What are ‘sovereign wealth funds’?
They are large-scale, state-controlled investment funds bankrolled by huge foreign exchange surpluses (in the case of Asian states, such as Singapore) or by petrodollars (in Norway and the Gulf states, for example). Wealth funds are different from government reserves. Nations have traditionally built up reserves for use in an emergency, or to protect their currency and banking system in a crisis. For that reason, reserves need to be highly liquid – gold, say, or (more commonly today) US dollars. By contrast, a sovereign wealth fund is better understood as a kind of national endowment or stabilisation strategy – a ‘future generations’ fund that will protect against shrinking natural resources or put excess foreign-exchange earnings to work for the long-term.
How long have they been around?
The Economist claims sovereign wealth funds (SWFs) may have begun life inadvertently in 1956 when the British administration of the Gilbert Islands in Micronesia came up with the wheeze of charging a levy on the export of phosphate-rich bird manure. Sure enough, the supply of manure has long since been depleted. But the money was invested on behalf of the islanders – and has since grown into the Kiribati Revenue Equalisation Reserve, a $520m investment fund now worth nine times as much as the tiny atoll’s GDP. Whether or not the Gilbert Islands experience directly inspired it, the principle behind Norway’s giant $300bn state fund is exactly the same – in this case investing a portion of its current oil wealth for the long-term benefit of the nation. The same goes for Singapore’s Temasek, started in 1974, and the two dozen other states known to have sovereign investment funds – including Botswana, Australia, Iran, Brunei and Khazakhstan.
How much money are we talking about?
A Morgan Stanley research paper published in March puts the total funds at the disposal of SWFs at some $2,500bn ($2.5trn) – about half the total official reserves of all countries. That may sound like a lot of money (and it is), but in the global investment universe, SWFs are not yet a hugely dominant player. Collectively, they account for around 2% of all the world’s financial assets – twice as much as hedge funds, but less than a third as much as insurance firms. But SWFs have made the news in recent weeks because they’re growing rapidly. Morgan Stanley’s Stephen Jen expects assets under management to hit $5trn by 2010 and $10-$12trn by 2015 as big players, such as Japan and Russia, join in.
Why are they growing so fast?
In part, because of the boom in the price of oil and natural gas. High energy prices mean Russia (which was broke nine years ago) now has reserves of $315bn and an initial investment fund worth £90bn. The Kuwait Investment Office manages an estimated $500bn, while the United Arab Emirates has the biggest state fund of all, worth up to $1,000bn, according to some (though the Arab states don’t disclose their holdings). The other reason state funds are booming is the massive imbalance in global trade. East Asia’s export boom means it has been accumulating vast foreign reserves – around $1,300bn in China’s case and $900bn in Japan’s.
And they want to invest some of that?
Exactly. The Beijing government doesn’t want to push up the value of its own (more or less pegged) currency by converting its dollars into yuan. That would hurt both its exports and the value of its reserves. But nor does it want to hold billions of US dollars indefinitely (in the form of ten-year government debt currently yielding around 5%) if it can put its money to work harder. That’s why China is starting its own wealth fund with a Norway or Saudi-sized kitty of $300bn – starting with a $3bn stake in US private-equity giant Blackstone. Japan may follow.
How does all this affect investors?
The growing size of SWFs and a shift towards higher-risk assets – even Norway’s long-established fund announced in April that it is upping its equity holdings from 40% to 60% – has several potential consequences. Most obviously, a wall of new money ($300bn is three times the cost of the postwar Marshall Plan to reconstruct Europe) risks fuelling global bubbles in property, stocks, commodities and other assets. In practice, it will be hard to track the specific investment strategies of SWFs because, for the most part, they are shrouded in secrecy. But in general terms, analysts believe a gradual shift from official reserves into SWFs should be positive for emerging-market assets and for riskier assets in general. Any overall shift from bonds into equities will boost the Japanese yen (Tokyo accounts for 10% of global market cap). However, it also implies rising global bond yields – and more expensive credit – as bonds are sold and their prices fall.
The impact of sovereign funds on the UK
Britain will be in the “front line” of the sovereign wealth phenomenon, says Ruth Sunderland in The Observer, in terms of investment in UK firms and with regards to the predicted political backlash if undemocratic foreign governments own chunks of strategically important Western firms. Singapore’s Temasek fund is already Standard Chartered’s top shareholder; Dubai owns P&O; the Qataris own nearly a fifth of Sainsbury’s. The Chinese and Middle Eastern governments know that protectionism is strongest in the US, and will search “for UK assets to add to their shopping list”. Britain shouldn’t turn protectionist, says Sunderland, but we should increase political pressure on these countries to open up their own markets.