SWFs are a mechanism for states to advance their interests through global financial markets. For example, commodity funds exist to diversify physical assets in the ground into financial assets around the world. Pension reserve funds exist to take advantage of the high returns from risky assets in order to bolster national pension systems. Each country seems to have slightly different objectives for why they set up a SWF, but in all cases investing in financial markets seems to play an important part of the equation. The trouble is, realizing the promise of SWFs in global financial markets is anything but easy.
The form and functions of these institutions are typically conceived in Western terms, which means the necessary ingredients and infrastructure for their effective performance may not exist in non-Western jurisdictions. As evidence, I present you with some remarkably candid comments from the Vice Chairman and General Manager of the China Investment Corp Gao Xiqing that shed light on this topic:
First and foremost, we lack an understanding of investment products.
The next challenge is a lack of experience in project design, investment structures and negotiations.
One big difference between Chinese overseas investment and that of developed Western nations is that we lack talent. The West has been involved in overseas investment for several hundred years, so their talent pool is vast. But Chinese efforts have only just begun. One could say that our first generation of investors has just emerged from the clay...Our greatest challenge is to establish a mechanism to attract talents, retain them and allow talents to rise to their full potential. Its not enough just to hire them; we must also be able to train them and build a reserve of talented individuals.
Gao goes on at some length about the difficulties the CIC has faced in getting up to speed on financial investments. The article is well worth a read. Anyway, this is why Gordon Clark and I argued in a recent paper that SWFs may transform themselves into long‐term investors whose holdings are selected on the basis of their strategic interests (of the fund and the nation) rather than the principles underpinning modern portfolio theory. It seems to make sense that these funds would prioritize 'deal-making' (which they know well) over 'investing' (which they know less well). And Gao even seems to agree with this view:
"We are probably most familiar with direct investments. However, in many countries and in many industries we have no precedent to follow. Our lack of experience exacts greater demands on us in risk management."
Perhaps the future of SWFs will be more like that feared by their critics: strategic investors that take advantage of their strengths instead of trying to play the west's game of finance...