Sovereign wealth funds are flogging assets – and that means big trouble

What do Norway, Saudi Arabia and Russia have in common? They are all players in the oil industry, perhaps? None of them have ever won the World Cup, or are ever likely to? Maybe true, but the answer I was looking for is that they all have massive sovereign wealth funds (SWFs). Rewind a few years and these state-owned investment funds were all the rage. Huge amounts of capital from mostly oil-rich countries were being accumulated.

By last year they had an estimated $7trn under their control, and were becoming some of the most influential players in the capital markets. But now, with commodity prices under huge pressure, so too are the SWFs. Many of them have had to start selling off assets. If the sell-off accelerates, that could spell big trouble for the world economy.

Serious money

SWFs have been around in some form for at least 100 years, but it is only in the last decade that they have become such big players in the markets. The idea behind them was always very simple. Take some of the wealth generated by a finite resource, such as oil, and store it up to share it with future generations. Some of the funds became massive. Norway’s is worth almost $900bn, enough to buy the whole of Apple, the world’s biggest company. The Abu Dhabi fund is worth more than $700bn, and the Saudi Arabia, Kuwait and Chinese funds all have more than $500bn in them. In other words, some serious money.

Even in this country, the idea of SWFs has picked up some support, although it is questionable whether we really have much wealth to set aside. Ukip has proposed setting one up for our shale gas resources. SWFs appeal to people who instinctively like big state solutions to every problem. The trouble is, the funds are now in retreat. Norway, Saudi Arabia and Russia have all tapped their funds this year to cover budget shortfalls.

Norway will be taking out $450m, while Russia is reported to have taken out a far more significant $14.5bn. And those are only the ones we know about. The big Gulf funds, much like their governments, are not exactly famousfor their openness and transparency. If they have started selling off assets, then we may never know about it.

The wealth of most SWFs is based on energy or commodities and so, with oil and commodities prices so weak, those countries are now under huge financial pressure. There are budget and trade deficits to cover and the money has to be found from somewhere. That could change if the oil price recovers. But with plenty of shale gas and cheaper solar power still coming on stream, and ever improving fuel efficiencies, that might not happen for a long time. That means we should expect the SWF sell-off to accelerate.

State bungling

There is another factor as well. Governments are proving no better at managing money than they are at anything else. Some of the SWFs have made very poor decisions. Qatar, for example, was the third biggest investor in Volkswagen, and also one of the largest investors in Glencore. Even the sober Norwegian fund had big stakes in both those companies and lost about 5% of its value in the market rout this summer.

Libya’s fund became famous for its losses and poor decisions and was involved in endless legal battles before the regime in that country fell.In truth, running any kind of investment fund successfully is very difficult. When you have all the pressures of dealing with a government, as well as a huge sum of money to deploy, it becomes virtually impossible.

Most of the time that might matter only to the SWFs themselves. But the funds have accumulated such vast holdings that, if they start selling en masse, it will lead to big drops in prices. Even worse, some of them may turn into forced sellers. That is unlikely to happen to Norway, but could easily happen to Russia, where the economy is in recession and facing huge financial pressure, and to many of the Gulf states as well – the finances of Saudi Arabia, with its large, young and unemployed population, look increasingly precarious. Faced with a choice between liquidating their funds at a loss and losing power, most governments will choose the former.

That may prove to be most critical in areas such as private equity, where SWFs have been huge investors, pouring money into funds and also buying up many assets directly. But if it becomes more widespread, that will spill into the banking system and then the wider equity markets.

The next crisis

There are plenty of things that could spark the next crisis in the markets. A sudden hike in interest rates, especially in America; a crash in the bond markets; or a collapse in the Chinese economy. But right now, perhaps the most likely one is something no one is looking at yet – a tidal wave of selling from sovereign wealth funds. It has already started, and if it carries on, the results will not be pretty.

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