Sovereign Wealth Funds: The Great Reconstruction

Some sovereign wealth funds have dived into turbulent COVID waters. Over the longer term, the pandemic will lead to fundamental changes in the form and function of SWFs right across the globe

Change is sweeping through sovereign wealth funds (SWFs). In some cases, it has been immediate and visible, with SWFs rescuing companies or injecting cash into depleted government coffers. In others, we are seeing a pivot to a more domestic focus, while some funds may not even be fully aware of the demands that will inevitably be made of them.

Preqin spoke with Michael Doran, Partner at law firm Baker McKenzie, about the seismic shifts occurring. “The backdrop now for all sovereign wealth funds is stark. The pandemic hit, international trade stalled, and global economic activity rapidly ground to a halt,” says Doran. 

“Commodity prices – crucial to many SWFs – collapsed. Governments had to step in to prop up their countries' economies and have had to assume massive liabilities. They’ve suffered an acute loss of taxation revenue and incurred enormous expenditure in trying to prop up the local economies, paying people not to work. Simultaneously, they have been compelled to make unprecedented investment in healthcare and vaccines. As the pandemic continues to rage, none of this has really played out yet," Doran explains.

"We are still in survival mode. But we can see the clear direction of travel and we can recognize that it will take a generation to fully recover from the deepest global recession we have ever seen. And that assumes that the correct macro and micro economic steps are taken, and that all the major market actors play a dynamic role. This is no time for bystanders.”

SWFs Administer First Aid
Some SWFs made high-profile interventions in the early stages of the pandemic. Turkiye Varlik Yonetimi (Turkey Wealth Fund) was established in 2016 to invest in regional infrastructure projects. Emergency legislation was passed in April 2020 to enable it to shore up state-supported companies, and the fund moved quickly to support aviation, telecoms, banking, insurance, oil & gas, and Turkey’s stock exchange, Borsa Istanbul.

In Asia, Singapore’s Temasek is making a virtue of its role in the COVID response. In addition to stepping in with a $13bn rescue package for Singapore Airlines and a $1.5bn rights issue for rig builder Sembacorp Marine, raising $2.75bn through a bond issue with terms up to 50 years, and increasing the size of its medium-term note program from $20bn to $25bn, the fund’s foundation arm has provided free reusable antimicrobial masks to all Singapore residents.

Other funds are also being tapped for cash. Outflows from Norway’s NOK 10.01tn ($1.16tn) Norges Bank Investment Management (NBIM, also known as Government Pension Fund Global) were NOK 302bn ($35.1bn) in 2020, compared with a net inflow from the government in 2019 of NOK 17.7bn ($2.1bn). Saudi Arabia’s Public Investment Fund (PIF) will pay a one-off dividend of up to SAR 25bn ($6.7bn) to the Saudi Government to plug a gap created by declining oil revenues. Funds in Kuwait, Iran, and Nigeria have reportedly paid out larger dividends to support government expenditure.

Preparing for a Slow Recovery
Among those SWFs with a longer-term action plan is PIF, with $360bn in assets under management (AUM). PIF has turned its focus to the Saudi economy, increasing investment in domestic projects from $16bn in 2019 to $40bn annually from 2020 through to 2025. PIF aims to contribute $320bn to non-oil GDP over the next five years, to grow AUM to over $1.07tn, and create 1.8 million direct and indirect jobs by the end of 2025.

In Europe, Ireland Strategic Investment Fund, which has €7.9bn ($9.5bn) of AUM, accelerated an already-established initiative to direct more of its resources to the domestic economy, and set up a €2.0bn ($2.4bn) Pandemic Stabilisation and Recovery Fund (PSRF) to support larger businesses. Announcing an increase in the size of the PSRF to €3.4bn ($4.1bn), Ireland’s Minister of Finance Paschal Donohoe said: “The Recovery Fund will be targeted and will help to stimulate increased domestic demand and employment. Crucially, given the evolving nature of COVID-19 and Brexit, the Fund will be flexible in its design in order to provide Government with the means to react swiftly to a constantly changing environment.”

SWFs Will Drive Economic Rehabilitation
In light of COVID-19’s sweeping impact, governments with SWFs are having to look at the role of those funds. “Historically, governments left SWFs alone and did not interfere, because the theory was that the funds were autonomous and not piggy banks,” explains Doran. 

“Now the game is one of necessity. This is not politicians or academics sitting around discussing economic theory. It is a desperate situation and most countries cannot afford to have SWF assets sitting under-utilized – such as in low-return US Treasury bonds. I believe that many sovereign funds will be obliged to step up, assume a central and energetic role in national and regional regeneration, make their assets sweat by raising cash, and act as dynamos in the reconstruction and recovery effort.”

Alternative investment funds are one way SWFs can play a part in the reconstruction and recovery efforts. SWF investments in private equity, real estate, and infrastructure funds have risen substantially over the past decade, with cumulative allocations rising from $206bn in 2011 to $717bn in 2020 (Fig. 1). Historically, SWFs have focused on large funds, driven by their need to deploy sizable amounts of capital. But investments in sub-$500mn private capital funds, which in 2020 accounted for 22% of the number of fund commitments recorded by Preqin, are likely to increase given the role SMEs will be expected to play in driving an economic recovery.

Over the coming years the strategies of SWFs will likely evolve substantially. In Preqin’s Sovereign Wealth Funds in 2021: Worlds in Motion report, which will be published in May 2021, we will analyze and classify SWFs according to their different remits.

The destination of SWF fund commitments reveals where there is room for strategic shifts. The mature economies of North America and Europe make the vast majority of investments in their respective regions (72% and 73%, Fig. 2). This is not true of less established markets: Asia-based SWFs make half of their investments within the region, and in the Middle East just 8% of the commitments made by SWFs are to funds based in the region.

“Some funds may have to sell off assets, because governments will be increasingly concerned about their credit ratings and need liquidity, credit support, or direct investment across the state sector,” says Doran. “But the funds that are going to attract the most attention over the next 5-10 years will be those that embrace being a catalyst and major engine in national and regional economic reconstruction and recovery. And if they can develop a true appetite for Building Back Better and genuinely embrace sustainable recovery and the greening of their economies, there are huge investment opportunities for them as well. They can do well by doing good.”

This is the second article in a series exploring the world of sovereign wealth funds, ahead of Preqin’s upcoming report in May 2021. Sign up to be notified when future articles are published and receive a copy of Sovereign Wealth Funds in 2021: Worlds in Motion.