Monday, July 18, 2011

Neutering Fears of Shareholder Activism by Sovereign Wealth Funds

(From Ken Squire, A Golden Age for Activist Investing, Barron'sFeb. 16, 2009; Dan Picasso for Barron's "On the hot seat: The financial crisis has eroded confidence in corporate leaders and boards of directors.")
Protecting against shareholder activism among large institutional shareholders has become an increasingly important, and well organized, sector of the financial services industry.
Companies around the world are experiencing an increased globalization of their shareholder bases as evidence reveals an escalation in ownership by investors outside a company’s home market. A significant portion of this investment is by U.S. and U.K. based institutions, which have been instrumental in pushing corporate governance reforms to the forefront of both boardrooms and the press around the world. As this activity has gained momentum and has at times become hostile, it has resulted in change in environments previously immune to governance activism.

As a result, companies can no longer ignore the importance of understanding who their shareholders are and any trends in the overall makeup of their shareholder base. This information has always been, and will continue to be, vital to the effectiveness of an investor relations efforts. However, it now has the added importance of allowing corporate officers to assess their vulnerability to an activist engagement. (From The Altman Group, GLOBAL SHAREHOLDER ID, Knowing your global shareholders).
Shareholder activism is a particular concern when the institutional investor is a sovereign wealth fund. The most influential SWFs have been at some pains to assuage fears that SWF investment presents the projection of state power into host state economies to further political rather than mere investment interests.  Moreover, SWFs have sought to reassure markets that their activity is essentially passive; shareholding is not meant ot signal a need to control or influence corporate behavior, with perhaps the notable exception of Norway.  See, e.g., Larry Catá Backer, Part XXVIII: Developing a Coherent Transnational Jurisprudence of Ethical Investing: The Norwegian Sovereign Wealth Fund Ethics Council Model, Law at the End of the Day, February 28, 2011.
(From Sovereign Debt Could Be 2010′s Subprime, Alter Now, Feb. 18, 2010)

This strategy is apparent in the work of the International Forum of Sovereign Wealth Funds  (IFSWF). Thus for example, on July  7, 2011, the IFSWF issued  a report on "IFSWF Members’ Experiences in the Application of the Santiago Principles".
Key findings of the report include:
--Members’ investment activities are based only on commercially-related considerations and they should be perceived and treated accordingly;
--The overwhelming majority of Members’ practices are fully or partially consistent with the Santiago Principles, while Members also acknowledge that some further progress can and will continue to be made; and
--Members see the value of transparency and have a strong level of commitment to it, via the Santiago Principles.

IFSWF Deputy Chair, Mr Bader Al Sa’ad, Managing Director, Kuwait Investment Authority noted: "We also believe that the report clarifies that the intent of the Santiago Principles is to increase understanding of SWFs and how they operate. Because of the individual differences in objectives of each of our Members, the approach to the application of the Principles differs across the membership. Additionally, not all of the Principles require public disclosure."

IFSWF Honorary Chair, David Murray, Chairman of Australia’s Future Fund Board of Guardians, said that "in consolidating direct responses from 21 Members, the report highlights the true value of the development of the Santiago Principles and the significant value it provides to members – particularly to newly established funds, as well as gives confidence to external parties about the commercial objectives and transparency of SWFs in conducting their investment activities." (From IFSWF, Press Release, International Forum of Sovereign Wealth Funds Publishes a Report on Members’ Investment and Operational Practices, July 7, 2011).
Among the most effective methods of showing SWF (good faith" in the economic rather than political agendas of such funds is by hiring host state financial advisers to manage some part of their portfolios.  It was recently reported by LS Global Advisory Group, Inc., that 
The dramatic increase in global equity investing by Chinese and South Korean sovereign wealth funds (SWFs) over the past two years has been mainly driven by hired external investment advisers, according to a research study just completed by LS Global Advisory Group, a leading global market intelligence and shareholder identification service provider. In-house managed equity portfolios have not increased significantly during the period, the study revealed. The SWFs, seeking to capture gains in developed and developing equity markets, are hiring specific types of investment advisers depending on the particular country they are investing in. (From L S Global Advisory Group, Inc., Chinese and Korean Sovereign Wealth Funds, Boost Global Equity Investments through External Advisers Engagement of Fundamental Investment Managers Suggests SWFs are not Activist Shareholders, July 12, 2011).
Of particular interest was the focus of investment and the private investment advisers hired.  Rather than invest directly, SWFs have hired outside fund managers to direct their investment in targeted investment sectors.
Big Increases into Japan
SWFs covered in the LS Global study – including China’s SAFE and China Investment Corp. (CIC), as well as Korea’s National Pension Service (NPS) and Korea Investment Corp. (KIC) – showed a combined 57% increase in total share ownership of Japanese companies in the six-month period ended March 31, 2011, based on market intelligence accumulated by LS Global. This data indicates that the funds’ external managers have been highly aggressive in their investment commitments over the past year.
Who’s Advising Whom?
The LS Global study identifies key external investment advisers for the Chinese and Korean SWF investments into developed and emerging markets over the latest six-month period. These are:
Chinese SWFs
SAFE (China’s State Administration of Foreign Exchange): Nomura Asset Management and Goldman Sachs Asset Management accounted for the largest portion of increased investments on behalf of SAFE. Additional SAFE accounts were externally managed by State Street Global Advisors, BlackRock Fund Advisors, and BlackRock Advisors UK.
China Investment Management Co. (CIC): External managers include Wellington Management Company, Grantham Mayo, Van Otterloo & Co., The Vanguard Group and BlackRock Advisors UK.
South Korean SWFs
Korea Investment Corporation (KIC): External advisers include State Street Global Advisors, JPMorgan Asset Management, Quantitative Management Associates, and Threadneedle Asset Management.
Korean National Pension Service (NPS): External advisers include Aberdeen Asset Management, Acadian Asset Management, AllianceBernstein LP, Baillie Gifford & Co., Fisher Asset Management, Franklin Templeton Investments, and Morgan Stanley Investment Management.
The point was clear enough--where a SWF hires a conventional investment manager for the purpose of investing some portion of its funds the SWF must be presumed to be engaging solely in economic and not political objectives.

