Pacific Continental film fund may benefit from new govt funding initiative

By Joyanta Acharjee

F&C Investments said on Thursday it has moved significantly overweight in India within its global emerging markets portfolios, as earnings continue to be strong and valuations are back to attractive levels.

According to Jeff Chowdhry, head of emerging equities at F&C, India is now one of his team’s favourite bets for the next 12 months.

Currently favoured Indian stocks include Reliance Industries, the largest company in the market and a dominant player in the oil and gas market and HDFC, the country’s largest mortgage lender which provides loans to the country’s rapidly rising middle classes.

Keen to buy more Indian stocks, Chowdhry’s team has sold positions in Malaysia and Korea, countries that are unlikely to outperform under the current global economic environment. The team has also slightly reduced its overweight position in Brazil, its favoured Latin American market.

‘On valuation, the Indian market now sells on a forward price earnings multiple of 12 which is below its 5-year average and below the Global Emerging Market average,’ Chowdhry said.

F&C is currently overweighting India by 3 percent above the benchmark.

Faced with the ‘disappointing’ performance of the market in recent months, Chowdhry remains very positive on the outlook for India.

‘Six months ago we were concerned about valuations but these have come down a lot and the market has corrected by 35 percent since the beginning of the year.

‘Whereas India was one the most expensive large emerging markets a few months ago, today it’s one of the cheapest as well as being one of the most attractive on long-term fundamentals.’

He points out that the sell-side analysts at brokers and investment banks are almost universally bearish on their outlook for India primarily because of rising inflation and interest rates worries.

‘This negativity is being reflected in stock prices and creates opportunities for us. Our view is that oil prices are unlikely to continue rising and we expect to see Indian inflation and interest rates toning down over the next 12 months.’

The Indian stock market has also been under pressure by huge outflows of foreign money since the beginning of the year.

‘Our estimates tells us that some $6 billion of foreign money has left the Indian market this year but we expect those outflows to slowdown considerably over the next few months, relieving some of that pressure.’

Chowdhry concluded: ‘We expect earnings growth of 20 percent over the next 12 months and therefore, even if the market does not rerate, the Indian stock market can rise at least 20% from current levels.’

Private equity product to launch IPO in Q1 2009 and will invest in land and operate cattle and crop farms.

The rush to capitalise on booming food prices and agricultural commodities continues apace as Dexion Capital prepares to raise $270 million for a private equity fund which will invest in land, and operate cattle and crop farms around the world.

The announcement came after Schroders revealed this week that it plans to launch an agricultural farming product for institutional investors in the second half of this year.

Dexion’s vehicle, Global Farming Ltd – a private company domiciled in Guernsey – aims to own and manage farms which are operating in largely unsubsidised farming countries.

Dexion hopes to raise $70 million from a pre-IPO fund raising which is due to close at the end of July and $200 million from an IPO in the first quarter of next year.

The firm said the pre-IPO is ‘going well’ and has attracted 14 main investors, including Sovereign Wealth Funds, family offices and wealth managers.

Global Farming will be positioned to exploit potential developments such as changes to Australian and Russian GM crop regulations and a continuation of the global soft commodity and agricultural land bull market, Dexion said.

It is aiming for a 12 to 16 percent return per annum over 10 years, with potential for significant upside.

Asset management will be provided by Global Farming Advisers (GFA), while Dexion is responsible for capital raising and marketing.

Peter Hannen of GFA said: ‘We believe this is a value proposition of buying the most inexpensive productive farmland in the world and bringing it into development over time.

He told Thomson Investment Management News: ‘We are aiming to be the low cost producer of all our products and that’s why we’ve chosen this mix around the world – because these countries are the low cost producers in their chosen spheres – and since we don’t know what’s going to happen to the prices, we are going to be efficient low-cost farmers of natural products as much as we can.’

Hannen is the former chairman of mining group Celtic Resources, which was acquired by Russian metals group Severstal last year for around 162 million pounds. Alongside his financial services career, which includes sugar trading and managing family assets, he has forty year’s experience of farming in the UK, Australia and South America.

Robin Bowie, chairman of Dexion Capital, said: ‘When you’re looking for who can do this type of thing, it’s quite a tall order. We at Dexion Capital have looked at lots of different managers in this area but what we’ve found is they tend to be country or continent specific, and in many instances they are financiers trying to get to grips with farming operations.

‘We think that we have a very unusual offering because the team is qualified to execute it and because the strategy is global and diversified, which is what we believe the investors want.’

Global Farming will invest in South America, Australia and Russia.

Of the IPO proceeds, 37 percent will be invested in land to be used for livestock, 52 to 53 percent for crops and 8.5 percent in a land bank, with the balance as working capital.

