Why sovereign wealth funds could be great news for equity investors

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More bad news for the dollar, we see.

In August, foreign investors sold more Treasuries (US government bonds, or IOUs) than they bought. It’s the first time that’s happened since 1998.

“These numbers are stunning,” Marc Ostwald, economist at Insinger de Beaufort, told The Telegraph. In all, US Treasury data showed an outflow of $163bn from US assets during the month.

So why’s this so important?

Although it may not seem like it, governments are just like the rest of us. If they spend more than they earn, they have to make up the difference by borrowing it from somewhere.

So if tax income doesn’t match up to public spending, then you either have to raise taxes, or you have to issue bonds (IOUs basically).

Now, in normal circumstances, people will only lend you money if they get a rate of return that adequately compensates for the risk that you might not pay them back. So you’d expect a banana republic to have to pay higher interest on its debt than an established world power.

America is no banana republic, obviously – but if any other country had its level of debt, then it would be described as one. The US gets away with it partly because – well, it’s the US. It’s the dominant power, be that in military or economic terms.

And with so many Asian countries reliant on exports to the US, they’ve been happy to prop it up, basically. They don’t want strong currencies to ruin their export industries, so piling up huge dollar reserves and stockpiles of US IOUs has suited them just fine.

But now they’re getting a bit fed up with the poor returns they’re getting on those IOUs. And they can’t help but notice that the dollars they’re holding are losing value by the day. So now they want bigger and better returns.

That’s part of the reason why a lot of that stockpiled money is now going into the controversial sovereign wealth funds. These are basically state-backed investment vehicles which allow governments to pump their money into riskier asset classes than their central banks would ever invest in – equities among them.

A Merrill Lynch report last week caused a bit of a stir when it reckoned that the amount of assets these funds already control is around the $2,000bn mark, and could be four times that by 2011. Make no mistake, that’s a lot of money. As Hamish McRae pointed out in The Independent, the entire global stock market capitalisation is about $24,200bn – so we‘re talking about a group with the combined capacity to buy up a big chunk of global assets.

So it’s no wonder that Western governments are getting a little bit edgy about where this money is now going to go. The Americans are happy for the Asians to park their money in bonds, keeping the dollar strong, and pacifying the struggling US consumer with cheap goods. But the idea that the likes of China, or worse still, Venezuela or Russia, might want to come along and buy something actually worth having – like America’s oil companies, or infrastructure – and it’s a different story.

This week’s G7 meeting is expected to see calls for codes of conduct, and greater transparency in the way sovereign wealth funds operate. And there are some good reasons to be concerned. Free trade is one thing – but as Jeremy Warner pointed out in The Independent a while ago, how sensible is it to allow foreign investors to snap up your prize assets when the deal’s not reciprocal? Can you imagine Centrica being allowed to bid for Gazprom, for example? And do we really want to see companies effectively being nationalised by foreign governments? After all, they didn’t work too well when they were nationalised under our own government.

Unfortunately, this is all a little beside the point. As Anthony Hilton described it in the Evening Standard recently, this is all just another step along the road towards economic dominance shifting from West to East. We might complain now, but we’re the ones who decided we could run a successful economy by doing all the ‘fun stuff’, like marketing and money-shuffling and shopping, then outsource all the boring stuff – like actually making things – to those industrious little eastern countries.

Somehow, in the process, we gave them all our money too – and now they want to swap it for assets of real value.

This could be great news for equity investors in the long-term. But meanwhile we’ve got to survive the transition – and as a Chinese acquaintance of mine used to say, “all change is traumatic”. When protectionism rears its ugly head, it’s always bad news for markets – the Great Depression of the 1930s was caused in great part by protectionist laws passed in the US at the time. For once, the outcome of the latest G7 meeting might actually be worth paying attention to.

Turning to the wider markets…


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In London, the FTSE 100 index fell 30 points to end the day at 6,614 on a mixed day for stocks. The high crude oil price helped the likes of BG Group and Royal Dutch Shell, but weaker metals prices and broker downgrades hit miners including Anglo American. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 fell 33 points to end the day at 5,774. And the German DAX-30 was down 6 points at 7,962.

On Wall Street, the major indices closed lower on more warnings from financial institutions as to the effect the credit crunch would have on earnings. The Dow Jones was down 71 points, at 13,912. The tech-rich Nasdaq fell 16 points to close at 2,763. And the broader S&P 500 was off 10 points, at 1,538.

It was a mixed day for Asian stocks, with Japan’s Nikkei down 182 points to 16,955 whilst the Hong Kong Hang Seng had risen 261 points to 29,215.

Crude oil hit an all-time high of $88.20 on the Nymex during yesterday’s session but had fallen back to $87.33 this morning. In London, Brent spot was at $84.25.

Spot gold rose as high as $764.60 yesterday but had fallen back to $765.40 in Asia trading. And silver had fallen to $13.51.

Turning to the currency markets, the pound spiked at 2.0361 against the dollar before falling back to $2.0355. The pound was at 1.4349 against the euro, whilst the dollar was at 0.7047. And the dollar was at 116.56 against the Japanese yen.

And in London this morning, soft-drink manufacturer Britvic announced that the wet summer had seen sales of its branded products fall 1.5% in the second half. However, the company had widened its operating margin by 0.1%. Britvic shares were up by as much as 1.75% in early trade.

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