Managers eye SWFs' massive fortunes

By Sophia Grene

Published: August 18 2008 03:00 | Last updated: August 18 2008 03:00

With their pockets full of money from the multi-year surge in commodity prices as well as the mountain of foreign exchange reserves that Asian central banks have acumulated, sovereign wealth funds face a dilemma - what to do with all this money?

The sheer volumes of assets - even the smallest SWF, the Timor-Leste Petroleum Fund is above $1bn - and the speed with which they have grown - the East Timorese fund was set up just three years ago - means the agencies established to manage the funds have to look for external help.

"Some sovereign wealth funds have got too much money too quickly and are struggling to manage it," said John Nugée, head of State Street's official institutions group and a managing director of State Street Global Advisors.

It is difficult in this case to pin down how much is too much because many SWFs do not publish accounts. But recent estimates put the global figure at about $3,000bn (£1,600bn, €2,000bn).

Naturally, asset managers are keen to grab some of this business, even though it is hard to know how much of it is being outsourced or what is being outsourced.

"There isn't even consensus over the absolute level of reserves, let alone what proportion is being outsourced," says Cynthia Sweeney Barnes, head of sovereigns and supranationals at HSBCGlobal Asset Management, adding that her personal impression is that the quantity of outsourced assets is at a record high.

Larger fund managers are hopeful they will be the beneficiaries as the scale of the SWFs limits their ability to spend governance resources on investigating smaller boutiques.

Many of the large asset managers have the further advantage of a parent, be it global bank or custodian, that has already established links with the government in question.

The exception to this is that some of the larger, longer-established SWFs have developed relationships with specialist investment
managers, especially in the hedge fund space.

With the exception of a few funds in developed countries, such as Norway, Ireland and France, the SWFs tend to have relatively opaque processes for assigning mandates.

In certain cases, an SWF may entirely bypass the usual process and simply go straight to a manager with the news that a mandate has been assigned.

But is it possible to distinguish a pattern in the kinds of mandates they are outsourcing?

Since "it is a fallacy to assume that the sovereigns invest in an identifiable pattern", according to Ms Sweeney Barnes, and it is unknown what proportion is outsourced, any generalisation about what kind of business asset managers might
win from them must be treated cautiously.

"Everyone is assuming that, because SWFs are growing at however much it is a year, all types of mandates are growing equally fast," says Mr Nugée.

This is not the case because "the ability of the funds to manage assets themselves is growing very fast".

As SWFs become more confident in their ability to manage cash, fixed income and even global equities, they are less likely to outsource these "vanilla mandates", as Ms Sweeney Barnes terms them. This improvement in capabilities comes, in some cases, courtesy of the asset managers. SWFs merit separate treatment from other institutional clients and one of their chacteristics, notes Ms
Sweeney Barnes, is that they frequently demand training as part of the package.

Thus, the ability to offer this becomes one of the requirements for an asset manager that hopes to manage sovereign money.

"It's important not to overplay the training," says Mr Nugée. "It may just be a desire to get to know the asset manager [and the business of asset management] better."

However, SWFs are tending to retain the management of core assets and "use managers at
the margin of their own capacity".

The prospect of SWFs improving their in-house expertise, hiring managers from the industry and taking back control of their core investment mandates holds no threat to asset managers, however, as they change and broaden their asset allocation.

Traditionally SWFs have been very cautious investors, with significantly more than half of their assets in fixed income, according to industry estimates.

Recently, some of the more established funds have looked further afield, particularly to take advantage of their long investment horizon, by putting money into illiquid assets such as private equity and real estate. Once again, they often have to look externally for support.

"What is happening is that the new money is being invested in a radically different way than the bulk of the money," says Mr Nugée.

"Asset managers are surfing the wave of the SWFs." By this, he means the industry may lose some of the core mandates but should more than compensate by picking up higher margin mandates in more challenging asset classes.

In business terms, working with SWFs may be attractive in terms of scale but the fees can be correspondingly low. Given the challenges of working with such a body, especially in cases where the fund has only recently been established, this is not a market for everyone.

