Sovereign wealth funds have long provoked controversy (Hillebrand 2008, Truman 2008). The recent debate on sovereign wealth funds culminated with the promulgation of the Santiago Principles on fund transparency, investment orientation, and accountability. According to OECD principles, sovereign wealth funds should be considered on the same basis as other institutional investors and be submitted to investment regulations similar to those of, say, public pensions, mutual, or hedge funds.
But does the practice match the principle? In order to test this, we compare different dimensions of investment between sovereign wealth funds and mutual funds, a type of institutional investor (Avendaño and Santiso 2009). Although differences exist in the allocation of sovereign wealth funds and other funds, our results do not suggest that their investment motives are radically different, i.e. in both cases the drivers tend to be mainly financial rather than political.
We also introduce a new dimension in analysing sovereign wealth funds investments: the political regime in the sending and recipient countries. Although it is not surprising to find differences in the political regime of sending countries (sovereign wealth funds regimes tend to be less democratic), we find that sovereign wealth funds investments are not different from mutual funds when it comes to the political regime characteristics of the destination countries. This evidence suggests that both sovereign wealth funds and mutual funds do not discriminate by this criterion in their asset allocation and invest indifferently in both democratic and autocratic regimes.
Comparative portfolio and governance characteristics
To compare the equity allocation of sovereign funds with other investors, we have gathered a database of the stock holdings of two groups. The first includes sovereign funds (both OECD and non-OECD) and the second includes the 25 largest mutual funds, representing a total sample of 14,000 sovereign and 11,700 mutual fund investments in equity.
The portfolio characteristics of sovereign wealth funds and mutual funds (i.e. holder style, capitalisation group style, turnover, P/E ratio, dividend yield, etc) immediately appear as very similar, although sovereign wealth funds portfolios do however show a slightly lower beta, higher price-to-earnings ratio, higher sales growth and dividend yield, and lower price-to-book ratio (Figure 1).
Figure 1. Average portfolio characteristics for sovereign and mutual funds - 2008
Sources: Authors’ calculation, based on FactSet and Thomson Financial databases, 2010.
Geographically, the main investment destinations for both sovereign wealth funds and mutual funds are also similar – both groups focus on Asia, North America and Europe. Sovereign wealth funds tend to be more diversified in their equity investments, and when similarity appears looking at sector and industry distribution. Moreover, OECD and non-OECD funds also show differences in their sectors of interest.
Looking at internal governance characteristics (transparency, use of benchmarks, credit rating restrictions, etc.) we find that mutual funds have higher transparency levels, their investment strategy is communicated more clearly, the use of benchmarks is more frequent, investments are more constrained by credit rating minimums, and their policy towards specific investments is more defined. This suggests a gap in the investment policies between the two groups. When comparing these same characteristics between OECD and non-OECD sovereign wealth funds or between commodity and non-commodity funds, internal differences in their investment governance and strategies are accentuated.
The political dimension
Much has been made of sovereign wealth funds’ attempts to gain influence on key strategic industries, but in reality very little is known about how sovereign wealth funds, and even institutional investors for that matter, allocate their assets in response to political regimes. While research has shown that levels of foreign investment are positively related to democracy levels in the recipient country, this relationship has not been studied in the case of sovereign wealth funds.
To assess whether asset allocation for sovereign wealth funds is independent from political regimes, particularly in the recipient country, we take into account two dimensions: the political regime of the (investment) sending and the recipient country. We match country holdings with information from Polity IV (a database examining democratic and autocratic authority in governing institutions) and the Bertelsmann Transformation Index.
In the case of investment sending countries, we are not surprised to find that the level of autocracy or non-democracies is higher in the case of sovereign wealth funds, whereas the polity score and various measures of political competition are higher in the mutual funds group. More often than not, Sovereign Wealth Funds’ investors belong to autocratic or imperfect democracy regimes rather than democratic ones. More interesting is the political regime of the recipient countries targeted by sovereign wealth fund and mutual funds (see Figure 2).
Figure 2. Political regime characteristics in sovereign wealth funds and mutual fund country target - 2008
Source: Authors’ calculation, based on LionShares, Thomson Financial and Polity IV Project, 2010.
Our comparison reveals considerable similarity in political regime and corporate governance in countries targeted by both sovereign wealth funds and mutual funds. The indicator of institutionalised democracy, which reflects the competitiveness of political participation, is also very similar for both investor types. Other indicators of political regime are also all nearly equal. We are thus led to conclude that there is no difference between the investments of sovereign wealth funds and mutual funds in terms of political regime or corporate governance. This reinforces the finding that sovereign wealth funds are in fact more oriented towards risk-return and profit-maximisation objectives than commonly believed.
Conclusion and policy implications
The OECD has adopted a non-discriminatory position towards sovereign wealth funds, arguing that such funds should be regarded in the same way as any other institutional investor. As such, sovereign funds should be required to comply with existing OECD investment guidelines which commit adherents to principles of transparency, non-discrimination, liberalisation and standstill.
Sovereign wealth funds investors, like mutual funds, invest in countries because it is financially rewarding, regardless of political regime. A straightforward consequence of this is that double standards should be avoided. What is requested from some (disclosure and more transparency to sovereign wealth funds for example) should also be required from other institutional investors. Indeed, the definition of such principles should be done jointly. The inclusive process of the IMF-led International Working Group of Sovereign Wealth Funds is a promising approach.
In light of these findings, we hope double standards will be more difficult to legitimise. Some emerging countries have proven that they can follow best practices and apply sound policies. Temasek or GIC from Singapore are today benchmarks comparable to the most transparent institutional investor.
Nevertheless, if indeed sovereign wealth funds investments are very similar to standard institutional investors, they might consider increasing disclosure levels in a balanced way, simply to anticipate future criticism. Furthermore, sound corporate governance will generate confidence in countries of origin as well as in recipient countries and will further boost these new forms of institutional investment.
Avendaño, Rolando and Javier Santiso (2009), “Are Sovereign Wealth Funds' investments politically biased? Comparison with mutual funds”, OECD Development Centre, Working Paper, 283, December.
Havro, Goeril and Javier Santiso (2008), “To benefit from plenty: Lessons from Chile and Norway”, OECD Development Centre, Policy Brief, 37.
Hildebrand, Philipp M. (2008). “The challenge of sovereign wealth funds”, VoxEU.org, 21 January.
Santiso, Javier (2009), “Sovereign development funds: financial actors in the shifting wealth of nations”, in Malan Rietveld, ed., New perspectives on sovereign wealth asset management, London, Central Banking Publications, pp. 173-193.
Truman, Edwin M. (2008), “Four myths about sovereign wealth funds”, VoxEU.org, 14 August.