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Independently Wealthy:
Sovereign wealth funds eye trophy real estate

Last week the Abu Dhabi Investment Council, a sovereign wealth fund from the United Arab Emirates, paid $800 million for a 90 percent share of Manhattan's iconic Chrysler Building. And just a few months ago, the Abu Dhabi Investment Authority (ADIA), the Investment Council's big sister, invested $7.5 billion in Citigroup.

These two Abu Dhabi deals illustrate the growing power of sovereign wealth funds (SWFs). These funds, which are typically defined as pools of domestic and international assets owned and managed by governments, are increasingly active on the global stage and particularly active in the United States.

Today, SWF assets are estimated to total roughly US$ 3 trillion - still much smaller than the aggregate assets of either pension funds (roughly US$ 21 trillion) or mutual funds (circa US$ 17 trillion), but larger than the aggregate size of all hedge funds (at about US$1.5 trillion). These funds are expected to reach as high as $12 trillion by 2015 as oil prices surge and trade imbalances swell.

"SWFs are getting too big to hide," says Guy Langford, a principal in Deloitte Consulting's mergers & acquisitions practice. "These funds keep growing, and they're looking to deploy more capital."

In fact, London-based International Financial Services estimates that assets under management of SWFs increased 18 percent in 2007 alone. And most SWFs are increasing their allocations to alternatives investments such as private equity, real estate and hedge funds, according to Jennifer Johnson-Calari, director of the World Bank's Sovereign Investment Partnerships. She points to the Korea National Pension Fund, the Fonds de Retraite in Paris, the Alberta Heritage Fund, Australia Future Funds, New Zealand Superannuation Fund, Canada-based CPP Investment Board and the Thailand Pension Fund.

"While SWFs have become more visible in the last year or so, they are long-term investors and highly experienced professionals whom we respect," says Joseph Parsons, president & CEO of Global Investment Management for GE Real Estate. "They are investors with a sophisticated understanding of risk/return ratios."

Long investment history
SWFs can be categorized into two types of funds: so-called stabilization funds, which aim to protect a country's wealth by separating it from short-term budgetary or reserve developments; and savings or intergenerational funds, which create a store of wealth for future generations through a country's natural resources.

Although SWFs are similar to pension funds, private equity funds and other investment funds when it comes to investment strategies and objectives, they are different in one very important way: because SWFs are not privately owned, they pretty much make their own rules when it comes to financial market policy and corporate governance.

That's why SWF investments (and their motives) are often called into question. Remember the so-called Dubai Ports deal: DPWorld, a company owned by the government of Dubai, made an effort to acquire London-based Peninsular and Oriental Steam Navigation Company (P&O), the fourth largest port operator in the world with major U.S. port facilities in New York, New Jersey, Philadelphia, Baltimore, New Orleans and Miami. The deal failed, primarily because of concerns about national security of "strategic assets".

Despite much of the recent buzz about SWFs, they've actually been around for decades. In fact, the history of SWFs dates back to the 1950s when the Kuwait Investment Board created a fund in 1953 to invest surplus oil revenues and to reduce the country's reliance on its finite oil resources.

"Sovereign wealth funds have been prudent, professional investors in the United States real estate market, several for a decade or more," Parsons says. "They have been — and remain — an important source of capital for U.S. real estate investors."

Over the past eight years, at least 10 new SWFs have been set up and there are reportedly more SWFs planned in Brazil, Japan and India. In Brazil, for example, following the discovery of new oil fields, the country's government has signaled its intent to launch an SWF that will initially be used to control inflation.

The majority of SWFs can be found in oil exporting or otherwise commodity-rich states in which the proceeds from the sale of the natural resources or taxes levied on commodity income of private corporations accrue to the state. For example, oil-exporting countries such as Kuwait, Qatar, the United Arab Emirates, Saudi Arabia, Russia and Venezuela operate SWFs. Even the U.S. has an oil-related SWF - the Alaska Permanent Reserve Fund Corp., established in 1976.

Natural resources such as copper, diamonds or minerals form the basis of SWF funding for countries including Chile, Botswana and Kiribati. In fact, Kiribati, a tiny Pacific island nation, was one of the first to establish an SWF to manage its revenues from phosphate deposits.

Beyond natural resources, several SWFs have been established to invest profits created through substantial net exports. In China, for example, strong manufacturing growth resulting from higher labor productivity has not been matched by higher domestic spending so savings have grown ahead of even dramatic investment growth.

According to the IMF's forecasts, the combined current account surplus of China and oil-exporting countries will be around $800 billion over the next three years.

See-through motives
For SWFs, the biggest criticism is lack of transparency. "They are shrouded with a little bit of mystery," says Deloitte's Langford. "People might not understand what their strategy is and wonder if foreign governments are making statements with their investments."

Late last year, the U.S. Senate Committee on Banking, Housing and Urban Affairs met to discuss the impact of SWFs and other foreign government investments in the U.S. The Committee called for an increased level of transparency by SWFs, and several SWFs are currently working with U.S. officials through the International Monetary Fund (IMF) to devise a SWF "best practices" code.

Moreover, many SWFs are actively working to improve their image with the public. For example, ADIA is co-chairing the IMF working group on SWFs, and earlier this year, it reportedly hired a U.S. public relations company and set up an in-house communications team.

A recent study conducted by Cambridge, Mass.-based Monitor Group indicates that SWFs have nothing to hide. The study, "Assessing the Risks: The Behaviors of Sovereign Wealth Funds in the Global Economy," is a first-of-its-kind report analyzing the actual behaviors and financial transactions of SWFs. It challenges widespread beliefs on the economic and political motives behind sovereign investments.

"We have seen a glut of opinion about the danger sovereign wealth funds present to the Western world in terms of political and economic influence," says Mark Fuller, chairman of Monitor Group. "However, these fears are based on very little evidence."

The Monitor Group collected and investigated data on 1,181 SWF transactions involving 25 funds from 1975 through March 2008 and found that the investment behavior of SWFs to date suggests the funds are driven primarily by financial objectives. In other words, they do not appear to be investing for political motives, but rather for financial gain.

Even more importantly, the firm says it found no evidence that SWFs, especially the highly scrutinized Middle East and East Asian funds, are active in ways that threaten the economic or national security of the countries where they invest. Investments in transportation, defense and aerospace, and high technology make up less than one percent of the value of deals in Monitor Group's study.

"Real estate is a good place for SWFs to invest because most people don't consider it to be sensitive to national security," Langford contends. "Real estate will be appealing to SWFs because it won't get the same scrutiny as rail lines, ports or airlines."

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