"The investment one needs to make from a dead start can be a challenge and that, coupled with what can sometimes be a relatively low-fee business, has led some asset managers to decide not to operate in this space," says Ms Sweeney Barnes. However, she says new entrants to the market are undercutting prices and cautions that the worst thing they could do is to win a mandate and not meet expectations.

"That reflects badly on all asset managers."

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SUBJECT: Angola and East Timor amongst petroleum producers  with least time to diversify economy

London, United Kingdom, 18 Aug ­ Angola and East Timor are among the oil producing countries which will have the least time to diversify their economies and sources of income, as production declines.

Angola is expected to reach its “peak” of oil production in 2010 ­ two million barrels per day ­ and will then enter into a transition period, according to the projections of John V. Mitchell and Paul Stevens in the report, “Ending Dependence: Hard Choices for Oil Exporting States,” recently published by the British Institute of International Affairs (Chatham House).

They add that this transition period could last as long as seven years, should new and significant reserves be discovered, or as little as two years.

The report, which looked at a total of 12 countries in Europe, Africa, the Middle East and Asia, puts Angola into the “Prematurely Dependent” group, along with East Timor, Azerbaijan and Kazakhstan.

“These four countries are relatively new in terms of large-scale oil wealth. However, their window of opportunity to resolve the diversification problem (…) is small, given that the increase in reserves will be limited,” say the authors.

For Mitchell and Stevens, these countries “face considerable barriers to diversification” and “so far there are few signs of a successful process [of diversification] beginning.” “They all sufferfrom a lack of infrastructure coupled with problems of inefficient spending and a general lack of administrative capacity within the government,” they say.

They add that in East Timor the dominance of the oil sector is complete, accounting for 95% of government revenue, 73% of GDP and virtually all exports.

“It has been estimated that when the Greater Sunshine field goes into production in 2010, the sector will account for 89% of GDP and 94% of government revenue. The rest of the economy is essentially subsistence agriculture,” says the report.

The Angolan economy is also “very dependent” on oil, accounting for 58 percent of GDP, 81 percent of government revenue and 96 percent of exports, according to projections in the Chatham House report.

Between 2001 and 2005, petroleum revenue contributed little to the country’s productive base and before that sustained a “highly skewed income distribution.”

“Angola faces not only a development challenge, but also a reconstruction task. Civil war destroyed infrastructures, leaving large parts of the country ­ rich in other natural resources ­ without power, communications, schools, hospitals
and public order,” say the authors.

The non-oil sectors of the economy are currently dominated by agriculture, though between 1975 and 2003 the cropped area fell by 40 percent.

Angolan oil reserves, estimated by the authors, based on various statistical sources, to be 544 barrels per capita, among the lowest amongst the countries included in the report, in which the Kuwaitis came out best with over 39,000 barrels per inhabitant.

Along with Kuwait, Angola is the country most dependent on oil revenue to finance fiscal and current account deficit, sitting at the opposite extreme from countries which are less dependent such as Norway, Indonesia, Malaysia and Kazakhstan.

The report divides the 12 countries into three groups: “near sustainable”, “soon in transition” and “long-term depletion options.”

Also, a fall in oil prices from the current level of above US$100 per barrel down to US$60 could force countries like Angola to make “radical changes,” according to the report.

Among the solutions proposed is the deceleration of domestic energy consumption, investments and the expansion of reserves through exploration and new technologies.

“Depending on the countries, expansion of reserves (…) would prolong the peak of production and, therefore, exports by between two and seven years,” say the authors.

They point out, nevertheless, that until 2025 countries such as “Angola, Iran and Malaysia will need to have improved the fiscal balance of their non-petroleum sectors by 10 percent or more”.

As regards foreign investments, namely via sovereign wealth funds, “they are an essential strategic protection for the exporting countries against the uncertainties of future oil prices, reserves and above all the uncertainty of their
non-petroleum economies to adapt to declining oil revenues.”

According to the authors, what is mainly at stake is the speed at which countries dependent on oil revenues can impelmenty their diversification process.

“Time, and not oil, is what is coming to an end. Several countries urgently need to speed up progress outside of the oil sector in order to survive a potential fall in oil and currency revenues,” the report says. (macauhub)

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