Sovereign Wealth Funds – The financial muscle to influence corporates and economies
Sovereign Wealth Funds – The financial muscle to influence corporates and economies
Overview:
Sovereign wealth funds (SWF) carry a great significance for both the big economies like like US, UAE, China, and the corporate world (including private equity, hedge fund) like Citigroup, UBS, Blackstone, AIG. SWFs have emerged as one of the most controversial issues in international finance – both politicians and the press have expressed concern about their activities. American Congressmen and the German Chancellor propose sharp surveillance, and possible restrictions on capital inflows from this particular source. Similarly Nicolas Sarkozy, the French president considers SWF “extremely aggressive” and he has promised to protect French managers from these funds. But not many corporates have complained, instead some like Barclays and Blackstone have welcomed funds from SWF..
Before we move ahead let us know what are SWFs. These are special purpose public investment funds, or arrangements. These funds are owned or controlled by the govt. The funds are commonly established out of official foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. These funds employ a set of investment strategies which include investments in foreign financial assets for medium- to long-term macroeconomic and financial objectives. By contrast, pension funds have well-identified liabilities that constrain their investment policies and horizons. Investment vehicles like hedge funds and private equity firms are privately owned and therefore subject to the control of their owners. Hedge funds are often opaque but, unlike SWFs, tend to be highly leveraged and so a different set of issues such as counterparty risk are present
They are not a recent invention – Kuwait created the first modern fund in 1953. Close to half of the top 40 SWFs have been created since 2000. In the recent past Saudi Arabia, Russia and China created large funds.
Two kind of governments are pumping money into SWFs:
- Commodity exporters (majority oil producers)
- Countries running fiscal and trade surpluses
Oil economies have created the largest SWFs. Here is the list of top 5 SWFs
Country
Fund
Assets $ Bn
Start
Origin
UAE
Abu Dhabi Investment Authority
875875
1976
Oil
Norway
Government Pension Fund of Norway
391391
1990
Oil
Singapore
Government of Singapore Investment Corp
330330
1981
Non-commodity
Kuwait
Kuwait Investment Authority
264264
1953
Oil
China
China Investment Corp
200200
2007
Non-commodity
Oman’s SWF is named as State General Reserve Fund, established in 1980. Its fund size is estimated to be $ 6 billions
Distribution of the SWFs
(Source: The Sovereign Wealth Fund Institute)
Support to the economy
SWFs offer various economic and financial benefits. In their home countries, they
facilitate the saving and intergenerational transfer of proceeds from nonrenewable resources and help reduce boom and bust cycles driven by changes in commodity export prices. They also allow for a greater portfolio diversification and focus on return than traditionally is the case for central-bank-managed reserve assets, thereby potentially reducing (or eliminating) the opportunity costs of reserves holdings. For economies with plentiful foreign reserve assets, greater and prudent diversification reflects sound and responsible asset management.
There are multiple incentives to create a SWFs especially for oil producing economies. These economies want to create assets that ensure a long-term stream of revenue to cushion themselves against the roller coaster of commodity booms and busts. As many economists have observed, these countries are simply converting assets extracted from the earth into a more liquid form. Also, many of these governments are trying to build up reserve funds for the day when all of the oil is extracted from below ground.
Other economies which are export oriented like China are also using SWFs to keep their currencies fixed at a low par value.
Wealth managed
In early 2008, the estimated assets of the ten largest SWFs exceeded USD 3 trillion compared with USD 500 billion at the start of the 1990s. This is more than the value of all private equity or hedge funds
Chart comparing asset under management
(Source: Morgan Stanley report February 2008)
Fear factor
These investments demonstrate the complex interdependence of the Pacific Rim and Middle East with the US economy. Official and private commentators have expressed concerns about the transparency of SWFs, including their size, and their investment strategies, and that SWF investments may be affected by political objectives.
Compared to mutual funds or pension funds, there is less transparency of most SWFs. Alan Greenspan (an economist and the ex-chairman of the US Federal Reserve) pointed out, the strongest check against financial misbehavior is “counterparty surveillance” – the incentive of investors to make sure that their investment funds are acting prudently and profitably. In light of this The Sovereign Wealth Fund Institute has developed Linaburg-Maduell Transparency Index. The index is a method of rating transparency in respect to the sovereign wealth funds.
There are several means through which SWFs could theoretically, influence the policies and capabilities of countries. It is possible, for example, that Blackstone has had preferred access to the Chinese market. Following Chinese SWF’s (CIC) investment in Blackstone IPO (2007), the latter has purchased stake in a state-owned Chinese chemical manufacturer, as well as a high-end commercial building in downtown Shanghai.
Chart showing investment approach and transparency for the Top 20 SWFs:
(Source: The Sovereign Wealth Fund Institute)
Savior in the current financial crisis
In the recent financial turmoil, SWFs have demonstrated that they can have a
stabilizing influence on markets. All big US and EU banks took help from SWF.