‘We think that we straddle the developing lands in the northern hemisphere and the unsubsidised farming systems of the southern hemisphere. We’re not going to be in the EU, we’re not going to be in North America,’ Hannen added.

‘I’ve included Russian farmland in my global mix where I think we’re uniquely positioned to be able to execute asset management in Russia, with all the difficulties you can run across there.’

In making his selection, Hannen will avoid areas of subsidised land.

‘I like to look at pure markets and pure price and whenever you have subsidy systems – like in Europe and North America – it’s very difficult to tell what percentage of the land value is being supported by subsidised internal prices.’

Dexion Capital currently runs four London-listed fund of hedge funds, including the 1.5 billion pound Dexion Absolute and 150 million pound Dexion Trading funds.

Firm cheers boost for smaller players as large funds of hedge funds chase major mandates.

Changes in the investor base of fund of hedge funds (FoHFs) have seen ultra high net worth (UHNW) investors increasingly neglected in favour of institutional business, according to one of the managers seeking to exploit the trend.

Investment advisory firm Oakley Capital runs a global macro fund of hedge funds designed to serve those UHNW investors ‘whose needs are becoming increasingly marginalised’ as FoHFs become more focused on the requirements of institutional investors.

Speaking to Thomson Investment Management News, Christopher Parkinson, portfolio manager for the firm’s Oakley Multi-Manager Funds Ltd FoHF, said that as they became larger, most FoHFs undergo a shift in client base.

‘It’s part of the evolution of a fund of funds; they go from this focus on UHNWs and their needs through to institutional [investors], so as they get bigger, the focus on UHNWs becomes smaller.’

Oakley Multi-Manager has delivered annual returns of 12 percent since inception in 2005 compared with the HFRX Global Hedge Index which returned 6.1 percent per annum.

It has $150 million under management, of which $65 million came from the partners of Oakley Capital.

‘By having that partner investment it means that we are and will continue to be completely focused on absolute returns rather than maybe the slight shift towards relative returns that has been seen elsewhere in the industry,’ Parkinson said.

He added that investment time horizons also differ between institutional investors and UHNWs, who typically have about $30 million of investable assets and are focused how much their wealth has increased or decreased in absolute terms.

‘Institutions seem to take a longer-term view which means that they can cope with a little bit of flat performance for longer if it’s affecting the whole industry and they can tolerate losses a little bit more as long as it’s affecting the whole of the industry. [For} high net worths it’s a month to month or quarter to quarter game.’

‘For the UHNW it’s really about absolute return, it’s about capital preservation, low draw-downs and incremental gains that make sure that when they measure their wealth in their currency – which is pounds, euros and dollars – that it’s going up and if it’s going down it’s going down in a limited fashion.’

The global macro fund of hedge funds’ mandate is to generate absolute returns that are uncorrelated with other asset classes by harnessing the returns of a small number of true absolute return hedge funds and supplementing them with directional thematic exposures either through long-only managers or hedge fund managers that are adept at managing directional exposure.

London-based Oakley Capital was founded in 2000. As well as its fund of hedge funds business, the firm also provides corporate finance advisory services and manages Oakley Capital Private Equity LP, a mid-market private equity fund.

Source: Thomson Investment Management News

By Joyanta Acharjee

Insurance may not be the top priority for hedge fund managers but investor lawsuits over funds hit hard by the credit crunch are helping to drive it up the boardroom agenda, according to an executive from specialist insurers Howden Risk Partners.

Speaking to Thomson Investment Management News, Ed Brennan, business development manager for Howden, said: ‘If you were to put everything in a list [insurance] would come reasonably far down but it wouldn’t be last.

‘I would say that in the last few years it’s been a box to be ticked; but that box has become more important over the past eight to nine months.’

Brennan said that the most noticeable effect of the credit crunch has been the increasing number of directors who were joining the board of a hedge fund only if sufficient insurance cover was place.

‘They are seeing it now as a necessity, particularly with [UK financial regulator] the FSA and the general public taking more of an interest in the hedge fund space.’

London-based Howden is a provider of insurance arrangements for both traditional and alternative asset managers, with policies including specialist wordings that encompass the risks to which hedge funds are regularly exposed.

Aside from the failure of a fund itself, Brennan said the main risk for hedge funds are litigation costs – either from disgruntled investors or a regulatory body.

In one example last month, a Florida-based investor filed a lawsuit against Citigroup over its Falcon Strategies Two B LLC hedge fund which lost over 40 percent of its value in the credit crunch.

In February, Citi provided a $500 million line of credit to bail out the Falcon line of funds and consolidate their $10 billion in assets and liabilities on the bank’s own balance sheet.

Specialist insurance, which is not compulsory, can cover the directors of the fund and the management entity with an excess ranging from $1 million to $50 million.

