Historians of western history point out that the past millennium can be broken into three distinct epochs, each based on the mode in which society organized itself. First, the Church served as the central organizing force in society. Then, as principalities coalesced into nation-states, governments came to dominate – most transcending religions. Finally, with the the industrial revolution came the supremacy of the corporation – culminating into today’s transnational companies that, according to critics, know no national boundaries. Five hundred years ago, for example, the largest building in nearly every European city was a church. Today, it is invariably a skyscraper containing a corporate headquarters. In between, the largest building was likely to be the palace or parliament buildings.
But although the national state had its moment in the Sun, it has often shown a knack for exerting its influence through other dominant institutions of the day. Several hundred years ago, social policy was often the dictate of the Church. And now sovereign states exert political influence through the private sector itself by deploying their treasuries toward political goals in the form of sovereign wealth funds.
Some view this with a jaundiced eye, believing that there must be something nefarious about extra-financial interests in global finance markets. An interesting study completed earlier this year by Alexander Dyck of the University of Toronto and Adair Morse of the University of Chicago attempts to delineate the financial goals of sovereign wealth funds (“SWFs”) from their policy goals. By doing so, the authors aim to shine some light on what they believe the media views as the “unspecified political economic objectives” and possibly “troubling political goals” of these behemoth pools of capital.
Rather than finding that SWFs shroud their political goals in secrecy, the duo actually discovered that many of the investments made by SWFs were first telegraphed by the state’s widely-available economic development plans. The extra-financial objectives of SWFs were found to fall into two main categories. First, SWFs tended to invest in areas where there was some sort of “market failure,” i.e. where there were possible economic externalities. Secondly, SWFs tended to invest in sectors where the state had some sort of “perceived skill.”
Dyck and Morse teased apart the roles of financial and strategic variables in nearly 20 SWFs. They defined “financial portfolio variables” as criteria such as the volatility of fiscal revenues, the size of the SWF and the delta between the SWF’s portfolio composite and that of the local benchmark. “State Planning variables” included: whether or not the target sector was in the nations strategic plan, whether there was a “market failure” and whether the nation perceived itself as having a unique skill in a particular sector.
The results are shown below. The blue bars represent the portion of overall portfolio variance explained by Dyck and Morse’s total set of variables. The beige bars are the proportion of variance explained by purely financial objectives and the brown bars represent the portion of overall portfolio variable explained by extra-financial (“State Planning”) variables. (Click to enlarge.)
The funds with a high proportion of variance explained by financial objectives include Kazakhstan’s SWF (which, according to the authors, pursues a passive indexing strategy) and the Alaska Permanent Fund. SWFs whose variance is better explained by “State Planning” variables include: Singapore’s Temasek (think Singapore Airlines) and Malaysia’s Khazanah Nasional.
Curiously, Abu Dhabi’s Mubadala Development Company appears to be motivated primarily by financial criteria, not by state planning objectives. Yet on a recent trip to the UAE, we met an official from the fund who explained to us that Mubadala was more focused on economic development initiatives than its sister fund ADIA.
The data used in the study showed that SWFs played varying roles in regional equity markets. In Latin America, for example, SWFs represented less than 1% of public equity markets, while in the Middle East and Africa they represented over 6% – likely due to a combination of size and the lack of regional public markets. (Charts below created with Data from Table 4.)
Differences were also apparent across sectors of the economy:
The data used by Dyck and Morse also revealed differences in the extent of active management (where the SWF owns 5% or more of the shares of a publicly-traded firm) across regions and sectors:
The bottom line is that no one at these funds seems to be hiding the fact that they pursue extra-financial objectives. Far from it: Many put such planning objectives front and center. What they still may be hiding, however, is how well those funds execute on the stated planning objectives. As Dyck and Morse conclude:
Showing that funds pursue industrial planning objectives does not mean that they necessarily do this well, or that this is the best mechanism to achieve these objectives. The attempt to achieve planning objectives by taking equity stakes in private companies also raises questions whether this is the best mechanism to achieve these objectives, and how sustainable is this approach. There are alternatives, including direct state subsidies delivered either through state owned enterprises or through direct subsidies to private firms.
The lack of transparency of this mechanism seems to open the room for non-efficiency based political allocations. Whether the advantages outweigh the disadvantages and this is a sustainable proposition remains an open question.