The U.K.’s vote to leave the European Union, known as “Brexit,” has placed political risk squarely on the agenda of sovereign wealth funds (SWFs) and other investors. The industry may be moving into a period in which political factors become as important as economic ones in pricing assets. Sovereign and government funds need to look very carefully at this transition. The outcome of the referendum implies some immediate consequences for the prices of assets that have shaped the industry over the past decades; it also signals a broader trend that may transform the interests that SWFs pursue and the strategies they employ.
SWFs have generally shrugged off short-term market responses to political events, stressing that they were investing for the long term and therefore could wait until markets recovered from such tail risks. But precisely because SWFs are long-term investors, they should place such events into context, and very thoroughly examine what longer-term systemic consequences emerge.
The uncomfortable truth? The wider international political system is reconfiguring itself. Over the past 25 years, the concept of the independent and sovereign nation-state has come under pressure from forces of economic and political integration. That integrationist theme has been a particularly pronounced one in Europe, where governments have given up core symbols of national sovereignty, such as their national currencies, in order to allow goods and services, capital, and labor markets to effectively allocate scarce resources. In return, European citizens expected jobs, rising incomes, and an improvement in their living standards.
The Brexit vote reveals that Europe has failed to convince British voters that the integrationist agenda benefits them. Instead, voters in middle England sought to position the nation-state in the center of political discourse by advancing what could be called a disintegrationist agenda and strengthening the centrifugal forces of national politics. And what has come so forcefully to the fore in the U.K. is certainly an attitude that has begun to manifest itself elsewhere, too.
Sovereign wealth funds have benefited tremendously from global market integration. In the years since the global financial crisis, SWFs have expanded their role as important stakeholders in an ever-more-inclusive financial markets. By and large, they are now free to develop geographically diversified portfolios and invest wherever they identify commercially attractive opportunities.
The Brexit vote and the prospect of the U.K. leaving the E.U. should therefore be of great concern to them, because it shakes one of the working assumptions on which the success of sovereign wealth management has been built. The coming battle between integrationist and centrifugal market forces leaves SWFs with their commercial interests and their political identity in a unique position.
The fragmentation of the global investment space places a burden on all government investors with a global perspective to integrate political risks into their portfolio strategies and risk management analyses. Political risks have been at the periphery of many investors’ attention in the past, but they now move to the center — and will have to be more systematically identified, assessed, and dealt with.
In this regard, SWFs are no less challenged than other global investors. But then again, one could assume that they are particularly sensitive to political risks, given that SWFs’ ultimate owners are their own nation-states.
But SWFs should not only adapt to a new risk environment; they should also become more proactive in shaping it. With their growing influence in global financial affairs, they have an ability to contribute materially to any discussion about how the global financial marketplace is going to be structured. And given their interest in being able to diversify their portfolios geographically, they should have a distinct interest in making sure that that financial marketplace is an open and inclusive one. They already have the financial firepower to work towards such an outcome — now they just need political support at home to back up their efforts.
In March this year, Yngve Slyngstad, CEO of Norges Bank Investment Management, suggested that the prospect of Britain leaving the E.U. would not pose any significant risk. His argument seems easy to dismiss in hindsight. The challenge is now to think through Brexit’s consequences — and how the fragmenting international political system will impact SWFs in the long run, for that is the time horizon that they’re looking at.
Credit: Sovereign Wealth Center