‘We are seeing an increase in start-ups enquiring and employing this sort of insurance. But we also still get enquiries from funds that have been running for years and London-based management entities that have been trading for 20 years,’ Brennan said.

Brennan’s firm is due to launch a new insurance product covering directors and officers liability this summer.

It isn’t just hedge funds themselves that can get cover – earlier this year, Protean Investment Risks launched an insurance policy for hedge fund investors, offering cover for losses that are a direct consequence of fraudulent actions by a fund manager or any other hedge fund employee.

Howden Risk Partners was set up five years ago and is part of the Hyperion Insurance Group. Private equity firm 3i Group Plc. last month took a minority shareholding, valuing Hyperion at more than 120 million pounds.

Source: Thomson Investment Management News

By Joyanta Acharjee

The credit crunch is forcing new hedge funds to take on a ‘hybrid’ part hedge fund, part private equity structure if they want to invest in illiquid assets, according to Paul Chain, president of AIS Fund Administration.

Speaking to Thomson Investment Management News, Chain said: ‘We had already seen this type of structure popping up several years ago but you’re just seeing more of that now as an answer to this illiquid [market] situation.’

‘A couple of years ago you would see funds using this structure because they were investing in things that looked like bonds or stocks but they’re very illiquid and very difficult to value.

‘So they came up with this, what I would call, hybrid structure where the portfolio looks like hedge fund investments but the structure may look more like a private equity structure.’

Chain said this means that more and more managers are lining up commitments and then drawing money as investments become available. ‘There is an open subscription period but after that the fund is closed,’ he said.

The change might be relatively short-lived though: ‘As liquidity returns - and who knows how long that will take - you’ll get more active and reliable pricing back again in some of these asset classes that aren’t there and you’ll see less of a need for that [hybrid] kind of structure.’

AIS Fund Administration, launched in 2003, provides outsourced middle and back office functions to hedge funds from its offices in New Jersey, Los Angeles and London.

Amongst the investors in the firm is Michael Spencer, the chief executive of interdealer broker ICAP Plc., who purchased an undisclosed stake in AIS three years ago through his privately owned investment vehicle, IPGL Ltd.

Source: Thomson Investment Management News

By Joyanta Acharjee

The hedge fund industry has hit back at what it labelled ‘unresaonable criticism’ of its techniques in the wake of an investigation into market abuse linked to short-selling in HBOS Plc.

The Alternative Investment Management Association (Aima)on Tuesday stressed the industry’s now mainstream credentials and warned against the ‘unwarranted’ scrutiny placed on its members at a time of extreme market volatility and falling asset prices.

Florence Lombard, chief executive of Aima, said: ‘Disappointingly, hedge funds are often made the focus of media attention when any suspicions of market irregularities arise. It is vital that the legitimate shorting of assets should not be confused with alleged market abuse by, as yet, unidentified players in the market.’

False rumours that HBOS Plc was in need of emergency funding resulted in its shares falling by as much as 20 pct on the morning of March 19, prompting the Financial Services Authority to launch an investigation and warn market participants.

In a statement issued at the time, the FSA warned: ‘We will not tolerate market participants taking advantage of the current market conditions to commit abuse by spreading false rumours and dealing on the back of them.’

It is understood that short sellers may have been behind the speculation.

The FSA is thought to be weeks away from making its initial findings public, but declined to comment on Tuesday on the potential outcome or progress of the investigation.

In the meantime, Aima’s Lombard is seeking to distance the industry from any allegations of market abuse.

‘In all areas of finance, there is sometimes a need for regulators to act against isolated instances of irresponsible behaviour. This is to be welcomed. However, around the world we are seeing hedge funds erroneously being represented in the media as being the focal point for any such investigation.’

Aima is trying hard to move hedge funds away from their reputation as the gunslingers of financial markets. It highlights the scale of new investments into the sector as it merges with the mainstream.

A recent survey from PricewaterhouseCoopers found that 33 pct of investors expected to increase their allocation to hedge funds in 2008.

‘[Hedge funds] are widely recognised as productive investment vehicles by investors, including pension funds, and have an important role to play in the current market. They protect the value of portfolios with skills specific to them,’ Lombard said.

Her comments came a day after Aima and its U.S. counterpart, the Managed Funds Association, agreed a collaboration deal to present a unified voice in the face of unprecedented regulatory scrutiny. Both are attempting to head of stringent legislation in their sector by developing a principles based system of self-regulation.

Source: Thomson Investment Management News

Currency fund likely to be first up as the firm builds its offering in a market where retail investors can buy into hedge funds for as little as $21.

Jyske Invest, the investment management arm of Denmark’s Jyske Bank AS, plans to exploit growth in the fledgling Nordic hedge fund sector by launching a series of new products which avoid ‘unfair’ lock-ups and performance fees.

