balance the needs of the current generation with those of the future generations. But, personally, I hope NSIA will grow by more than $1bn a year – there is a benchmark rate for the price of oil and anything that is above that will be allocated to the fund.”  

Governance rules

As part of its efforts to achieve good governance, in April 2013 NSIA applied for membership of the Santiago Principles – a set of 24 voluntary guidelines that assign best practices for SWFs in terms of legal framework, institutional and governance structure, and investment and risk-management policies

“We have enshrined in our act the observance of the Santiago Principles as we want it to be a financially sustainable fund that is transparent and has an independent decision-making process," says Mr Orji.

The Santiago Principles were drawn up in 2008 through a collaborative effort between the IMF and the International Forum of SWFs, with 25 countries currently having signed up to them. FSDEA may soon make it 26 as it is another SWF that is looking to subscribe to the principles. It has also applied to be measured by the Linaburg-Maduell SWF Transparency Index.  

“The SWF is an autonomous fund so fiscally speaking it is managed separately from the government,” says Mr dos Santos of the FSDEA. “We want it to be a transparent and well-governed fund.”  

The Santiago Principles are considered a good benchmark by which a country can ensure the best organisation and governance framework for its SWF. “By complying to these principles, emerging SWFs can significantly reduce political concerns and mitigate the risk of protectionist pressure on their investments and restrictions on international capital flows,” says Pierre-Emmanuel Iseux, who as a board member of the Swiss-based financial advisory company La Compagnie Peter Hottinger is in charge of mandates for the establishment and management of stabilisation funds in Africa and the Middle East.

“To overcome concerns over transparency and independence, a government’s role must be clear, with an independent governing body well defined, with explicit benchmarks and performance targets," he adds.

Raw potential

By subscribing to international norms, NSIA hopes to increase public trust and promote good governance. It has also hired Cambridge Associates to act as its adviser and JPMorgan as its custodian.     

“We’ve all watched the developed markets struggle over the past few years and when you look at the countries that will come to your rescue today – the list is dwindling. Plus, the IMF now has much bigger fish to fry,” says Mr Orji. “At the same time, we have seen a sustained high level of commodity prices and a rising trend of democratic governments starting to serve African countries. As governance is improving across Africa, we’re starting to see the creation of SWFs becoming part of the country’s law.

"Over the past few years, we have gone from having practically zero African SWFs to four new ones being established. And they are all being set up in such a way that the governance of the fund has been insulated from the political machinations of the country and with laws to protect it.”

With a proper governance framework in place, an SWF can play an invaluable role in helping to stabilise an economy during upheaval, but also in helping it to chart its growth strategy over a longer period. In this way, these new funds have great potential to help both African and other commodity-dependent countries to not only save funds for future generations, but invest excess revenues in projects with long-term development targets.

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