Making Foreign Investment: Safe Property Rights and National Sovereignty

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SWFs invest both in real and financial assets, ranging from stocks, bonds, real estate, precious metals, and hard infrastructure, to alternative investments such as private equity , hedge funds, and venture funds.


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Though SWFs are principally global in outlook, they also invest domestically, especially where strategic development sovereign wealth funds are concerned. The vast majority of sovereign wealth funds are domiciled either in oil exporting countries or East Asia. Thus, and from a capital sourcing perspective, SWFs fall into two categories : 1 commodity sovereign funds , and 2 non-commodity sovereign funds.

Commodity SWFs are financed from the proceeds of non-renewable commodity exports oil, gas, precious metals , which grow the AUM base in times of high prices but destabilize their source economies and budgets in times of low. Non-commodity funds, on the other hand, are typically financed from currency reserves or current account surpluses, driven by corporate or household saving rates. Thus, and ignoring superficial currency reserve math, actual savings would be net negative for oil nations unless their exhaustible resources are fully reinvested.

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The first SWF originated in as a constructive investment outlet for countries with budgetary surpluses and surplus export incomes. Since then, the size and number of sovereign wealth funds has exploded to over sovereign wealth funds today, but with heavy asset concentration.

Making Foreign Investment Safe: Property Rights and National Sovereignty - Oxford Scholarship

There are three broad priority categories most often pushed by sovereigns onto their wealth funds: 1 economic stabilization, 2 capital maximization, and 3 strategic development. In turn, five broad classes of SWFs exist to actualize these agendas: 1 stabilization funds stabilization priority , 2 savings and future generations funds capital maximization priority , 3 pensions reserve and other future liabilities funds capital maximization priority , 4 reserve investment funds capital maximization priority , and 5 strategic development sovereign wealth funds strategic development priority.

Such shocks include commodity peaks and troughs most acute in petroleum nations and global and domestic economic boom-bust cycles. Russia, for example, is a big oil and gas exporter with an effective oil stabilization fund. Its mandate is to mitigate the impact to domestic budgets and exchange rates from downswings brought about by periods of low oil and gas prices. Pensions are just one form of future public liabilities, and thus pension reserve funds are just one form of the broader category of future liabilities funds.

At the highest possible level, future liabilities funds are in the business of preserving the real value of capital to meet future, contingent liabilities. Their investment strategies involve investing in higher-yielding, long term assets, with a secondary mandate of reducing the negative carry costs associated with holding reserves. Such goals might include developing hard or soft infrastructure domestically e. To understand historical asset allocations and portfolio mixes, SWFs must be distilled by both economic priority and liability structure, in turn dictating their risk profiles, investment horizons, and thus allocation strategies.

This breakdown is as follows:. Thus, these funds tend to have short investment horizons and high liquidity orientations given the need to provide liquidity on short notice.

Making Foreign Investment Safe: Property Rights and National Sovereignty

These parameters largely limit the investable universe of stabilization funds to cash and equivalents, short and long-dated bonds, and money market instruments fixed-income securities , with appropriate currency hedges to match potential liabilities. They have transgenerational time horizons and are mandated to be of the most risk-seeking of the SWF types. Their portfolio allocations thus tend to overweight toward global equities and alternative investment classes aggressively in pursuit of alpha.

Most recently, the tech industry has been a net beneficiary of SWF capital injections with such high profile deals as Uber, Didi, Noon, Xiaomi and Jawbone, each of whom received lifelines or valuation reinforcement at critical junctures.

In recent times, SWFs, alongside all others asset classes, have been faced with an atypical monetary environment. This environment, characterized by low interest rates, subdued inflationary pressures, depressed commodity prices, and low global growth rates, is one that has persisted despite quantitative easing and loose monetary policies. The result has been a marked shift in SWF portfolio allocations since The big trend in this respect has been a flight from traditional fixed income safe-havens e.

Though this trend began in , the crisis triggered an acceleration in the shift into alternative assets, with a material migration of allocations to private markets. And even despite the slight de-risking between and , two thirds of assets remain invested in higher-risk assets, with public equities continuing to be the single largest asset class.


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The first is that portfolio reallocations are the direct consequence of quantitative easing. Second, the vast majority of the funds established since have been explicitly mandated to maximize returns, inducing some drift from low-yielding, fixed income securities.

Louis T. Wells and Rafiq Ahmed

And third, longer vintage SWFs with more balanced mandates have, over the years, developed the institutional maturity and expertise to confidently venture into more unconventional asset classes. Looking to the future, sovereign wealth funds continue to be preoccupied with four global megatrends. Specifically, by the year , million of the 1. This reality poses material contingent liability, pension, and social security challenges for countries in both the developed and the developing worlds.

Introduction

The second megatrend is urbanization. Currently, 1. In this book, Louis Wells and Rafiq Ahmed show why disputes developed, point out how investments and disputes have changed over time, explore why various firms responded differently to crises, and question the basic wisdom of some of the enthusiasm for privatization. The authors tell how firms, countries, and multilateral development organizations can build a conflict-management system that balances the legitimate economic and social concerns of the host countries and those of investors.

Without these changes, multinational corporations will lose profitable opportunities and poor countries will not gain the contributions that foreign investment can make toward alleviating poverty.

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State Takeover of Infrastructure New International Property Rights in Action Wells is the Herbert F. His research has focused on foreign investment and development; his principal consulting activities have been concerned with foreign investment policy and with negotiations between foreign investors and host governments. Rafiq Ahmed is a retired academic and manager. He did postdoctoral research at the Harvard Business School and taught and managed international programs at Tulane University's Freeman School.

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He was a business manager for 28 years, primarily with the Exxon Corporation.

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