(From BlackRock Inc. buys Barclays unit to become world's largest money manager; manages $2.7 trillion, Daily News, June 12, 2009; "BlackRock headquarters in New York. It has taken over an investment until of Barclays, making it the largest money manager in the world - in charge of $2.7 trillion. (Lennihan/AP)")

It would follow that this evidence reinforces the "deal" inherent in the Santiago Principles--where a state projects its economic power into the economic markets of other states, such activity is to be treated like that of private  (non-state) actors, as long as the principal objectives are economic. But, of course, that does not necessarily follow.  An investment manager is as capable as a state functionary to work aggressively to meet the political objectives of the SWF retained by them.  And indeed, in the case of sovereign investing, where political objectives have an economic welfare maximization component, this would not require more than a limitation of the focus of investment objectives. 

 (From CIC reveals US equity holdings, China Daily, Feb. 8, 2010; "Lou Jiwei, chairman of China Investment Corp, attending the Asian Financial Forum in Hong Kong last month. The sovereign wealth fund, based in Beijing, has reportedly begun stockpiling cash in US money-market funds. [Agencies] "

Importantly, any analysis of a presumption about SWF intent is complicated by the possible ownership relationships between the SWFs and the investment managers hired to manage SWF finds.  For example, CIC, the Chinese Sovereign Wealth Fund, holds stakes in at least some of the investment firms hired to manage their funds.  "According to CIC's report, three previously disclosed investments now comprise about 63 percent of its US holdings. These include a $1.77 billion stake in Morgan Stanley, the New York-based securities firm; a $3.54 billion interest in Teck Resources Ltd, Canada's largest diversified mining company; and $714 million of stock in BlackRock, a New York firm that is the world's largest money manager." (From CIC reveals US equity holdings, China Daily, Feb. 8, 2010).  Indeed, hiring these firms to manage targeted investment takes on a different complexion when it is considered together with another investment decision of CIC--the investment in indigenous funds operating in host states.  "The filing shows that CIC has been buying exchange-traded funds that track stock indexes, economic sectors and commodity prices, such as the SPDR Gold Trust. Its ETF holdings, including about 4.1 million shares in each of the iShares S&P Global Materials Index Fund and the Energy Select Sector SPDR Fund, had a market value of $2.4 billion on Dec 31, according to the filing."  (Id.).

This is not to suggest that there is sham here.  Rather, it is that merely hiring conventional host state based investment advisers, standing alone, does not necessarily mean that the SWFs are just engaging in passive economic activity without a shareholder activist agenda.  
So what’s behind CIC’s growing investment savvy and international manoeuvres? According to an FT analysis in December, much of it has to do with CIC’s managing director Zhou Yuan, a former UBS banker in China from 1994 to 1998.

Zhou, who now heads CIC’s Strategic Investment and Concentrated Holding division, is in charge of the fund’s large positions in public companies such as Blackstone, Morgan Stanley and Noble Energy, and is popular with foreign visitors to CIC’s Beijing headquarters, according to the report. (From Gwen Robinson, CIC Takes on the World, Alphaville, Feb. 9, 2010).
Sovereign investing may well redefine the meaning of shareholder activism, the way SWFs have begun to redefine the character of state investment in economic markets abroad.

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