FRONTIERS-Sovereign wealth rewrites old-world rules

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* SWFs often enormous, established fish in small ponds

* Their need for discretion suits many “frontier” targets

* Declining rich-world power weakens push for transparency

By Natsuko Waki

LONDON, May 27 (BestGrowthStock) – Sovereign wealth funds —
national vehicles created to grow state wealth for the future —
have long experience investing in exotic and lesser-known lands.
To these funds, many of which originate in what the West calls
the “frontier” region, it’s a local market.

This year alone, countries including China, Singapore, South
Korea, Kazakhstan, Azerbaijan and Abu Dhabi have invested easily
more than $1 billion in frontier markets, in such projects as
mines in Mongolia and companies in Africa, the Caribbean and
Latin America.

The often secretive heavyweights of the financial world,
sovereign funds control around $3-4 trillion in assets and
include some established players on tricky terrain. Because
their investments are so influential, their presence can be
manipulated to wrong-foot other investors.

So the sovereign wealth funds’ tendency to be opaque adds to
the challenge for investors in frontier markets. But beyond
this, they are also having a broader influence, bringing a
“frontier factor” to the rest of the world.

“Most SWFs are themselves a creation that should be looked
at in the context of frontier markets,” said Alexander Mirtchev,
independent director of a sovereign wealth fund from the
“frontier” region and a member of the board of trustees on the
Kissinger Institute on China and the United States.

“The frontier is part of their DNA, and this ‘frontier
make-up’ to a large extent determines their competitive
advantages, as well as in some cases the problems that SWFs
sometimes face.”

Backed by leverage-free reserves beyond the dreams of most
indebted rich-world countries, the funds’ “south-south”
investment is more than a sideshow: it’s reinforcing their role
as powerbrokers of global markets.

HISTORY LESSON

To get the picture it’s worth considering that in a sense,
sovereign funds have been actively investing on the frontiers
for at least 400 years.

The East India Company — an English trading company in the
17-19th centuries backed by the state — functioned loosely like
a modern sovereign wealth fund. It pursued trade in commodities
including spice, cotton, tea and opium in the then-frontier
markets of China and India, creating regional markets and
helping develop local economies.

Other European corporations including the 17th-century Dutch
East India Company, VOC, served as tools of colonial power — an
extension of states — just as do some sovereign funds today.

The difference between the pioneers of the past and the
present is that today, much of the wealth and influence come not
from the modern rich world, but from resource-rich countries
with very different values.

SOUTH-SOUTH TIES

Concrete figures are hard to come by, but experts estimate
the allocation of sovereign wealth fund assets to frontier
markets is less than 5 percent.

That would translate into $150 billion, which eclipses the
total market capitalization of the benchmark MSCI Frontier
Markets equity index at $120 billion.

What for the funds is small exposure makes a huge difference
to recipients. Their presence brings mutual benefits.

The funds and their targets in poor countries often have
shared experience on the economic margins, which fosters a
cultural affinity.

Countries on the investment frontiers desperately need
long-term capital, which sovereign wealth funds can provide.

Recent economic ructions in the West add to the incentive
for stronger ties: the risk in developed-market investments has
increased, but the prospect of commensurate rewards has not.

Sovereign funds are keen to diversify into illiquid but
higher-yielding assets in frontier economies in the hope of
providing returns for future generations. And unlike the
quarter-to-quarter reporting required from companies in the
West, these funds can wait a long time before showing returns.

“Most SWFs are seeking new and untapped sources of
diversification and alpha generation,” said Cynthia Sweeny
Barnes, global head of sovereigns and supranationals at HSBC
Global Asset Management.

“Frontier markets offer interesting risk-reward dynamics,
particularly for investors with permanent capital. The low level
of information in frontier markets creates often significant
pricing inefficiencies, which active investors can exploit.”

SHHHH

Modern sovereign funds have been thrust further into the
global economic limelight since the credit crisis cut funding
for the hedge funds and private equity groups that had been
cocks of the walk.

Only a few years ago, Western politicians were making
headlines with attacks on sovereign funds for their secretive
ways: behind this were fears their motives were political,
rather than commercial.

Keen to be accepted, many did make an effort to open up. But
since the credit crisis, political calls for greater
transparency from the funds have quietened.

“Once regarded as subversive agents of state capitalism,
they are now sought-after providers of capital,” Sven Behrendt,
a visiting scholar at the Carnegie Middle East Center, said in a
study for the centre this month.

“Their growth dynamic suggests that their investment and
policy behavior will resonate across the global economy.”

These funds need a degree of secrecy to function.

Already, their investment decisions are closely followed by
the wider investment community, as the global importance of the
industry grows. It is forecast by Deutsche Bank to more than
double in less than 10 years.

In a fiercely competitive investment environment, others in
the market sniff about for deals that anticipate the moves
sovereign funds will make. A practise known as front-running,
that risks pushing up prices before the funds invest.

“Because we are generally large institutional investors,
there is the whole community of investment banks, brokers,
analysts and others who want to front-run our investments in the
market,” David Murray, chairman of the board of guardians at
Australia’s Future Fund, told a news conference last October.

“In doing so they would use all sorts of techniques to find
out from us exactly where we are in the market in terms of
timing. It is not in the interest of the funds nor our community
to be involved in that game because it would be detrimental to
our investment returns.”

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FRONTIERS-Sovereign wealth rewrites old-world rules