Bjarne Gier, portfolio manager for Jyske Invest’s Hedge Market Neutral – Equities fund, told Thomson Investment Management News his firm wants to demystify the hedge fund industry – and does not turn its nose up at smaller investors.

The Nordic region – with an estimated 16 billion euros under management across Sweden, Denmark, Norway and Finland – is playing catch-up to Europe’s bigger, more established hedge fund markets such as the UK and Switzerland. The first fund was launched in Sweden in 1996, and 65 more have launched there since then; there are also about 23 in Denmark and 18 each in Norway and Finland, according to Gier.

He said: ‘We are currently looking at ways to bring more hedge funds to market and one of the first ones would probably be a foreign exchange market neutral fund. There’s a high probability of that being the next fund.

‘It’s still not final but we have some good ideas on what strategies to follow within that space.’

In October last year, Jyske launched a fixed income market neutral hedge fund which now has 134 million euros in assets under management. Following legislation passed in 2005 the firm launched its first hedge fund, a market neutral equities strategy in September 2006; it currently has 262 million euros under management.

Unlike other European funds, Jyske Invest’s products are available for both retail and sophisticated investors alike with a low entry limit of just 100 crowns – or about $21 – and no lock-up period.

And the performance fee is just 10 percent – in stark contrast to the 20 percent that is the norm elsewhere in the industry.

‘We are making hedge funds a bit less mysterious,’ said Gier. ‘If you look at some of the hedge funds in London, [they have] very high performance fees and long lock-up periods. We think this is simply not fair.’

Referring to the equities hedge fund which he manages, Gier said: ‘We are actually pricing this fund daily and the trading is available on the OMX stock exchange so it’s very much like buying a mutual fund.’

Jyske Invest’s equities hedge fund employs an investment process known as Vamos – which stands for valuation, momentum and strength.

Gier explains: ‘We are buying cheap stocks characterized by rising earnings and a great ability to yield high cash flow returns.’

He said that his goal is to derive alpha from the underlying factors of Vamos.

‘The factors we are focusing on are very powerful performance contributors.’

Managers from the firm’s long-only side also contribute to the hedge fund investment strategy.

‘When we compare ourselves to other hedge funds, we are very team-oriented. Choosing stocks is not that much different if you are a hedge fund or if you are long-only. Of course risk systems are completely different; I have totally different risk limits. I also have to think about liquidity in other ways than the long-only guys, but I gain a lot of insight working together with the specialized long-only managers.’

Jyske Invest was formed in 1988 and manages 75 long-only funds with 8.2 billion euros under management.

Source: Thomson Investment Management News
]]> http://investmentstories.wordpress.com/2008/04/03/danish-manager-lines-up-hedge-fund-range-shunning-unfair-fees/feed/ 0 joyanta http://investmentstories.wordpress.com/2008/03/28/investors-should-avoid-blind-faith-in-paranoid-quant-funds/ http://investmentstories.wordpress.com/2008/03/28/investors-should-avoid-blind-faith-in-paranoid-quant-funds/#comments Fri, 28 Mar 2008 10:23:09 +0000 joyanta http://investmentstories.wordpress.com/?p=18 ]]> By Joyanta Acharjee

The reaction of quantitative hedge funds to this summer’s market turmoil has highlighted their underlying limitations, such as their abuse of mathematical techniques and the lack of transparency in disclosing strategies, according to Rowan Williams-Short, investment director for Nedgroup Investments.

And he criticised quant fund managers for a ‘paranoid’ fear of replication, which prompts a lack of transparency in the first place and then leads them to frequently alter models unbeknownst to investors.

The summer’s turbulence pushed quant funds into the spotlight as they were blamed for exacerbating the fallout from the subprime meltdown. The highest profile casualty was Goldman Sachs’ Global Equity Opportunities quant hedge fund which had to be bailed out to the tune of 3 bln usd.

There have been some robust defences mounted since then and claims that quant strategies have successfully navigated their way out of the storm, but Williams-Short is dismissive of their ability to deal with any future shocks.

‘Most of them don’t have enough data on the underlying instruments to have been even tested in economic cycles,’ he said. ‘They’ve only been tested in one phase of a cycle – so how would you reasonably expect them to behave when liquidity vanishes.’

Williams-Short picks out the lack of transparency as another key obstacle to investing in quant funds. And even if an investor knows of the underlying strategy, quant managers often change this out of fear of duplication.

‘They don’t come close to showing you their programming; they barely tell you what sort of techniques they use. They seem to be fairly paranoid that they will be imitated by other quant funds, so they just don’t tell you.

‘In my experience they re-calibrate their entire models quite frequently anyway. So even if you had a passing idea what drives the model, six months later the actual trading outputs are driven by something else altogether.’

