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Wealth funds await market bottom to make the kill

SWFs are waiting for the right time to make deep value investments. (REUTERS)

By Yazad Darasha

Globally, sovereign wealth funds (SWFs) expect better asset values later this year and are keeping their powder dry for such a time, a new survey has revealed.

The world's most powerful global SWFs confirmed that they are still awaiting the bottom of the market before committing to further substantial investments, according to a survey by Financial Dynamics International (FD). The survey also confirmed an unanimous view that SWFs see their role as that of passive long-term investors, with no desire to behave in an activist manner towards investee companies.

In a series of one-to-one non-attributable interviews, FD interviewed senior executives from a number of the world's leading SWFs – whose total assets accounted for well over 50 per cent of the $5 trillion (Dh18.35) worth of collective global funds currently held by the SWF asset class. The research focused on current SWF attitudes towards valuations, investment strategies and where they see regional investment opportunities.

"Our research confirms that while sovereign wealth funds are currently adopting a very cautious investment approach to world markets, they are clearly poised to re-enter the global equity markets in the not too distant future with compelling valuation propositions beginning to present themselves across North American and Western European equity markets," said Charles Watson, FD's Group Chief Executive.

"Our research has also determined that contrary to widespread perception, SWFs are primarily genuine long-term passive investors, who have no agenda to exercise management control or behave in an activist way."

While a number of key SWF investments have been made over the last 18 months and they are still interested in broadening their portfolios, the findings showed that this particular class of investor is keeping a watchful eye on global markets, waiting for the right time to make deep value investments.

"The bottom has yet to come," said one SWF executive. "Obama's first 100 days may see bear markets rally but the entire financial system and capital market has been stressed to the point of collapse and now needs time to adjust.

"We are behaving in a very cautious manner at present. We are convinced there will be better value in markets later this year. We are ready to re-enter the market in a major way – but not for several months given that we are sure prices are only heading down. Our view is that valuations may bottom out towards the end of this year."

The interviews indicated that SWFs are conservative with regards to participating in further bailouts of companies in financial difficulties given that a number of such funds are currently sitting on major capital losses from previous investments.

"Having supported some of the earlier capital raising of distressed banks, we are not planning to make any follow-on investments of a similar nature. We see the real opportunities as being investing in well-managed sound firms whose shares are trading at all time lows, rather than putting good money into failed companies," said another SWF executive.

Some funds are reducing their exposure to the listed market. At least one adopted this strategy as early as 18 months ago, having noticed early warning signs in market excesses. Another executive commented that corporate governance and management quality were also very important issues in the current market conditions.

He said: "Investors will now turn to value a company using a holistic valuation method, including corporate governance and measures of a reliable management team with good checks and balances, for example."

When determining "value" within prospective investments, the sustainability of and growth prospects of dividend streams was as critical as capital growth prospects, the survey revealed.

"Yield is as critical to us as growth. Sustainability of dividend payments is therefore a critical area we focus our analysis on," one executive said.

The SWF interviewed stated without exception that their preferred option for investing was through minority participation via capital injection, with no SWF stating a desire or intention to control or manage investee companies, indicating their passive investment style. The majority also iterated that they had no desire to have board representation within their investments.

Those who are investing in the current market are all clear on one thing – they are not looking to take operational control of their investments. Full acquisitions and majority stakes are not on the agenda, and have not historically been of particular interest to SWFs.

In the current market conditions, debt for equity swaps are increasingly being seen as an opportunity to enter investments in an efficient manner.

"We are increasingly interested in seeing how it might be possible to secure a cheap entry into an investment by either buying the debt or structuring some form of convertible instrument – but our intentions in doing so is purely to create value, not to seek any form of control," one SWF executive said.

SWFs see themselves as passive and therefore fundamentally very different from hedge funds or private equity investors.

"It is very unfortunate that we get tarred with the same brush as 'alternative assets' such as hedge funds and private equity. In complete contrast to these asset classes, we are passive investors. Our normal form of investment is buying minority shareholdings in tradable liquid assets… we do not seek to engage in confrontational situations or exert influence… if we don't like management's strategy, or the strategy changes, we sell."

The majority of SWFs interviewed confirmed that Asia and South America are the two regions SWFs deem to be the most attractive for a combination of qualitative and quantitative reasons. Mexico and Brazil were sited as the two most attractive countries.

It was also stated by several of the survey's participants that North America and Western Europe clearly present the most compelling value proposition.

A quantitative financial analysis of the top 800 companies in major markets across the world (Central & South America; North America; Western Europe; and Asia Pacific) indicates deepest value in North America and Western Europe.

The majority of the SWFs interviewed in the survey confirmed that it was only a matter of time before they started to commit significant funds again to the North American and Western European markets.

However, the speed with which SWFs will re-enter this market will be moderated by two things: firstly a genuine sense of caution prevails with regard to fears that continuing negative sentiment will drive equity markets lower – and secondly, some SWFs are seeing cash sources diverted by the need to support local financial stimulus packages in their own regions/countries.

"A proportion of our free cash holdings have been diverted to supporting local investments – meaning that our international investment activities have been temporarily put on hold," one executive said.

"Although our objectives are solely international, we are slowing down our overseas activities, while we firstly wait for market conditions around the world to stabilise – and secondly we have seen funds diverted to support a variety of local stimulus packages."