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What’s So Special About Sovereign Funds?

I was in Boston on Monday giving a speech at a big conference. I was there to reflect on a rather simple question: “What repercussions will SWFs have on other institutional investors?”

I was in Boston on Monday giving a speech at a big conference. I was there to reflect on a rather simple question: What repercussions will SWFs have on other institutional investors? I really liked this question, as it implied (in fact it assumed) that SWFs have significance for pensions, endowments, foundations, and other long-term investors. And that’s largely been my view; that SWFs may offer some useful lessons for the broader community of investors. But, too often, people come to me wanting to talk about the repercussions of SWFs for geopolitics or for external managers' ability to feed their fee machines. Alas, I'm just not interested in that as much.

Anyway, let’s get back to the question: What repercussions will SWFs have on other institutional investors? At first glance, it isn’t clear that SWFs will have a major impact on this community at all. Weighing in at $6 trillion in AuM, SWFs are a small subset of the broader community of long-term investors (which tips the scales at roughly $95 trillion). So even if they did do something remarkably different, logic would seem to suggest that the repercussions on other investors wouldn’t be too great. Right? Wrong. Actually, I argued in my speech that SWFs will have profound repercussions on the broader community of institutional investors. Why? For the simple reason that SWFs are new and, as a result, they are doing new things.

More SWFs were created in the past decade than in all the years prior, which means there have been (and will continue to be) numerous cases of potential innovation and creativity being brought to bear on the design of these funds. Every time a government launches a new SWF, it is in effect being given a blank canvas upon which to sketch ‘the optimal investment organization’. The plan sponsor launching a new SWF thus has an opportunity to revisit some of the foundational assumptions of the investment industry that, due to path dependence, the existing community of institutional investors has struggled to deal with.

For example, a public pension fund in the USA doesn’t seem to blink an eye at paying hundreds upon hundreds of millions of dollars in fees to Wall Street for “financial services”. But show these same figures to a plan sponsor setting up a sovereign fund for the first time, and I’ll show you a plan sponsor that’s immediately asking about other options (and quickly getting on a plane to Canada).

In short, SWFs may just come up with a new model of institutional investment that is far better than the models we have today. Angola, Ghana, Nigeria, Colombia, Panama, Peru, Lebanon, Israel, North Dakota, West Virginia, Western Australia, Papua New Guinea ... these are all governments that have the capacity to remake the business of institutional investment. Seriously. One of these governments may come up with a new way of running an institutional investment organization (or at least one component of an investment organization) that serves to challenge existing models.

And when I look around the world at the new SWFs, I’m astounded that there are already some remarkable models popping up among SWFs.

- I see a SWF in New Zealand generating 26% returns in a year and 9.5% returns over a decade, while fully integrating ESG into their investment process.

- I see sovereign developments funds in places like Palestine, Malaysia, and South Africa generating double digit financial returns over a decade, while also creating positive externalities for local communities.

- I see the Kuwait Investment Authority seeding new, wholly owned infrastructure managers in order to access an attractive industry in a fully aligned manner.

- I see AIMCo, ADIA and NZSF collaborating to make growth equity investments in VC backed companies.

In short, I see lots of very innovative things going on. And, I promise you, these innovations may be confined to a small group of intrepid investors willing to challenge some the fundamental assumptions of finance... but the best ideas will inevitably make it out to the mainstream.

Think of it this way, innovation often comes from the margins of a community, in this case from the ‘frontiers of finance’ (e.g., 'Canadian Model'). Over time, however, the truly successful innovations will secure legitimacy and be copied by other institutions around the world. In short, the best models will be diffused and eventually become the status quo. Perhaps one of these new SWFs is already setting the new standard...

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