Should the Largest SWFs Be Split Up?

(August 8, 2013) — Renewed calls for the Norway Pension Fund-Global and the Qatar Investment Authority (QIA) to be broken into smaller pieces has re-ignited the debate over how big is “too big” for sovereign wealth funds (SWFs).

In Norway, the government’s opposition this month said it was time to consider breaking up the world’s largest SWF—which stood at $737 billion at the end of June—into smaller, more manageable funds.

In Qatar, there have been suggestions that the $115 billion QIA could function better as a couple of smaller entities, but so far there has been little political will in either country to change the status quo.

That the question has been asked again is a good thing, according to Patrick Thomson, global head of sovereigns at JP Morgan Asset Management.

“There is no hard data on the matter,” he told aiCIO, “as each of these funds are unique—especially in their size. There is no way to measure Norway against Yale or Harvard, for example, but there are intuitive things to consider.”

Being of such a magnitude makes nimble trading difficult, but it also causes problems with diversification. Channelling large amounts of capital into the equities market even through a range of managers is likely to lead to overlap and discount the diversification benefits.

For example, the Norway SWF could buy its entire domestic stock market—twice.

Last year, Petter Johnsen, CIO (equities) at Norges Bank, which invests on behalf of the Norway fund, told aiCIO the fund employed 50 external managers to invest 5%, or $30 billion, of the fund across specialist mandates, such as emerging markets and small cap companies. The internal direct investment team is just over a hundred and each manager has a distinct portfolio. “It is a single ownership structure—the portfolios are all managed separately—but together they are a combination of specialized mandates. Combined, they follow and invest in some of the largest 1,000 global companies—mainly in the developed markets.”

Johnsen maintained the fund was well diversified—and invested outside of Norway.

Considering the recognised push being made by these funds to alternatives asset classes, there is another problem waiting, said Thomson.

“A lot of these alternatives—hedge funds, private equity, and credit—are not large funds, so even a 10% allocation to the sector would swamp many managers. These managers would also not want just one client, so the SWF would have to spread the allocation across a large range of funds. “

The cost of compliance and due diligence across an army of managers might be unimaginable for many investors.

“There is a benefit to size and scale, but there is a tyranny to size in certain asset classes, but we don’t know where the tipping point is,” said Thomson.

Although there is no right or wrong answer, Thomson suggested looking to Sweden’s state pension investment system. The government created a series of so-called buffer funds that were allocated the same amount of starting capital and given similar growth targets.

“They all have similar asset allocations and while they have set themselves different goals the system creates competition and that should lead to better returns,” he said.

This is also the case in Singapore where the three SWFs operate differently, but do have some overlapping investments.

Will these investment giants split up? Thomson thinks so, but there are very few people who know—and they’re not telling for now.

Related content: Defeating All-Comers? A profile of the Norway Pension Fund Global  & Interactive Map Created By SWF Institute