Nedgroup Investments, part of the Old Mutual group, has 860 mln usd under management and manages four fund of fund products, with its flagship Target Return fund, which was up 9.74 pct in the first ten months of the year, having pure hedge fund exposure.

As part of Nedgroup’s due diligence process on fund of hedge fund allocations, Williams-Short avoids quant funds partly because of the difficulty in assessing when is the right time to invest.

‘I defy anybody to say quant funds look cheap or look expensive on any given day; it’s impossible. They use these quantitative techniques and they dabble in various instruments and how on earth do we assess that that asset class is cheap in any sort of fundamental sense.’

Williams-Short, who himself has a masters in statistics and mathematics, argues that in essence quant funds operate on principles that were designed to analyse scientific data rather than financial data. He suggests that none of the designers of the underlying mathematical models employed in quant funds have ever claimed that they could forecast shares and prices.

‘These things are fantastically elegant mathematically, they have some wonderful statistical insights but I don’t think the inventor of any one of them ever held out they were capable of forecasting stock and bond prices.’

To illustrate his point, he took the example of a tree in a forest.

‘You will be able to say a pine tree is likely to reach such and such a height if it receives this much water and this much sunlight over 20 years. That’s fine, it works quite well,’ he said.

‘[But] it doesn’t suggest that if a seedling is lying on the grass now, you can forecast its height unless you happen to know about future rainfall and future sunlight. Scientists are very good at recognising those sorts of limitations to those models; practitioners in asset management tend to be less so.’

He said that there was a fairly widespread view that quant funds were great for their lack of correlation to other assets, which seems to be the single biggest reason given for inclusion of quant funds by other fund of hedge fund managers.

‘Lack of correlation is great; all sorts of things have a lack of correlation which are terrible. You know, the Zimbabwean dollar has got a low correlation to US equities but under no circumstances would that suggest it’s a good investment.’

Despite a long list of reservations, Williams-Short does concede there is a place for quant funds.

‘I do think in risk management that quants are essential… [but] risk management is not the same as alpha generation.’

‘If you go back, even in the City of London, more than 10-15 years ago, you’ll find fund managers completely ignorant of terms like volatility, tracking error, value at risk. That’s not excusable today. Any proper fund manager must be competent in that sort of quantitative technique for risk management. All those three [terms] I mentioned are about risk management, not generating alpha.’

It is not only the troubles faced by quant funds over the summer that have helped make Williams-Short something of a sceptic, and he recalls an incident from early on in his career which helped shape his view.

In the early 1990′s, shortly after starting a career in asset management as a bond analyst in South Africa, he was preparing to deploy some client money in a quant model when a rumour took hold on the trading floor.

‘What had happened was that Nelson Mandela, who hadn’t been out of jail all that long, had moved into his official residence and somebody saw an elderly black man being loaded into an ambulance, the doors slamming shut, the sirens coming on and the ambulance belting towards the hospital.

‘As rumours can do, it was thought ‘What if it’s Mandela and he’s dying of a heart attack or something?’ Given this was just into the new South Africa, there was massive consternation at this and bonds sold off very aggressively, in other words the yields shot up.

‘And that model of mine had been forecasting a gentle fall in yields over the next few days - we would have got it completely wrong. The money would have been bet completely the wrong way. And so I use that as a nice true story, of one analyst’s wake up call to the weaknesses of pure quant models.’

Williams-Short reckons he learned a valuable lesson from that experience – but thinks some managers are still making the same old mistakes.

‘Had I got lucky and the model had worked we would have put more money into it, and that is indeed something that quant funds do – they start thinking for a while that their models are infallible.’

Source: Thomson Investment Management News

State-owned investment funds are forecast to loom large on the global investment scene, but are provoking intense reaction. Western institutions either fear them or love them.

The dominant emotion amongst western political circles seems to be a fear that Machiavellian motives, rather than the pursuit of investment performance, might guide the policies of these funds controlled by foreign governments. These worries however, are far from universally held in the west. In sharp contrast to the anxieties of politicians and official bodies such as the IMF and the OECD, a wide spectrum of western companies is rolling out the red carpet.

In this sharply polarised division of opinion between political authorities and business, who is right?

State-controlled funds come in two forms – state pension funds (SPFs) and sovereign wealth funds (SWFs). Only the latter cause concern.

The SPFs have, as the name indicates, been set up by states to fund their pensions obligations. SPFs in the G10 group of nations exceed $4 trillion and the global figures are much higher. The process of asset selection is subject to regulatory scrutiny and more open. So, there appears to be less fear that these funds will be used for a purpose other than profit.

The SWFs, the funds causing controversy, are directly controlled by governments, and generally originate from the latter’s reserve assets. There are nearly 30 SWFs and their current assets are estimated to be $3.2 trillion. The top 10 SWFs account for over $2.7 trillion of this. Morgan Stanley has projected the total to rise to $12 trillion by 2015 .the magnitude of which is behind much of the alarm.

