What can the individual investor learn from sovereign wealth fund management? The main lesson seems to be that even with the earnings power of an entire sovereign entity behind you, it’s still not easy to avoid mistakes.
The New Frontiers of Sovereign Investment, edited by Malan Rietveld and Perrine Toledano of the Columbia Center for Sustainable Investment, explores the current state of affairs in sovereign wealth management.
New Frontiers is careful to clarify that a precise definition of a sovereign wealth fund is elusive, but for the purposes of this review: a sovereign wealth fund is a portfolio of assets controlled by a government, usually to meet long-term goals. As of 2015, sovereign wealth funds command an estimated $7.25 trillion in assets, if you use a broad definition like that one.
Somewhere between a textbook and an industry overview, the book is a broad collection of largely theoretical discussion. Outlines and frameworks dominate, although there are some enlightening charts and tables stemming from empirical study. The main objective appears to be to provide students and professionals with an overall framework that describes the current state of affairs and offers some helpful pointers for those involved in sovereign wealth management. Hence the division of the book into three sections:
- Part 1: The Evolution of Sovereign Wealth Funds: Mandates and Governance
- Part 2: The Rise of Sovereign Development Funds: Debates and Policy Implementation
- Part 3: Toward The New Frontiers of Sovereign Investment
I took my most active notes during Chapter 3, “Sovereign Wealth Funds as Long-Term Investors,” where Adrian Orr, CEO of the New Zealand Superannuation Fund, provides perspective on the connections among a sovereign fund’s objectives, the constraints on what is possible for sovereign fund managers to achieve, and implementation of a strategy. I found it striking that the biases that plague individual investors take up residence just as comfortably at the highest levels of sovereign investment decision-making. Orr writes:
“It is common for current generations to want instant gratification and enjoy wealth now. Also, future generations do not get to vote for current governments, meaning their voice is never heard. Time inconsistency, myopia, and principal-agent problems all drive inappropriate risk taking and insufficient financial provisioning for the future. Not saving now to meet a known demographic challenge implies an assumption that the challenge can be met at some future unknown date and interest rate.”
Orr places special emphasis on the characteristics of the long-term investor, which he defines as “one that can hold any investment strategy for as long as they wish,” and one who can “invest in a countercyclical and contrarian way across economic and financial cycles … benefitting from its stable risk appetite.”
Here, we see the potential advantage of institutional investors over the individuals. Employment tends to correlate positively with financial market performance, meaning that exposure to risk assets can be catastrophic during downturns, as an individual is likely to see his wealth plummet at the same time that employment opportunities and income dry up. Sovereign wealth funds have theoretically infinite lives; an individual’s wealth may not.
The book also shares a useful perspective on sovereign funds’ role in direct investment. All governments, including mine in the U.S., make investment decisions, and infrastructure is among those on the U.S. docket. Chapters 4 and 5, “The Governance Implications of Increasing Levels of Direct Investment of Sovereign Wealth Funds,” and “Playthings and Parallel Budgets” freshened my perspective on government’s role in the private sector. From Chapter 5:
“Sovereign wealth funds (SWFs have helped a number of countries improve public financial management. … However, a survey of fund performance makes apparent that these “good news” stories are the exception rather than the rule.”
The chapter goes on to detail the difficulties of countercyclical spending policies, currency stabilization, and even the basic goal of storing wealth. “Perhaps most alarmingly, SWFs have often become channels of patronage and corruption.”
Other highlights include Chapter 13, “North America’s Sovereign Wealth Funds” (did you know there’s a good case to be made that the State of Texas invented sovereign wealth management or that U.S. sovereign wealth funds have in the neighborhood of $150 billion in assets?), and Chapter 14, which documents the rise of sovereign venture funds (whose rise may have had something to do with the recent tech unicorn phenomenon).
Although the book did not explicitly set out to prove this, my main takeaway was that rational long-term decisions can be just as tough when an investor commands the taxation power of a sovereign entity as it is when the investor is a humble worker trying to save for a rainy day. If this is true, then it’s worth looking out for market inefficiencies, and it’s also worth spending considerable effort developing an explicit strategy and actively working in the interest of that strategy.
Developed with support by the Ford Foundation, KPMG, and PGIM, The New Frontiers of Sovereign Investment bears the markings and limitations of a consulting report. The conclusions are often not very adventurous, and one has to sort carefully through a lot of heavy theory to find the surprising and evidence-driven nuggets of insight. Overall, it’s an informative look at a powerful segment of the financial marketplace that doesn’t get a great deal of media attention and whose methods are often mysterious. It’s not the type of book I’d recommend to a friend but can serve as a useful starting point for a research process or job interview that touches on the structure and activities of a sovereign wealth entity.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.