In recent years we have heard a lot about sovereign funds acquiring western world assets, including famous football clubs and ports and banks, especially during the crisis.
What are they exactly?
Sovereign funds are state-owned funds that are set up by countries to serve three main purposes: accumulate savings for future generations (commodities’ exports countries), manage foreign reserves and strengthen regional economic development. Assets under management are estimated at USD 4.2 trillion at the end of December 2010, an increase of 10% compared to 2009. Commodities' exporting countries represent the bulk with some USD 2.7 trillion in assets, and the remainder is split between foreign exchange reserves funds, and to a lesser extent funds set up to handle budget surpluses and privatisation revenues.
Countries falling into the commodities exporting category are oil and gas producing nations such as the United Arab Emirates and Norway. China, Singapore and South Korea fall into the second category of foreign reserves funds while the last category includes countries such as France, Ireland and New Zealand.
Investment patterns and strategies
Sovereign funds are usually long term investors, and therefore have higher risk tolerance. They are mainly passive investors and have invested heavily in developed countries, traditionally investing in fixed income instruments such as the US treasury bonds. Nevertheless there is a trend to raise allocations to alternatives to increase investment return. There are increased investments mainly in infrastructure and private equity. These investments are very often done in a consortium of PE investors, with minimal usage of leverage. Hedge strategies are also increasingly being favoured.
Sovereign funds have also made strategic investments in PE houses and banks in support of their investment strategies. Banks and PE houses such as Blackstone, Carlyle group, Citigroup, Merrill Lynch, UBS, Credit Suisse, all have sovereign funds as investors.
In view of its growing investments and importance, there has been greater demand for transparency for sovereign funds and in 2008, a group called the International Working Group was set up, and a set of 23 principles referred as the “Santiago Principles” was agreed. The principles are however non binding and are expected to be applied on a voluntary basis. The document covers three main areas, the legal and macroeconomic framework, risk management and investment practices and governance principles.
With high commodity prices sovereign funds are set to continue to grow, putting pressure on countries for more transparency. It is hoped that by adopting these principles and being more transparent, there will be less concerns about the strategies and opacity. There are already certain countries such as Norway which have already adopted these principles.
Sovereign funds in Luxembourg
Little is known about activities of sovereign funds in the Luxembourg financial sector. However sovereign funds have been using Luxembourg structures to benefit from double taxation treaties and other tax advantages, and the country is still seen as offering the right framework through which investments may be channeled.
For more information, please contact:
Victor Chan, Partner
+352 22 51 51 6514