Specific Steps that Hedge Fund Managers Can Take to Increase the Likelihood of an Investment from a Sovereign Wealth Fund
Hedge Fund Law Report
Sovereign debt has been the historical repository of foreign exchange reserves. In the old model, state enterprises would export goods (often commodities, such as oil) abroad, and the revenue from such sales would be used to purchase debt issued by other governments or their subdivisions, often the U.S. Treasury. Alternatively, private firms would export goods produced with a state license, thereby generating tax revenue that the host country invested in sovereign debt. With the bull run in commodities that began in the late 1990s, the foreign exchange coffers of various nations – especially the oil-rich – swelled, and the financial authorities in those nations took notice. Rather than reflexively pouring growing foreign exchange reserves exclusively into sovereign debt, resource rich countries and other countries organized sovereign wealth funds (SWFs). The goals of such funds included more concerted and disciplined management of reserves, and diversification among asset classes, industries and geographies. For various countries, SWFs represented an effort to surmount the “resource curse” – the paradox in which development is often stunted in a nation rich in a single or a few natural resources. Historically, SWFs have invested primarily in straightforward, liquid assets such as public equity and bonds, and allocated only a modest proportion of their net assets to hedge funds and other alternatives. However, the credit crisis complicated the assumptions that undergirded that investment approach. Among other things, the crisis demonstrated that investments in public equity – for example, in the stock of bank holding companies – could entail greater risk and exposure to more leveraged entities than investments in hedge funds. Accordingly, SWFs are now looking to invest a greater proportion of their assets in hedge funds. For example, in August of this year, the China Investment Corporation confirmed its plan to allocate approximately $6 billion to alternative investment strategies by the end of 2009. For hedge funds managers still facing a difficult money-raising climate, the significant volume of assets in SWFs presents a compelling fund raising opportunity. However, fund raising from SWFs is different in subtle but important ways from fund raising from the more traditional hedge fund investor base. With the goal of assisting hedge fund managers in this unique but critical fund raising niche, this article explores: what SWFs are and how they are funded; the history and purpose of investments by SWFs in hedge funds; specific considerations for hedge fund managers when seeking to raise funds from SWFs; and potential concerns arising out of the receipt by hedge fund managers of SWF investments.