SWFs have a variety of origins. In the case of Russia and Middle Eastern nations, oil wealth has been behind the build-up of these funds. Rather than being used for current expenditure, they have been set aside for long-term investment. In other cases, such as China and Singapore, the SWFs grew out of large reserves built up through recurrent balance of payments surpluses. In some cases, the reserves originally provided a cushion against the type of currency debacle that afflicted Asia in the late 90s, but have since grown well beyond the original motive for accumulation.

Some SWFs have been around for decades. The oldest, the Kiribati Revenue Equalisation Fund (set up by the tiny Pacific state), has existed for 50 years. The biggest fund, Abu Dhabi Investment Authority (ADIA), has more than a quarter of the $3.2 trillion and has a long history as a respected professional asset manager.

Altogether, Norwegian, Singaporean and Middle Eastern SWFs, all from countries supportive of the west, account for the bulk of the above total. Norway in particular is lauded as a model for other SWFs.

The Russian and Chinese funds have a little over $300 billion. It is these recently set up funds, currently amounting to only about 10% of the sector total, that seem to be at the root of all the political fuss. For reasons of political correctness and global realpolitik, it is on the cards that the political authorities dare not call a spade a spade but are instead lumping all the disparate SWFs together.

Though the politicians might be worried, many others in the developed world, particularly those in trouble, have been welcoming SWFs with open arms. In the forefront of those putting out welcome signs are leading financial companies. Severely bloodied by the subprime crisis, they are direct beneficiaries of the SWFs’ largesse. Over $40 billion has been channelled into these institutions in recent months, with UBS and Citigroup being amongst the beneficiaries.

It is not just the SWFs’ capital investments that are wholeheartedly sought by western companies. These funds are seen as lucrative sources of fee income. Investment banks are falling over themselves to service the SWFs and are establishing specific divisions for this purpose. Currently, they are facing reductions in fees from traditional sources, such as private equity firms, which have also been hit by the credit crisis. SWFs could replace this lost income and keep the banks’ deal makers occupied.

Fund management houses too are eager to manage SWFs’ money. China Investment Corporation has invited western fund management firms with solid pedigrees to apply to manage global equities, and about a hundred applications have been reportedly received. SWF’s are also seen as natural long-term partners in joint projects by pension funds. A public sector New Jersey pension fund is already working together with the SWFs.

Outside the financial sector, there have been many instances of SWFs coming to the rescue of troubled companies. Companies so supported include Advanced Micro Devices and Sony. SWFs have also been welcomed by European corporates. The CEOs of Lafarge, the French cement maker, and Edison, Italy’s second-largest utility, were both reported in the Financial Times as welcoming small stakes.

What are the possible reasons for fretting about the SWFs? The fear is that large stakes taken by SWFs in key companies of strategic significance can be used as Trojan horses to further the political aims of the government controlling the SWF, at the expense of the country hosting the investment.

For example, there is horror, with some justification, at the thought of the Russian state fund taking control of a key strategic business. If indeed they did this, it could be dynamite. Imagine the Kremlin, rather than a commercial Spanish operator, in charge at Heathrow.

Official circles in the US, Germany and France have been amongst those expressing concerns, which are mainly based on potential dangers rather than actual current behaviour.

The one government that stands apart from the crowd with a relaxed attitude is the UK. One of the reasons for the UK being much more relaxed is that London, as a global centre, has had a long history of attracting SWFs in search of investment management expertise.

Political anxiety concerning SWFs’ potential misbehaviour has been gathering momentum in the last few months. The IMF and the OECD are working on codes for investment by these funds. The G7 countries have got together with the heads of eight SWFs and have apparently agreed to establish voluntary codes of best practice.

In drafting these codes, the authorities are being urged to consider a number of different issues. For instance, Prof. Jeffrey Garten, writing in the Financial Times, urged Washington and Brussels to consider guidelines reflecting three principles: transparency, reciprocity and limitations on ownership. Others have suggested that there should be limitations on the maximum stake an SWF can buy in any one company. Another proposal is that a list of prohibited companies for investments by SWFs should be drawn up, the constituents’ inclusion reflecting their vital strategic importance to the host country.

Some of the issues recommended for inclusion in guidelines are questionable. For instance, consider transparency, and the related topic of risk management.

The interpretation of the word transparency differs according to the context. In a portfolio sense, it means that the set of risks run by the portfolio managers is visible or easily identified by others. The same applies to transparency of a complex financial instrument. However when it comes to shareholdings in a company, transparency refers to the identification of the beneficial owners of the shares.

