Risk & Compliance

Gulf in Opinion

Sovereign wealth funds: friends or foes?
Jason KaraianSeptember 3, 2008

As they shopped an impending IPO to investors this summer, Hartmut Mehdorn and Diethelm Sack, CEO and CFO of state-owned German railway group Deutsche Bahn, made headlines by visiting the offices of sovereign wealth funds in Dubai and Abu Dhabi. They’re not the only executives adding the Gulf to the list of stops along the traditional roadshow route. The region’s deep-pocketed funds, whose combined assets under management range between $3 trillion and $4 trillion, are now impossible to ignore for any company seeking capital. Just ask the host of banks that would be in even worse shape than they already are if not for multi-billion dollar infusions from sovereign funds over the past year.

At a summer press conference in London, John Nugée, a managing director at State Street Global Advisors, provided an eyebrow-raising statistic about the rapid growth of sovereign funds. These funds are expected to invest some $5 trillion over the next five years, and given their likely asset allocation mix, sovereign investors collectively could own more than 5% of each of the 8,000 companies in the FTSE Global All Cap Index. As a result of the funds’ size and growth, the “thirst for knowledge” about these investors is considerable, Nugée explained.

Another reason for the growing curiosity over the funds is their lack of transparency. A recent report by JPMorgan noted that the funds are “accused of having hidden agendas and yet are welcomed as saviours.” A survey of institutional investors by law firm Norton Rose found a similar dichotomy, with a roughly equal share of respondents saying that sovereign funds’ primary goal was to make investments of strategic importance to their home nations, as those who regard achieving the highest return as the primary objective.

For its part, the European Council has noted “concerns relating to potential non-commercial practices” among sovereign funds, urging the use of “national and EU instruments if necessary” to curb their activities in Europe. But JPMorgan argued that officials are unduly wary of sovereign funds, which are “not set up and have little interest to actively manage the operations” of companies they invest in.

But this passivity is itself drawing criticism. Peter Montagnon, chairman of the International Corporate Governance Network, declared that sovereign funds risk “supporting bad boards” if they continue to eschew voting their shareholdings. Proxy adviser RiskMetrics has also weighed in, noting that other institutional investors may sour on investing alongside sovereign funds if this reticence hinders their ability to “hold directors accountable over subprime-related losses, runaway executive pay and other governance failures.”

Next month, the IMF is expected to publish a set of voluntary principles and practices relating to the “institutional framework, governance and investment operations” of sovereign funds. However, as the IMF will ask them only to “either adhere to or aspire to implement” the guidelines, the inner workings of sovereign funds will probably remain opaque for some time.