Spotlight on sovereign wealth funds

Asian wealth funds need clarity of purpose and governance

Asia has witnessed the creation of more than a dozen new sovereign wealth funds (SWFs) over the past decade, each with its own governance structure and mandate. And more countries are seeking to set up such funds.

According to US research firm Sovereign Investment Fund Institute, there are now 33 state-owned investment funds in Asia, up from 22 a decade ago. Collectively, they oversee US$5.4 trillion of assets, comprising stabilisation funds, future generation funds, contingency pension reserve funds, reserve investment funds, and strategic development funds.

As of end-2023, there were 175 SWFs worldwide managing $11.2 trillion of assets, an 11-fold increase from just $1 trillion 20 years ago. They have emerged as significant global investors, accounting for 39% of total assets among the world’s 100 largest asset owners.

SWFs have existed for decades, operating mostly under the radar. The secrecy surrounding them ended in 2005 when Andrew Rozanov, a State Street financial analyst, coined the term “sovereign wealth funds”, bringing them into the spotlight as a distinct group of institutional investors.

The wealth funds have their own specific objectives. By and large, their overarching mandate is to manage a portion of their country’s national wealth, striving to achieve optimal long-term returns for the nation’s future. It is this focus on maximising long-term gains without immediate disbursement obligations that distinguishes SWFs from foreign exchange reserves held by central banks.

Today, the Norwegian Government Pension Fund is the world’s largest wealth fund, boasting $1.54 trillion of assets. Notably, seven Asian SWFs rank among the top 15 in the world by assets, including three from China – China Investment Corporation, SAFE Investment Company and National Social Security Fund; Singapore’s GIC and Temasek Holdings, and Korea Investment Corporation.

The 1997/98 Asian financial crisis served as a catalyst for the creation of many SWFs in the region. In the aftermath of the crisis, several East Asian countries, buoyed by strong economic growth and budget surpluses, recognised the importance of forming SWFs to bolster their foreign reserves to protect their currencies and invest in strategic projects for sustainable growth.

In addition, several Central Asian nations followed the lead of the Kuwait Investment Authority, utilising proceeds from the sale of oil to set up SWFs with the aim of preserving national wealth and promoting economic diversification.

Controversies

It’s not just the developed nations in Asia that have formed wealth funds. Less developed ones, including Mongolia, Bhutan, Indonesia, Malaysia, Pakistan, Philippines and some Central Asian countries, have followed suit, and some of them have run into controversy.

Indonesia, for instance, often has fiscal and current account deficits. Nevertheless, it set up the Indonesia Investment Authority in 2021, with an initial funding of $5 billion. The aim is to use the SWF as an investment vehicle to pool capital from global investors for investing in strategic domestic sectors such as infrastructure, telecommunications, pharmaceuticals and green energy.

It’s a bold concept. Global investors need reassurance that the fund will operate without political interference and implement robust governance measures to prevent corruption.

To strengthen its governance practices, the fund will join the International Forum of Sovereign Wealth Funds as an associate member, voluntarily committing to work towards the application of the Santiago Principles, a set of generally accepted principles and practices viewed as the gold standard for SWFs.

Through intensive marketing efforts, the fund managed to attract $20 billion in commitments from 50 foreign investors, including prominent names such as Canadian pension fund Caisse de dépôt et placement du Québec, Algemene Pension Groep from the Netherlands, Japan’s Bank of International Cooperation, and the International Development Finance Corporation from the US. Investors will have the option of investing in a “master fund” or a “thematic fund” focused on a specific industry or project.

Time will tell if the Indonesia Investment Authority can successfully achieve its strategic development goals.

Spectre of 1MDB

In neighbouring Malaysia, the resource-rich Sarawak state decided in November 2022 to establish its own SWF using surplus oil and gas revenues, with an initial capital of 8 billion ringgit ($1.68 billion). The goal is to invest the money for sustainable growth and maximum return, serving the best interests of the state and its future generations.

The proposal is a difficult sell considering the scandal over the now-defunct 1Malaysia Development Berhad (1MDB) which was established by former Prime Minister Najib Razak in 2009 to fund infrastructure projects. The fund started with $1 billion from the national coffer and ended up accumulating debts of $11.5 billion six years later, with $4.5 billion being embezzled. Najib was found guilty and imprisoned for misappropriation of funds, while Jho Low, the mastermind of the fraud, remains a fugitive with Interpol red notices issued against him.

The Sarawak government brought in the Norwegian Government Pension Fund to advise on its SWF model to lend credibility to the plan. The state’s premier also pledged that money in the fund will remain untouched for 20 years under “normal circumstances”, and that the state government will not interfere with the management.

The fund commenced operations this January under the supervision of a board of guardians consisting of nine independent members, with a retired Federal Court judge at the helm.

In the Philippines, President Ferdinand Marcos Jr. announced in 2022 a plan to create a SWF called Maharlika Investment to serve as a “gateway fund” to attract foreign investors for much-needed infrastructure projects. But his proposal faced strong resistance due to concerns about potential corruption. The public has little faith in the integrity of the nation’s public sector, underscored by Transparency International’s 2023 corruption perception index which ranks the Philippines 115 out of 180 countries.

During the presidency of Marcos’ late father Ferdinand Marcos from 1965 to 1986, several investment and development programmes were implemented, which involved granting of monopoly powers and government subsidies. These programmes became associated with cronyism, corruption and patronage, ultimately requiring costly bailouts.

There is apprehension among the public that Marcos’ son may follow in his father’s footsteps, taking advantage of Philippines’ weak institutions and governance, and potentially repeating history.

To address these concerns, Marcos Jr. made significant modifications to the original proposals, including removing mandatory contributions from the pension systems, requiring an external auditor to review financial statements, and having the finance secretary rather than the president as the chairman. It was approved by the Philippine Congress, and legislation to create the Maharlika Investment Fund was signed into law in May 2023. But five months later, Marcos suspended the implementation due to ongoing opposition, stating the need to make it foolproof.

Bucking the trend

India has resisted constant calls to form a wealth fund. The closest equivalent is the $4 billion National Investment and Infrastructure Fund established in 2016. But this fund is not included in the Sovereign Investment Fund Institute's list of Asian SWFs.

Wealth fund advocates argue that it makes no sense for the South Asian economic powerhouse to invest its $600 billion foreign reserves in low-yield US and European debt. They say an SWF would allow for more productive investment of a portion of these reserves across multiple sectors and asset classes worldwide, promoting diversification and risk mitigation.

But opponents contend that India consistently runs a current account deficit, at times as high as 2% or 3% of gross domestic product. The country relies on foreign investment through the capital account to finance its trade deficit, and hence needs to maintain significant foreign exchange as insurance against sudden capital flight. The government is not actively pursuing the establishment of a SWF.

The challenges experienced by Indonesia, Malaysia and the Philippines are a reminder that clarity on the purpose and governance of SWFs is paramount in their creation. Public trust in the funds’ integrity, competence and independence in investment decisions and managing the flow of money is absolutely crucial. Asia cannot afford another scandal like 1MDB.

*This article was published in Asia Asset Management’s March 2024 magazine titled “Spotlight on SWFs”