Much of the comment demanding transparency from the SWFs refers to transparency in a portfolio context. This type of transparency is a matter of legitimate concern with respect to portfolios or balance sheets of regulated entities such as banks, insurance companies and pension funds. There is also a pressing need for many financial instruments to be more transparent, as the sub prime crisis has amply demonstrated. However, transparency in the portfolio sense in relation to SWFs is another matter.

Any attempt to apply the principles of transparency to a private investor’s portfolio amounts to an invasion of privacy, and it is difficult to find justification in terms of the public interest. What goes for a small-scale private investor also holds for people of the likes of Bill Gates and other members of the billionaire club.

Given this, it is difficult to see how different principles should apply to SWFs. Transparency in their portfolios is a matter only for the governments of the countries concerned and their citizenry. An insistence on this from SWFs seems to be introducing new political factors not justified by the danger of SWFs holding sensitive strategic stakes.

It should be remembered that many hedge funds and private equity firms are not transparent either. The SWFs could feel unfairly singled out, especially since many have behaved well in other ways.

Transparency in a shareholding sense could be relevant if SWFs establish secret stakes through nominees in quoted companies. There appears to be no suggestion of this. In any case, there are already rules requiring declaration of holdings beyond a certain level in public companies precluding this. Moreover, judging by the episode of China buying a stake in Blackstone, the SWFs will be hard put to avoid investing in a blaze of publicity.

Insistence that reciprocity in capital market access be provided by the SWFs’ home country is another red herring not relevant to the problem at hand. It appears to be yet another attempt to use the SWF controversy to pursue other political objectives. Furthermore, the issue of reciprocity cannot be just applied to SWFs’ investments. If reciprocity is to be used as a weapon, it should apply to even private investors, not just those from the SWF’s country but also those from all countries in the world attempting to invest in the west.

A more blatant example of using the SWF issue to achieve wider political aims comes from California. The California State Teachers’ Retirement System (Calstrs) has pointed out the negative impact of a bill proceeding through California’s legislature aimed at SWFs. This stands to prohibit investment by pension funds in private equity firms that have been invested in by SWFs. Calstrs has calculated that it will lose a significant element of performance when the bill becomes law. Apparently the motivation here is singling out countries with poor human rights records. Using the SWF issue to promote this goal falls into the same category as attempting to ban trade with countries on the grounds of their human rights stance.

Limiting investment in companies on a blanket basis defies reason. Many fans of Chelsea Football Club would have something to say if, for instance, Roman Abramovich was asked to pack his bags, given his friendship with Putin. Equally it is difficult to envisage any problem with China owning, say, a retail clothes chain or Starbucks outright.

There is a possible case for drawing up a list of sensitive industries and companies, and prescribing maximum stakes allowable in them. However, if this is warranted, again it is dubious why SWFs should be singled out. There are several other types of investors who might do harm. Moreover, The Economist has pointed out that sensitive industries are already regulated and subject to ownership restrictions.

Furthermore, the effectiveness of codes is a matter for doubt. State funds are not the only tools at the disposal of potentially hostile countries with malicious intent. What about the oligarchs, the rich elite and leading financial institutions in these countries who might work closely with their governments?

So far, the SWFs have not misbehaved in the way that politicians fear they might. The question of misuse of a large strategic stake is a real possibility. To quote The Economist, “Yet, for all these imagined fears, it is hard to find examples of sovereign-wealth funds abusing their power”. One or two of them might possibly misbehave in the future, but it does not seem sensible to treat this disparate group of funds in a homogeneous manner.

The SWFs have given clear signals that they are not playing political games, but are genuine investors. For instance, China’s plans to hire top outside money managers demonstrates their professional intent. Rather than posing a serious threat, the SWFs actually hold out the promise of benefits on several fronts.

The state funds will have access to the best practices and know-how the global markets can offer, and accordingly they can become some of the most sophisticated investors on the global scene. In the process, major strides could be made in expertise trickling down to others in their home countries, promoting globalisation in the asset management industry.

SWFs are not motivated by short-term profit, but have long-term goals seen as a plus by many western pension funds and corporates. Another aspect of their investment decisions includes wanting access to the expertise of western companies. This is not a malign motive, but potentially symbiotic. For instance, the state-controlled China Development Bank’s stake in Barclays could facilitate the latter’s operations in China.

It is expected that, with the credit crunch in place, the SWFs will be able to wield their firepower to pick up bargains out of reach for those requiring credit. John Pierpoint Morgan acted to provide liquidity during a similar credit crunch in the early twentieth century, and SWFs could conceivably play the same role today. In this role, there could be a very valuable contra-cyclical contribution with their long-term approach, as SWFs pick up bargains during bad times. It is widely recognised that this could reduce volatility in financial markets.

Furthermore, if as hoped stakes held by SWFs in western companies allow the latter to gain a foothold in the former’s country, it can only serve to integrate these countries more closely into the global economy, to the benefit of all.

