Strategic Investment Funds

This paper defines SIFs as special purpose investment funds that exhibit all of the following six characteristics. These funds: 

• Are sponsored and/or fully or partly capitalized by a government, by several governments, or by government-owned global or regional finance institutions; 
• Invest to achieve financial as well as economic returns, in accordance with a double bottom line; 
• Aim to crowd in private capital by co-investing at the fund and/or project level; 
• Operate as expert investors on behalf of their sponsors;
• Provide long-term patient capital, primarily as equity, and may also invest in quasi-equity or debt; and 
• Are established as investment funds or investment corporations.

Appendix A contains a non-exhaustive list of SIFs categorized according to their geographical scope. 

SIFs come in different flavors. Their investments tend to focus on infrastructure projects and/or funds, but may also include investments in private equity (PE) and venture capital (VC) funds for small and medium enterprises (SMEs). A useful categorization of SIFs can be derived from research carried out by Clark and Monk (2015) on sovereign development funds, which the authors define as publicly sponsored commercial investment funds that combine financial performance objectives with development objectives. The authors suggest four operational and not mutually exclusive strategies for sovereign development funds: (i) reinforcing, by reorganizing, professionalizing, and innovating state holdings (companies, infrastructure, or other real assets) so as to drive commercialization and higher returns; (ii) crowding in private capital, by acting as a cornerstone investor in key sectors or projects; (iii) catalyzing, by seeding new industries, thereby diversifying the economy away from industries that are no longer profitable or sustainable over the long term; and (iv) financializing, by deepening local financial markets, thereby underwriting the development process through the growth of the capital market and the emergence of new financial intermediaries and investors focused on opportunities in the region. Each of these strategies is situated along a double spectrum, from strategic to commercial in terms of investment objectives, and in tight or loose alignment with national endowments and advantages (figure 1).

Figure 1. Categorization of Strategic Development Funds

Because SIFs are first and foremost commercially oriented investors focused on leveraging public investment by crowding in new sources of funding from the private sector (either domestic or foreign), by definition they populate the upper-right quadrant in figure 1. Within this operating environment, SIFs could be categorized on the basis of their policy objectives as mainly catalytic, or reinforcing, or financializing. Figure 2 applies the proposed taxonomy to a subset of SIFs. The graph helps to visualize SIFs' strategic positioning, and suggests that financializing and reinforcing are the most common strategies for the SIFs observed in this paper, particularly in emerging markets and developing economies (EMDEs). On the other hand, SIFs that focus on climate financing appear to play a catalytic role independent of the country of operation. Examples include the Africa Renewable Energy Fund (AREF), the Renewable Energy Asia Fund (REAF), and the Global Energy Efficiency and Renewable Energy Fund (GEEREF).

Figure 2. The Strategic Positioning of Sovereign Investment Funds

As with sovereign wealth funds (SWFs), SIFs' sources of funding may include balance-of-payment surpluses, official foreign currency operations, the proceeds of privatization, pension reserve funds, fiscal surpluses, government (or government guaranteed) borrowing, and/or receipts resulting from commodity exports (IFSWF 2009). However, monetary authorities' foreign reserves held for balance-of-payment purposes, government employees' pension funds, traditional public enterprise operations, and assets managed for the benefit of individuals are not sources of funding for SWFs and SIFs. 

International, bilateral or multilateral financial institutions, domestic development banks, and some commercially focused development and climate finance institutions are not SIFs. Although these institutions may fulfill the four criteria proposed above, they differ from SIFs in their governance structure, and/or investment policy, deal sourcing, and staffing. In all these respects, they are more akin to government institutions than to SIFs, which – as discussed further in this paper – are nimbler structures that derive much of their modus operandi from the PE model. For example, South Africa's Public Investment Corporation is a state-owned asset manager that invests on behalf of the Government Employees Pension Fund (89 percent), Unemployment Insurance Fund (6 percent), and other public funds. Its main investment objective is to achieve strong long-term capital returns above the clients' benchmark while contributing to the broader social and economic development of South Africa and the rest of the African continent. The Public Investment Corporation lacks a formal double bottom line and, being a pension fund manager, is not an SWF, as defined by the International Monetary Fund (IMF) and the International Forum of Sovereign Wealth Funds (IFSWF). By the same line of reasoning, pension funds are not SIFs even when they align with responsible investment principles (consider, for example, the California Public Employees' Retirement System, CalPERS, which is the largest pension fund in the United States). 

Public pension funds derive at least part of their resources from contributions made by employees, and their fiduciary responsibility is toward their contributors. Specifically, for a defined contribution scheme, the fiduciary obligation is to maximize the replacement value of pensions provided to members upon their retirement. For this reason, pension funds' investments are entirely commercial and cannot be subject to a double bottom line – though they can and do invest in SIFs on commercial terms (for example, the South African Government Employee Pension Fund has invested in the Pan-African Infrastructure Development Fund). Unlike public pension funds, pension reserve funds are generally capitalized by budget transfers. Their objective is to hold precautionary savings for future government expenditures, which may include public pensions without having any contractual obligations to future pensioners (IMF 2008). Pension reserve funds function very much like other long-term government savings funds. Some pension reserve funds, such as Australia's Future Fund and the Ireland Strategic Investment Fund (ISIF), have combined commercial and developmental objectives. These particular reserve funds are SIFs. Others, such as the New Zealand Superannuation Fund, invest on purely commercial terms and are not SIFs. 