Bank
Sub-prime losses ($ billions)
Sovereign Wealth Funds involved and funds injected
Merrill Lynch
31.7
11 including
4.4 Tamasek, Singapore
2.0 Korea Investment Fund
2.0 Kuwaiti Investment Fund
0.3 New Jersey Division of Investment
Citigroup
40.0
20.0 including
7.5 Abu Dhabi Investment Authority
6.8 Singapore Investment Corp
3.0 Kuwait Investment Authority
0.4 New Jersey Division of Investment
UBS
38.0
9.7 Singapore Investment Corp
Morgan Stanley
12.6
5.0 China Investment Corp
Barclays
4.2
2.9 China Development Bank
Since the subprime-mortgage fiasco has unfolded, such funds have contributed almost $69 billion on recapitalizing the world’s biggest investment banks. In this the SWF have also lost their wealth like Abu Dhabi SWF, invested $7.5bn in Citigroup bonds that will convert to shares in 2010 and 2011 at prices from $31 to $37. But since then Citigroup casualties of the sub-prime mortgage crisis and its share price has plunged as low as $20 i.e. nearly 40% lower than when the Abhu Dabi SWF made its investment. SWF have deftly played the role of rescuer just when Western banks have been exposed to the global financial system.
These funds have also supported their home markets like funds in Qatar and Kuwait bought shares of listed banks to boost confidence, while the Chinese funds (CIC) pumped cash into state commercial banks
Going forward funds have plans to take long term position in the markets like Qatar’s SWF plans for new real estate acquisitions in 2009 as global prices decline and investors and developers are forced to sell assets at depressed prices.
Departing thoughts
So clearly from the viewpoint of international financial markets, SWFs can facilitate a more efficient allocation of revenues from commodity surpluses across countries and enhance market liquidity, including at times of global panic and financial stress. These are likely to facilitate the replenishment of the capital. In near future countries like Brazil, India and Nigeria plan to create new funds. Morgan Stanley estimates an annual growth of 10%-20% for next few years, and its assets are expected to exceed those of central banks by 2015. These funds have some serious transparency issues which the IMF, the World Bank, and the OECD are jointly working through creation of broad guidelines for both the home and the recipient countries.
SWFs and financial stability
Stabilizing effects
Destabilizing effects
Long term investment strategy
Lack of transparency
Provision of ample liquidity
Lack of regulation
Non-reliance on debt financing
Risk of financial protectionism due to non-commerical investment motivation
Sovereign Wealth Funds – The financial muscle to influence corporates and economies
Overview:
Sovereign wealth funds (SWF) carry a great significance for both the big economies like like US, UAE, China, and the corporate world (including private equity, hedge fund) like Citigroup, UBS, Blackstone, AIG. SWFs have emerged as one of the most controversial issues in international finance – both politicians and the press have expressed concern about their activities. American Congressmen and the German Chancellor propose sharp surveillance, and possible restrictions on capital inflows from this particular source. Similarly Nicolas Sarkozy, the French president considers SWF “extremely aggressive” and he has promised to protect French managers from these funds. But not many corporates have complained, instead some like Barclays and Blackstone have welcomed funds from SWF..
Before we move ahead let us know what are SWFs. These are special purpose public investment funds, or arrangements. These funds are owned or controlled by the govt. The funds are commonly established out of official foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. These funds employ a set of investment strategies which include investments in foreign financial assets for medium- to long-term macroeconomic and financial objectives. By contrast, pension funds have well-identified liabilities that constrain their investment policies and horizons. Investment vehicles like hedge funds and private equity firms are privately owned and therefore subject to the control of their owners. Hedge funds are often opaque but, unlike SWFs, tend to be highly leveraged and so a different set of issues such as counterparty risk are present
They are not a recent invention – Kuwait created the first modern fund in 1953. Close to half of the top 40 SWFs have been created since 2000. In the recent past Saudi Arabia, Russia and China created large funds.
Two kind of governments are pumping money into SWFs:
- Commodity exporters (majority oil producers)
- Countries running fiscal and trade surpluses
Oil economies have created the largest SWFs. Here is the list of top 5 SWFs
Country
Fund
Assets $ Bn
Start
Origin
UAE
Abu Dhabi Investment Authority
875875
1976
Oil
Norway
Government Pension Fund of Norway
391391
1990
Oil
Singapore
Government of Singapore Investment Corp
330330
1981
Non-commodity
Kuwait
Kuwait Investment Authority
264264
1953
Oil
China
China Investment Corp
200200
2007
Non-commodity
Oman’s SWF is named as State General Reserve Fund, established in 1980. Its fund size is estimated to be $ 6 billions
Distribution of the SWFs
(Source: The Sovereign Wealth Fund Institute)
Support to the economy
SWFs offer various economic and financial benefits. In their home countries, they
facilitate the saving and intergenerational transfer of proceeds from nonrenewable resources and help reduce boom and bust cycles driven by changes in commodity export prices. They also allow for a greater portfolio diversification and focus on return than traditionally is the case for central-bank-managed reserve assets, thereby potentially reducing (or eliminating) the opportunity costs of reserves holdings. For economies with plentiful foreign reserve assets, greater and prudent diversification reflects sound and responsible asset management.
