The world’s markets – and Western governments – are waking up to the power of sovereign wealth funds.
The funds – state-backed investment vehicles fuelled by the vast currency reserves accumulating in emerging market economies – are estimated to hold between $1,586bn and $2,228bn of assets, according to a Merrill Lynch report that came out last week. The investment bank reckons the “capital managed by sovereign funds could hit nearly $8trn by 2011”. To put that into perspective, says Hamish McRae in The Independent, “the total market capitalisation of the world’s equity markets is $24,200bn, while non-government debt instruments amount to $13,400bn”.
So it’s a significant sum. Governments in China, the Middle East and Russia have built up these vast reserves through booming exports of cheap consumer goods (in the case of China and other Asian economies) and surging oil prices (for Gulf States and Russia). Up until fairly recently, much of this has been left sitting in US government bonds. But now – fuelled partly by the falling dollar and a desire for better investment returns – they are creating sovereign wealth funds to find better opportunities.
Merrill Lynch reckons this will have five main consequences, including a large-scale shift from bonds to riskier investments, such as equities; a move away from US dollar-denominated assets; and a shift in the global ‘centre of gravity’ towards Asia and Russia. “Investors should rejoice in the more balanced global economy to which these tectonic shifts contribute,” said Alex Patelis, head of international economics for Merrill.
But rejoicing seems to be the last thing on the minds of Western politicians. The scale of the sums means, as Anthony Hilton puts it in the Evening Standard, that “there is almost nothing they [the funds] could not buy, and they could end up owning a massive chunk of the West’s assets”. And many of the countries involved are not necessarily friendly to the West. McRae wonders “whether the US will feel happy about its assets being bought up by the sovereign funds of China, Russia and the Middle East. I rather think not.”
Washington is widely expected to call for “draconian rules” on the funds at the meeting of G7 ministers this week, say Leo Lewis and Gary Duncan in The Times. And they have no shortage of supporters – the French are already looking at what they can do to protect their “industrial jewels”, while Japan is “institutionally terrified”, according to one source quoted in The Times, that its high-tech industries will fall into the hands of foreign emerging market governments.
As Jeremy Warner points out in The Independent, some of these concerns are justified. “Should we really be allowing our best companies to be effectively renationalised, and renationalised to boot by a foreign power?” While some funds, such as Singapore’s Temasek, have published accounts and governance procedures and “hardly represent a threat to anyone”, others “fall a long way short of these standards”. Funds that Standard Chartered’s chief economist Gerald Lyons picks out as being ‘Secret Funds’ include some from Taiwan, UAE and Venezuela.
But as Hilton observes, any attempt by the G7 to govern the transparency and conduct of such funds is only a short-term fix. Ultimately, this is about the long-term transfer of economic power from the United States and Europe to Asia. “The reality is that the balance of power is shifting and, tragically, history has shown how hard this is to manage without conflict… handling this transition peacefully and equitably is one of the most serious challenges the world faces in the coming decade.”
For more on what sovereign wealth funds mean for investors, see John Stepek’s recent MoneyMorning article: sovereign wealth funds