Government-owned investment funds that are fully capitalized by the government or a subnational entity to serve a politically defined purpose, and that do not seek private capital participation at the fund or project level, are also not SIFs. These funds represent pools of public capital destined for public investment, often in infrastructure, that could in principle be implemented through the normal budget process. They are fiscal funds: essentially, quasi-fiscal tools for governments. Like SIFs, fiscal funds provide increased functionality to public investment, since managerial and professional capacity is centralized in a specialized body. Their singular focus on policy objectives makes the attainment of these objectives more straightforward than for SIFs. But it also may cut them off from sources of private capital since profitability is a critical factor in attracting private investors. A notable example is the State Oil Fund of the Republic of Azerbaijan, which lists among its objectives "financing major national scale projects to support socioeconomic progress". 

SWFs may exhibit some of the characteristics of SIFs, particularly if their domestic investment strategy involves a double bottom line (for example, Malaysia's Kazanah Nasional Berhad, and the Nigeria Infrastructure Fund owned by the Nigeria Sovereign Investment Authority). However, unlike SIFs, SWFs' international investments are usually guided by commercial principles only. That said, an SWF with an exclusively domestic investment mandate may be considered an SIF if it exhibits the six characteristics listed in section 2 of this paper. 

SIFs support the development of local economies through direct investment that aims to generate a high level of private sector participation. To achieve their objectives, SIFs use different approaches: some domestically focused SIFs are owned by both the public and the private sector, while others are wholly owned by a government; some SIFs operate at a global or regional scale, and may be funded by several governments. For example, the Philippine Investment Alliance for Infrastructure (PINAI) is a 10-year closed SIF, managed by a specialized private investment manager – Macquarie Infrastructure Management (Asia) Pty Limited – that invests exclusively domestically in a broad range of infrastructure projects. The PINAI was created in 2012 by the Government of the Philippines with assistance from the Asian Development Bank (ADB), and has a domestic and a foreign pension fund as the two largest shareholders. Senegal's Fonds Souverain d'Investissements Stratégiques (FONSIS) also invests only domestically. It was established in 2013 to catalyze external investment supporting the development of a strong local economy and the creation of jobs. However, its capital structure is much simpler than the PINAI: it is wholly owned by the Government of Senegal, and operates as a private equity firm on the government's behalf. As a result, its investment strategy is closely guided by the government's national development plan. The European Fund for Strategic Investments (EFSI) is a regional SIF. It was established in 2015 and is funded through a €16 billion first-loss guarantee facility provided by the European Commission (EC) and by €5 billion capital provided by the European Investment Bank (EIB) – the European Union's long-term public lending institution. The fund is managed by the EIB and aims to generate additional investment of €60 billion by the EIB and by the European Investment Fund (EIF) and to unlock at least €315 billion in private sector investment over a three-year period.3 Box 1 outlines PINAI, FONSIS, and EFSI in more detail. 

Box 1. Examples of Strategic Investment Fund Strategies: PINAI, FONSIS, and EFSI

SIFs may also act as VC funds. The first state-sponsored VC fund programs were created by the U.S. and U.K. governments to improve financing for fast-growing young firms and foment post–World War II productivity. In the 1960s these funds represented the bulk of VC raised in the United States. Some of these programs are still functioning. For example, the Small Business Investment Company (SBIC) program, established in 1958, consists of federally guaranteed risk capital pools. State-sponsored VC programs are now seen in a growing number of EMDEs. In Senegal, Teranga Capital is an equity impact investment fund launched in 2016. The fund targets promising domestic SMEs, with financing needs between €75,000 and €300,000. In addition to long-term finance in the form of minority equity participation, Teranga Capital provides management coaching to support the growth and consolidation of the SMEs in its portfolio (sales and marketing; accounting; and environmental, social, and governance benchmarking). FONSIS invested in Teranga Capital as a limited partner alongside Investisseurs and Partenaires (the general partner and fund manager), Sonatel, Askia Assurances, and two private professional investors. Another SIF, the African Agricultural Capital Fund (AACF), provides growth financing to Africa's undercapitalized agriculture sector through SME investments in East Africa. The AACF was created in 2011 by the United States Agency for International Development (USAID) and another six investors. Managed by Pearl Capital Partners, the AACF aims to invest $25 million through equity investments to smallholder farmers with a target of around 15 percent annual compounded return. Successful VC industries have also been seeded by the governments of Israel and Brazil (box 2). 

Box 2. Venture Capital Funds in Israel and Brazil

SIFs may also be thematic investors. Particularly in clean-energy finance, several SIFs have been established with the objective of attracting private investment in wind, solar, and thermal energy infrastructure; and energy efficiency. Some climate-focused SIFs are funded by multilateral financial institutions, including Asia Climate Partners (established by the ADB) and the GEEREF (a hybrid fund with both private and public shareholding established by the EIB and several European governments) (box 3). Green SIFs are emerging at the national level, too. For example, Norway recently announced its intention to establish a domestically focused renewable energy investment fund, Fornybar AS, and the Government of China is considering the establishment of a national green investment fund.

Box 3. Examples of Green Strategic Investment Funds