The Guardians of State Wealth Resume Investing in the Future

The past twenty years have seen a resurgence of state capitalism. In contrast to the old model of state-led entrepreneurship, in which the state owned and ran companies by ministerial diktat, today the most important government stock buyers tend to act primarily or solely as investors. Among state-owned investors, sovereign wealth funds (SWFs) play an especially prominent role, with investable assets estimated at over $5 trillion growing faster than any other institutional investor group over the last decade.

But the landscape of SWFs has dramatically changed in recent years. After a prolonged period of asset growth and high returns, SWFs are grappling with the consequences of the oil shock and ultra-low yields of the "New Normal." In some resource rich countries, governments tapped their accumulated wealth to fill holes in the budget and prop up their battered economies. Several SWFs shifted their allocation in favor of more risky, less liquid assets to reap better returns. This regime change, however, has also triggered deeper, structural changes in the behavior and organization of SWFs, with long-lasting consequences. Some funds, especially from the Gulf, have launched ambitious plans to diversify away their commodity-based economies using the financial dry power of their old and new funds. Rather than investing in established ventures, SWFs are taking big bets in the riskiest and most innovative sectors, placing themselves as frontrunners of the next wave of technological progress. Other funds, notably the Norwegian fund, have gradually increased their exposure to equity and in parallel flexing their muscles as shareholder by playing a more active role in corporate governance.

Against this backdrop, how is the global outlook affecting SWF investment? With two thirds of SWF assets originating from resource-rich nations, the oil price is always a key starting point to understanding their behavior. After the oil shock and the historical lows reached by the end of 2015, oil prices have recovered in the course of 2016, and fluctuated around a reference price of $50 in Q12017. The agreement signed by OPEC and non-OPEC countries on production cuts in late 2016 has started to pay off, and future contracts suggest that absent exogenous shocks, prices should remain in that range for the rest of the year. The conditions of commodity exporting nations (notably Russia and Gulf countries) suffering a macroeconomic strain caused by the oil shock have thus gradually improved. Global trade is showing some signs of recovery after a long period of weakness also in emerging and developing nations, including China and other Asian countries, where growth remains strong. After a disappointing 2016, most economies hosting SWFs are thus gaining momentum, contributing to a global economic growth which, according to the most recent IMF estimates, is expected to rise to 3.5% in 2017.

The improved macroeconomic conditions have thus allowed some countries to shift "back to normal" in early 2017, after a period when SWFs have been used to fill the gap in the public budget as fiscal stabilization tools. Thanks to increased trade surplus, the accumulation of foreign reserves should resume, and SWFs can focus on proper long-term investment in order to preserve the wealth of the nation for future generations rather than short-term stabilization.

Indeed, sovereign investors, and particularly SWFs, have special characteristics which make them unique, and immensely relevant in present times. They are the guardians of their countries' wealth and owners of patient capital to deploy with a long-term investment horizon. Together with other like-minded investors, they can play a fundamental role to bring the global economy back to robust growth and fostering sustainable investment beyond our present generation.