LONDON-BASED EXPERTS ASSESS SOVEREIGN WEALTH FUND

C O N F I D E N T I A L SECTION 01 OF 03 LONDON 001497

SIPDIS

E.O. 12958: DECL: 06/24/2019
TAGS: EFIN ECON EINV UK
SUBJECT: LONDON-BASED EXPERTS ASSESS SOVEREIGN WEALTH FUND
ACTIVITIES

Classified By: Economic Counselor Kathleen Doherty for reasons 1.4 b an
d d.


1. (SBU) Summary: The global financial crisis eroded the
market value of sovereign wealth funds' holdings, leading
many to refocus on liquidity in the short term with moves
towards cash balances and fixed income government securities,
especially U.S. Treasuries. However, experts with whom
ECONOFFs met recently, suggested the funds were still keen on
maintaining diversified portfolios and would avoid
fundamentally rebalancing their portfolios. Several experts
suggested one consequence of the global financial crisis
might be for funds to take more activist roles, including
greater participation in corporate governance. End Summary.

Building Liquidity Buffers Now
--------------


2. (SBU) Experts agreed sovereign wealth funds (SWFs) have
been focused on liquidity since the collapse of Lehman
Brothers and subsequent intensification of the global
financial crisis. Andrew Rozanov, Managing Director Head of
Sovereign Advisory at State Street Global Markets, recently
told ECONOFFs sovereign wealth funds were refocusing on
liquidity in the near term. Governments, particularly
monetary authorities, underestimated the amount of dollar
liquidity needed. Post the 1997 Asian financial crisis,
emerging market economies became self-insured vis--vis
foreign exchange reserves, by holding a larger amount of
FOREX, but Rozanov pointed out massive drawndowns of reserves
to combat the downturn, in countries like Russia, meant
officials could become less comfortable adding risky assets
to their portfolio because of the need for liquidity.
Cynthia Sweeney Barnes, Global Head of Sovereigns and
Supra-nationals at HSBC Global Asset Management, agreed with
Rozanov's assessment and told us she saw an uptick in cash
investment, particularly money market funds, following the
U.S. Treasury Department's guarantee of U.S. money market
funds. She also noted the adjustment back to equilibrium
could take longer in the Persian Gulf states, so cash and
real assets were the focus. Robert Ryan, Managing Director
at Morgan Stanley, who had recently returned from a trip the
Persian Gulf, told us local market watchers were not buying
the green shoots theoy of economic recovery that were
receiving press of late. Instead, locals in the Gulf
anticipated a drawn-out recovery and funds continued to build
cash balances in the short term.



3. (C) As further indication of SWFs' risk-averse behavior,
HSBC's Barnes told us there had been a consolidation among
asset managers since the onset of the global financial
crisis. She asserted HSBC benefited because it was seen as
more conservative. Robert Ryan, Managing Director at Morgan
Stanley, told us funds, such as Abu Dhabi Investment
Authority (ADIA),were demanding explanation for bad
performance and even demanding managers waive fees for poor
returns.


Real Fundamental Rebalance of Portfolios Unlikely
--------------


4. (SBU) Guy Henriques, Head of Official Institutions at
Schroeder Investment Management, and Morgan Stanley's Ryan
told us during recent meetings they did not envision
significant and long-lasting shifts in SWFs' portfolios
because most were multigenerational funds with long-term
horizons. Henriques asserted strategic asset allocation was
based on performance of asset classes; fund managers had
already "factored in 1930s downturn type scenarios so they
would likely stick to their guns." Ryan stressed funds were
working through existing positions vice rebalancing
portfolios, and he expected a reallocation of assets later in
the year from liquid, fixed income securities into equity.
Henriques, Ryan, and State Street's Rozanov all agreed
Norway,s Government Pension Fund-Global (GPF-Global) has
continued to purchase equities during the current
downturn--$65 billion worth--as part of its long-term mandate
of a 60-40 equities to fixed income portfolio split.


Instead, Funds Likely to Maintain Diversified Portfolios
-------------- --------------


5. (SBU) State Street's Rozanov asserted funds were still
looking at diversification over the longer term. At a
sovereign wealth-themed conference held in London in early
May, Norway's GPF-Global representative cautioned against

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making judgments around just one year's performance,
particularly 2008, said Rozanov. The representative stressed
downturns were part of the risk when entities, such as
sovereign wealth funds, have long-term investment horizons
versus those chasing short-term returns; long-term investment
horizons kept assets exposed but the returns were to
compensate for the greater risk.


