Canadian Investment Review

SWFs the New Endowment Model?

Written by Ashby Monk on Wednesday, October 27th, 2010 at 1:40 pm

story_images_yale-bulldogGreg Bright has quite an interesting article on top1000funds.com. In it, he suggests that the ‘SWF model’ may be the new ‘endowment model’ (aka Swensen model), which is another way of saying that a variety of different investor classes should think about adopting some of the investment strategies of SWFs:

“Some sort of shape is starting to take place, post-global crisis, as to how the biggest, longest-term investors are spending their money. If the endowment model was the one to follow for the past 20 years, the sovereign wealth fund model may be the one to follow for the next.”

This is a hard argument to swallow. Last I checked, the economists (such as these guys, this groupthose guys, and these two) have been dragging SWFs over the coals for their investment strategies. So, it’s a tad surprising to see someone saying that these funds should now — in the name of achieving financial outperformance — be copied.

Nonetheless, I’ve said repeatedly that I think SWFs have strategic advantages over other investors. So, I’m one of those (few?) who would potentially be amenable to such an argument. So, Mr. Bright, let’s hear it:

“What the big endowments did was invest directly, with their own teams of specialists and professionals, in areas where they had particular expertise, such as private equity and real estate. They then laid off the other parts of their portfolio in much the same way as big pension funds do anywhere, with a mix of growth and defensive allocations.”

I’m a big fan of direct investing in areas where you have a strategic advantage; it’s classic management theory. (You need excellent governance to do this in-house, but it’s doable.) However, that’s still the ‘endowment model’; we need to learn about the ‘SWF model’:

“What [SWFs] have in common, though, is a single shareholder – a government – with a legislated genuine long-term aim for the fund’s investments…a common element is the desire to take significantly large stakes in companies or other assets which reflect a long-term theme. SWFs have, for instance, waded into hostile takeover battles for resource companies. They have invested directly in big infrastructure projects. And they have backed IPOs of established businesses, which are targeting future growth areas…SWFs have the added advantages of fire-power to get a seat at any table and the inhouse resources to analyse and negotiate their positions.”

And what does this imply to Mr. Bright?

“…a common element is the desire to take significantly large stakes in companies or other assets which reflect a long-term theme…all investors can identify themes and direct their asset allocation accordingly.”

It’s an interesting argument, but the punch line wasn’t quite as exciting as the buildup (…which reminds me of the hours of my life I wasted watching the show Lost…how I want those hours back). Anyway, Mr. Bright isn’t wrong, but I still don’t think the SWF model will ever be as popular as the endowment model.

The reason SWFs are able to do what they do is because they are unique…as in, other investors are dissimilar in form and function. SWFs have a single shareholder (which is the government); they have no liabilities beyond this sponsoring government; they have an inter-generational time horizon; they have enormous scale; and, in some cases, they have certainty of cash flows for decades. Private investors have a hard time ticking any of those boxes. So, what’s appropriate for SWFs most likely is not appropriate for other funds.

Moreover, these “themes” that SWFs are focusing on (which seem to be the crux of the ‘SWF model’) are, in some instances, more about national strategic priorities than about returns. Granted, funds such as the CIC argue that their interest in commodities and resources have nothing to do with China’s broader priorities, but other funds are more forthcoming in their “thematic” objectives. For example, Mubadala is as interested in creating jobs in Abu Dhabi as it is in returns when it invests. The same goes for Qatar. Other non-governmental investors (with liabilities) have no interest in these sorts of “themes” because they have no desire (or ability) to invest for the generic benefit of the country they inhabit. They need to show their (many) shareholders measurable returns (and in the short-term). In addition, focusing on themes and taking big stakes in firms goes against the typical focus private investors have on diversification.

Anyway, I’m grateful to Mr. Bright for inspiring some fun thought this morning. I promise to think more about his idea of ‘what investors can learn from SWFs’. It’s worth doing.

This post originally appeared on the Oxford SWF Project website.

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