The amount of attention that sovereign wealth funds (SWFs) around the world get these days is something that any serious follower of financial news probably is very familiar with. While it could be interesting to scrutinise the particular investments that sovereign wealth funds have pursued over the years, it would be an even more worthwhile effort to gain investment insights as to how governments actually manage their reserves!
As BillionaireInvestor has pointed out in an earlier post (see Investment Lessons From A Sovereign Wealth Fund Part I), investors can learn a great deal by adopting the perspective of these billion dollar asset management entities and their manner of portfolio management.
Here are 3 key principles that sovereign wealth funds around the world have abided by:
Safety First – Preservation of Capital
The foremost rule in the investment world is preservation of capital. It is the utmost fundamental principle by which every investor have to abide by! However, many have forgotten this classic adage as pressures to generate returns rein on the minds of investors. Sovereign wealth funds know that they cannot even afford to risk a major portion of their capital as it consists of a nation’s wealth and comprises a big stake of a nation’s future. Thus, this principle of capital preservation has to run through their entire mandate, corporate governance and organisational philosophy.
Any investor would do well to adopt this mindset, and basic fundamental queries like “How much can I afford to lose?” are good starting premises before any level of risk is undertaken and assumed when making investment decisions. As CEO of Employees Provident Fund (EPF) of Malaysia Datuk Shahril Ridza Ridzuan once mentioned, “Paramount in the way we structure our assets is basically capital preservation. We cannot afford even a low risk in the loss of capital.”
Betting On Secular Trends
While many SWFs are risk averse and tend to manage their portfolios conservatively, some of them orientate their management styles to investing in secular trends. While there is no clear definition of a secular trend, it is most characterised by a huge trend or shift or change that will alter the world across a period of time (probably 20 – 30 + years). Some examples of secular trends include the rise of American industrialism and economic might from the 1870s into the early 1900s and the rapid expansion and usage of the internet in our everyday lives (you definitely will know about this if you are reading this now). In the institutional investment world, secular trend investing is also known as thematic investing.
SWFs orientate towards secular trends because these trends tend to unfold over various market and economic cycles, which is practical for them as they normally have to adopt longer term horizons when managing investments – and not making knee-jerk reactions to short term developments. The Government of Singapore Investment Corporation (GIC) is well known for overlaying some of their active bets with secular themes.
Focusing on Strengths and Acquiring External Expertise
Managing a large portfolio and ensuring that good returns are generated might be a daunting task, many SWFs have tend to augment their strengths and focus on working within their circle of competence. A circle of competence is basically a playing field in which one is very confident about and is very competent in. However, due to their diversified mandates in managing their portfolios, SWFs have to occasionally venture beyond their circle of competence, whatever their circle of competence might be.
In order to address this issue, many of them partner managers with specialised capabilities in various asset classes, or even hire external fund managers to manage discretionary mandates for them. This allows them to focus on their strengths while still maintaining exposure to other asset classes and investments outside their core management expertise. One such example of a SWF that does so is China Investment Corporation (CIC). CIC does have an allocation to alternative asset classes like private equity, and they have done that via an investment in well-known U.S. private equity giant Blackstone Group.
But how does the individual investor “focus on strengths and acquire external expertise”? The ability to “hire” external, specialised assistance when investing one’s portfolio is actually not limited to large institutional investors like the SWFs. Buying a mutual fund that invests in equities in a geographic region that one is not familiar with is an example of acquiring external expertise when managing one’s investments.
SWFs have abided by these 3 key principles when managing their gigantic portfolios, and investors can actually learn from these entities as mentioned above.
More information on sovereign wealth funds can be found at the website of the SWF Institute. Happy Investing!
*Image taken from GulfNews.com*