6. (SBU) HSBC's Barnes saw signs of the flight to quality,
vis-a-vis U.S. Treasuries, already abating. Funds could not
sit on Treasuries for an extended period of time. Barnes
also saw greater interest in real assets. She called the
pursuit of physical assets by SWFs in the Middle East and
North Africa "comfort" investing; for example, private equity
investments tended to go towards real estate and
infrastructure.


Economic Climate Favors South-South Diversification But Lack
of Deep Capital Markets Present Hurdle
--------------
-------------- --------------


7. (C) Experts we met agreed South-South investments (from
the Middle East, Asia and Latin AMERICA to other countries
within these three regions) now appeared more attractive in
terms of growth prospects, but were not always possible.
Gerard Lyons, Chief Economist and Group Head of Global
Research at Standard and Chartered told ECONOFFs in late May
the economic climate favored regional diversification towards
the East, but in reality emerging markets lacked depth
relative to the U.S. and UK. If the funds invested
regionally, they would need to buy and hold longer term.
HSBC's Cynthia Barnes and Schroeders' Henriques also told us
Middle East funds would like to invest more locally but want
to avoid creating inflation at home and the region lacked
capacity to absorb the volume of potential investments.
Morgan Stanley's Robert Ryan asserted investors interested in
long-term growth in stock markets should go to emerging
markets and agreed sovereign funds would like more exposure
to emerging markets but questioned whether the funds were
comfortable with the volatility in returns inherent in
emerging markets.

Recent Liquidations of Stakes in Financial Institutions Not
Likely to Create Domino Effect
--------------
--------------


8. (C) Standard and Chartered's Lyons told us the global
financial crisis changed the environment for Singapore's
Temasek Holdings. The fund was likely scaling back global
aspirations and focusing on regional development. Lyons
suggested the sale of its Bank of AMERICA stakes earlier this
year reflected the refocused approach but would not lead to a
spree of sovereign wealth entities liquidating their stakes
in Western financial institutions. Recent press reports
suggested Temasek also sold its stake in Barclays some time
between December 2008 and January 2009 at a loss of $500-600
billion. From Lyon's perspective, Singapore, feeling Hong
Kong nipping at its heels, was looking to regroup and
strengthen its regional status. He also noted the risk of
Middle East funds liquidating foreign assets seemed to have
subsided because of confidence about of oil prices; oil
prices have climbed back to $71 per barrel, and the funds
budgeted for lower break-even point. (Comment: In late
April, Qatar Holding, an arm of the Qatar Investment
Authority, sold 35 million shares, lowering its original 6.4
percent stake to 5.8 percent--officials claimed it was part
of its trading strategy, according to press reports. Qatar
Holding still holds 488 million shares and its stake is due
to increase by 326 million shares upon conversion of
mandatory convertible notes before the end of June. One of
Abu Dhabi's multiple sovereign investment arms, the
International Petroleum Investment Corporation sold its stake
in Barclays in early June for a sizable profit. This could
have been a simple move to cash in on a higher share price,
256 pence per share, ahead of conversion--IPIC's stake
consisted of securities with a conversion price of 153 pence
per share--or one suggesting a refocus on hyrdo-carbon
investing.)

Potential To Become More Involved in Corporate Governance
-------------- --------------


9. (C) Several experts who met with us suggested SWFs could
take on more activist investor roles. Rozanov suggested
sovereign funds would become more involved on corporate
governance issues, in part because of the underperformance of

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major financial institutions. SWFs could pressure management
without exposing the funds to political risk by engaging with
peer institutions, such as large pension fund or activist
hedge funds--activist hedge funds typically took take larger
stakes in companies and were corporate activists. In
partnering with the activist hedge fund, the SWF would be
entrusting the stake to the hedge fund. Rozanov argued the
political risk of engaging the hedge fund would be limited
because, from his perspective, U.S. regulators seemed
comfortable with non-political investing of hedge funds and
private equity firms. Transparency on the part of both SWFs
and hedge funds would help mitigate political risk with
outsourcing to activist hedge funds. In Europe, however,
working with large institutional investors who voted shares
actively, like pension funds, would be more palatable even
though the activist hedge fund objectives would be a better
match for the SWFs, according to Rozanov. HSBC's Cynthia
Barnes argued that anger over losses stemming from the
on-going crisis was palpable and SWF officials have been
looking at banks and asset managers to blame. Therefore, she
saw the potential for fund officials becoming more involved
in the details, despite the typical penchant of SWF officials
to avoid courting publicity.



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