Overall, the state funds can be the conduits for massive advances in globalisation, through expertise transfer, copying of best practices and greater integration of their home countries in the global economy.

The case for considering SWFs as Trojan horses with ulterior agendas in mind is tenuous. In fact, there is a much stronger argument for the reverse to hold true. It is more likely that the SWFs will be the advance guard of western liberalisation, in breaking down barriers to financial globalisation in their home countries.

The fear of SWFs seems to be very much overblown, both in the media and by certain governments. They might collectively amount to a huge force in statistical terms, but they are by no means a monolithic collective entity. It is far-fetched to think, for instance, of the Singaporean SWF acting in concert with its Russian counterpart. With their disparate aims, even if they occasionally invest for reasons other than the best return, it might not be significant in global terms.

Current coverage of SWFs in the financial media conjures up images of gigantic flows of money sloshing around in a relatively stagnant pool of total global wealth. In terms of money, the total firepower of the SWFs is currently only $3 trillion, small compared with total world wealth estimated at over $140 trillion and does not warrant the scale of the current concerns. It should be borne in mind that the projections of $12 trillion or more that is behind much of the alarm are just that, projections.

These projections largely assume that current economic conditions will continue, that countries presently in surplus will continue to generate them on the same scale and that they will divert the additional funds into SWFs, rather than holding them in reserves. Given that the projections are the best part of a decade away, their actually materialising on the scale expected cannot be considered a forgone conclusion. Plausible scenarios suggesting much lower growth rates, and hence a lesser impact, can be easily drawn up. Exchange rates, oil prices and economic performance of the different players, some currently in deficit and others in surplus, may not stay the same.

Furthermore, it also needs to be assumed that the surplus countries will not start diverting their resources into consumption. The impact of a possible world recession or slowdown cannot be estimated either.

Even should the $12 trillion materialise, whether it would all be channelled into western capital markets is a moot point. Under current projections, the size of the Asian, Russian and other emerging markets will take a bigger share of global finance. Many of the non-western regions in the world are already stepping up their trade with each other, and increasing direct investment could follow.

Asset allocation considerations also come into play. There is an implicit assumption that a large segment of the $12 trillion will go into equity stakes in developed country companies, but there is every possibility that good proportions will be diverted into other sectors, such as real estate, commodities, emissions trading and high-yield bonds, none of which can justify the scares. Similar considerations apply to hedge funds. While some hedge funds may invest in equities, many others are very short-term and use strategies that cannot upset the politicians in the SWF context.

Those worrying about SWFs now are acting as if there is a mountain immediately ahead, while even in 10 years’ time it might still be a molehill relative to the global wealth pool.

Politicians are anticipating trouble prematurely. On the evidence, codes and similar documents drawn up by official bodies seem to be overkill, particularly because the projections of massive growth may not materialise. It might be true that they have secured the “voluntary” co-operation of leading SWFs for their proposals. But just how voluntary this was is open to question. One particular SWF has apparently claimed that they only participated to avoid a potential backlash.

It cannot be said that it is possible for an SWF to be used for hostile purposes, but this is likely to be infrequent. If they do indulge in undesirable activity, the Western governments have the ultimate deterrent of legislation in their hands.

By shifting from liquid Treasuries to much less liquid instruments, the SWFs are taking on more risk, with much more of a long-term commitment to the Western-dominated world economy, which can only be for the good. The reduction in the liquidity of their investments goes hand in hand with a reduction in their power to destabilise the global economy.

Could the SWFs focus their investments on a narrow number of companies or sectors for strategic reasons, as some fear? They might do in a few cases, in the same way that Western companies might. However, it would probably make more sense for governments to respond only in serious situations, rather than to issue generalised guidelines now, with unnecessary bureaucratic force.

The chances are, based on evidence to date, that any serious threat to national interests from a foreign state fund is likely to be a relatively rare incident. Instead of blockbuster codes, a case-by-case approach makes much more sense.

The nationalisation of Northern Rock in the UK demonstrated how such an approach could work in practice as an ultimate deterrent. It only took a few days between the Northern Rock decision and the legislative implementation of nationalisation. There is no reason why the same cannot be done with any SWF that gets out of line in terms of political misbehaviour.

The benefits of SWFs for the global fund management industry, financial markets and society at large have already begun to accrue, regardless of their size. On the other hand, the dangers are distant, and for these to become significant the current growth projections for SWFs need to become a reality.

Trade has already done much to align the interests of many countries, including those of all-important China, with the west. SWFs have the potential of pushing this process further down this road, with increased integration in global finance and the global economy.

It is to be hoped that premature anxiety on the part of the authorities will not adversely affect the beneficial aspects of SWFs’ activities. There is a case, with the moral support of western businesses behind them, for SWFs collectively resisting unfair bureaucratic guidelines.