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Sovereign rules of engagement

Sovereign rules of engagement

Proactive and reactive measures for official asset owners

by Pooma Kimis and David Marsh

Mon 17 Nov 2014

  1. Increased wealth and aspirations in the funds’ home jurisdictions intensify the dilemma of how to allocate resources according to domestic as opposed to international requirements. Sovereign funds from energy exporters, faced with falling oil prices, are doubly squeezed – by pressures to shore up domestic budgets and demands to glean rewards from foreign investment. Finding the right balance requires political as well as investment expertise.
  2. Global public investors need to be alive to the full repercussions of the fall in commodity prices, especially oil. Among investee countries in the developed and emerging world, there will be winners and losers from the price decline. Sovereign fund managers must ensure they are abreast of the political consequences and their effect on the supply/demand balance.
  3. Some GPIs may wish to join the vanguard setting investment patterns for the renminbi. In line with the Chinese authorities’ efforts to internationalise their currency, many market observers believe the renminbi will eventually become, over time, the No.2 reserve asset after the dollar.
  4. Co-investment has become a watchword for many GPIs, as attractions of investment in the classic limited partner/general partner private equity structures (high fees often out of kilter with rewards) have started to pall. So there’s a greater need than ever to pick partners carefully, from the public and private sectors – and to hire skilled personnel.
  5. Real estate/infrastructure have maintained their popularity as cheap money floods markets. But investors have to watch out for bubbles, even in areas associated with the ‘real economy’. The market for ‘trophy assets’ is overheating. Off-market investments in less fashionable areas (e.g. bundles of unglamorous energy or retail assets in out-of-the-way locations in Germany or the Netherlands) may gain favour.
  6. The yen and the euro look like structurally weak currencies in the next 12 months – so investing in technologically-proficient exporting companies from these regions could make sense, as could arranging borrowing in these currencies (for those funds, or their investee companies, that use leverage).
  7. A question mark hangs over fixed income as US interest rates rise. European and Japanese rates will increase too next year (although less quickly), but there is still money to be made in bonds. Fixed income euro positions in ‘core Europe’ (German, Swedish, Swiss and Danish bonds), even at yields close to zero, could pay off over time – in the context of possible longer-term changes in the euro’s constituents.
  8. Learning from peers brings benefits. The schism between mature and younger sovereign funds is increasing, but the way to overcome this is through bilateral co-operation at strategic and deal-making levels, aided by informal internal forums for transaction proposals, exchanges of best practice, and secondments.
  9. Yield-hungry sovereign funds may consider building up expertise in emerging market currencies. A more proactive approach is needed: official asset managers and owners can promote domestic currency debt issuance from sovereign borrowers in Africa, Asia and Latin America by underwriting a proportion of appropriately-priced newly-launched bonds.
  10. GPIs should take a more activist approach on corporate governance, engaging constructively with investee managements and setting up stakeholder structures for voting purposes. They could adopt a similar policy to Norway’s NBIM, for example. Joining the corporate governance network pioneered by CalPERS, the Californian state employees fund, may be advisable.
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