There are multiple incentives to create a SWFs especially for oil producing economies. These economies want to create assets that ensure a long-term stream of revenue to cushion themselves against the roller coaster of commodity booms and busts. As many economists have observed, these countries are simply converting assets extracted from the earth into a more liquid form. Also, many of these governments are trying to build up reserve funds for the day when all of the oil is extracted from below ground.
Other economies which are export oriented like China are also using SWFs to keep their currencies fixed at a low par value.
Wealth managed
In early 2008, the estimated assets of the ten largest SWFs exceeded USD 3 trillion compared with USD 500 billion at the start of the 1990s. This is more than the value of all private equity or hedge funds
Chart comparing asset under management
(Source: Morgan Stanley report February 2008)
Fear factor
These investments demonstrate the complex interdependence of the Pacific Rim and Middle East with the US economy. Official and private commentators have expressed concerns about the transparency of SWFs, including their size, and their investment strategies, and that SWF investments may be affected by political objectives.
Compared to mutual funds or pension funds, there is less transparency of most SWFs. Alan Greenspan (an economist and the ex-chairman of the US Federal Reserve) pointed out, the strongest check against financial misbehavior is “counterparty surveillance” – the incentive of investors to make sure that their investment funds are acting prudently and profitably. In light of this The Sovereign Wealth Fund Institute has developed Linaburg-Maduell Transparency Index. The index is a method of rating transparency in respect to the sovereign wealth funds.
There are several means through which SWFs could theoretically, influence the policies and capabilities of countries. It is possible, for example, that Blackstone has had preferred access to the Chinese market. Following Chinese SWF’s (CIC) investment in Blackstone IPO (2007), the latter has purchased stake in a state-owned Chinese chemical manufacturer, as well as a high-end commercial building in downtown Shanghai.
Chart showing investment approach and transparency for the Top 20 SWFs:
(Source: The Sovereign Wealth Fund Institute)
Savior in the current financial crisis
In the recent financial turmoil, SWFs have demonstrated that they can have a
stabilizing influence on markets. All big US and EU banks took help from SWF.
Bank
Sub-prime losses ($ billions)
Sovereign Wealth Funds involved and funds injected
Merrill Lynch
31.7
11 including
4.4 Tamasek, Singapore
2.0 Korea Investment Fund
2.0 Kuwaiti Investment Fund
0.3 New Jersey Division of Investment
Citigroup
40.0
20.0 including
7.5 Abu Dhabi Investment Authority
6.8 Singapore Investment Corp
3.0 Kuwait Investment Authority
0.4 New Jersey Division of Investment
UBS
38.0
9.7 Singapore Investment Corp
Morgan Stanley
12.6
5.0 China Investment Corp
Barclays
4.2
2.9 China Development Bank
Since the subprime-mortgage fiasco has unfolded, such funds have contributed almost $69 billion on recapitalizing the world’s biggest investment banks. In this the SWF have also lost their wealth like Abu Dhabi SWF, invested $7.5bn in Citigroup bonds that will convert to shares in 2010 and 2011 at prices from $31 to $37. But since then Citigroup casualties of the sub-prime mortgage crisis and its share price has plunged as low as $20 i.e. nearly 40% lower than when the Abhu Dabi SWF made its investment. SWF have deftly played the role of rescuer just when Western banks have been exposed to the global financial system.
These funds have also supported their home markets like funds in Qatar and Kuwait bought shares of listed banks to boost confidence, while the Chinese funds (CIC) pumped cash into state commercial banks
Going forward funds have plans to take long term position in the markets like Qatar’s SWF plans for new real estate acquisitions in 2009 as global prices decline and investors and developers are forced to sell assets at depressed prices.
Departing thoughts
So clearly from the viewpoint of international financial markets is that Sovereign Wealth Funds (SWFs) can facilitate a more efficient allocation of revenues from commodity surpluses across countries and enhance market liquidity, including at times of global panic and financial stress. These are likely to facilitate the replenishment of the capital. In near future countries like Brazil, India and Nigeria plan to create new funds. Morgan Stanley estimates an annual growth of 10%-20% for next few years, and its assets are expected to exceed those of central banks by 2015. These funds have some serious transparency issues which the IMF, the World Bank, and the OECD are jointly working through creation of broad guidelines for both the home and the recipient countries.
SWFs and financial stability
Stabilizing effects
Destabilizing effects
Long term investment strategy
Lack of transparency
Provision of ample liquidity
Lack of regulation
Non-reliance on debt financing
Risk of financial protectionism due to non-commerical investment motivation
About the Author
Author holds one of the highest internationally accredited professional qualification in finance and accountancy.
Author have more than 12 years of experience. His experience includes working with Private companies – World’s leading consulting firms including BIG 4, Renowned Strategy Consulting firm and Government – state owned industrial companies.
He has worked majorly in the United States, Middle East and Asia region. He has advised top corporate on Strategies, Mergers & Acquisitions and International Finance.
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