[lbo-talk] "Sovereign wealth funds"

Marvin Gandall marvgandall at videotron.ca
Sat May 26 07:11:13 PDT 2007

China's recent purchase of a $3 billion stake in the US hedge fund Blackstone and its plans to recycle hundreds of billions of its USD and other foreign exchange reserves into global equity and real estate markets has drawn excited attention by the financial press to the proliferation and rapid growth of so-called "sovereign wealth funds" in China and elsewhere, and the implications of this massive new injection of capital into the world economy. The following piece from yesterday's Financial Times is indictive; Barron's, the US financial weekly, is running a similar feature in it's latest issue.

The export of capital from the developing nations to the advanced capitalist countries was unforeseen (so far as I'm aware) by the classical theorists of imperialism, although Western finance capital still stands to benefit hugely from its management of these surpluses. The scale of the current flows dwarfs the recycling of Middle East petrodollars in the 70s when the phenomenon first appeared. It's estimated that the SWF's have some $2.5 trillion available to invest, representing about half the reserves deemed necessary to protect their currencies. China's investment fund alone will have at its disposal about two-thirds more capital in real terms than did the postwar Marshall Plan.

As with derivatives, the other major development in modern global finance, note the concern about the possible catastrophic consequences on world markets and the global economy of governments shifting from bonds to riskier and often more opaque pooled asset funds. Note also there is no mention or calculation of the current costs to domestic economic and social development represented by the diversion of these surpluses to the financial markets. ====================================== How sovereign wealth funds are muscling in on global markets By Tony Tassell and Joanna Chung Financial Times May 24 2007

Highly solvent SWF seeks mutually rewarding relationship. That might sound like an advert in a singles column but it is in fact shorthand for what is rapidly becoming a huge force in global markets and economies.

A vast arsenal of money to invest in markets is fast being built up by the swelling ranks of so-called sovereign wealth funds (SWFs), schemes set to invest the growing foreign exchange reserves and savings of countries from Norway to China.

Driven by trade surpluses unequalled as a percentage of the global economy since the beginning of the 20th century, official reserves held by some governments are now astronomically high and there is pressure to earn a better return by putting the money with specialised investment agencies.

Morgan Stanley estimated in March that the total funds at the disposal of SWFs may be as high as $2,500bn (£1,157bn, €1,710bn), already around half the gross official reserves of all countries. By comparison, worldwide conventional fund management assets (pension, insurance and mutual funds) reached $55,000bn at the end of 2005, according to the industry body International Financial Services London. But SWFs are already larger than the global hedge fund industry, which is thought to manage about $1,500bn to $2,000bn of assets – some of which may include existing SWF money.

The SWFs are growing fast as countries reap the benefits of high oil prices or large trade surpluses. “If we are right that these funds will grow by roughly $500bn a year, at the expense of official reserve growth, the total size of the SWFs should be as big as the official reserves in only five to six years’ time,” Morgan Stanley estimated.

How and where this massive – and often secretively managed – pool of funds is deployed will be one of the big investment themes of coming years. China, for example, is setting up an SWF to manage more aggressively a portion of its $1,200bn in foreign reserves. Plans are still taking shape for the fund, likely to be called the China Investment Corporation when it opens an office later this year, but it is expected eventually to have a kitty of up to $300bn.

“That amount represents the single largest pool of cash that any government has thrown at anything, ever. Adjusted for inflation, the US’s largest effort, the Marshall Plan, comes in at just over $100bn,” says Statfor, a US security consulting intelligence agency.

As significant as the size of the SWF pool is the changing mix of investments. Until now, the foreign reserves of countries such as China have been largely parked in passive investments, mostly in US Treasury bonds. The investment priority of their managers, usually central banks, was security and liquidity.

But in many countries – such as in the Middle East and China – reserves have risen to such a level that their managers can no longer pretend they need more liquidity for the purposes of currency or economic management. In China, reserves rose by about $1m a minute in the first quarter and the overall total could double within four years if the country’s trade surplus continues to expand and Beijing’s currency policy stays the same.

That is what made last week’s news that China is investing $3bn in the initial public offering of Blackstone, the private equity group, such a landmark event. China is expected to adopt a gradual approach to shifting its strategy. The $300bn kitty for its SWF is unlikely to be transferred in a single tranche for immediate investment, either domestically or offshore.

However, the Blackstone deal was widely seen as a clear signal that China is preparing to take a more active approach to investing and is willing to take more risk. “China Inc’s investment decisions are going to have the capacity to move markets for a long time,” says Brad Setser of Roubini Global Economics

But the SWF story is more than just China. The global SWF club of countries taking a more active approach to investing foreign reserves has broadened out to 25 members, including nations as diverse as Botswana, Australia, Iran, Singapore, Brunei and Kazakhstan.

Jennifer Johnson-Calari, director of Sovereign Investments Partnerships at the World Bank, says there is a huge opportunity cost to “uninvested” capital tied up in reserves. “This is financial capital that is unexploited, very much like agricultural land lays fallow, unploughed,” she says.

Even long-established SWFs such as Norway’s giant $300bn Government Pension Fund are changing tack to adopt more risk. It announced last month it would increase its exposure to global equities from 40 per cent to 60 per cent.

Russia’s finance ministry has similarly decided to boost equity exposure, splitting the country’s $108bn stabilisation fund in two. One chunk of assets will be maintained at a fixed percentage of gross domestic product, and will be called on to cover emergency budgetary shortfalls. The other will be a “future generations” fund with no set mandate – except to last forever. This fund is expected to invest more in domestic and international equities.

Such shifts will reverberate around markets. Analysts say the evolution from official reserves to SWFs should be positive for emerging market assets and positive for risky assets in general. A wholesale move from bonds to equities by the world’s central banks should also boost the yen.

Only 3.2 per cent of the world’s total official reserves are held in yen. However, global equity managers typically hold a greater percentage of their portfolios in the currency – the market capitalisation of the Tokyo stock market is more than 10 per cent of the world’s total. If SWFs invest funds in equities in line with Japan’s global weighting, they will have proportionally more money in yen assets than they would have if they kept funds in traditional reserves.

The big question, however, is the impact on bonds. The International Monetary Fund recently cited estimates that central bank buying has depressed yields on long-term US Treasury bonds by between 30 and 100 basis points as prices have risen.

If buying eases, bond yields could rise and prices fall. Although countries with large foreign exchange reserves in US bonds are unlikely to want to risk damaging the value of their investments through heavy sales of them, a greater share of new reserve accumulation will flow into non-bond assets.

Such moves have raised the antennae of banks and asset managers around the world hoping to gain lucrative mandates to advise the SWFs or manage their “wall of money”.

But the growing role of the SWFs in markets is beginning to attract criticism, particularly over a lack of transparency. Few SWFs give details of their operations, with exceptions such as Norway’s GPF. “Monitoring the currency and asset compositions of official reserves is difficult, but tracking the sovereign wealth funds would be nearly impossible, as these funds are blended with the massive pool of private capital,” says one investment banker.

Gary Kleiman, a senior partner at Kleiman International Consultants, adds that trying to work out what some SWFs are doing is like chasing a shadow. “In terms of disclosure on fund performance, investment strategy or even basic philosophy, many rank below the most secretive hedge fund,” he says.

Some of the newer SWFs appear to be following a similar path to the Abu Dhabi Investment Authority, one of the first SWFs, which has for 30 years acted as a savings fund for the emirate’s future generations. It is rated highly as a professional manager with a diversified portfolio and a cadre of talented managers. But there are few public details on its operations, with no official figures released for Adia’s investments. Morgan Stanley estimates it is the world’s largest SWF, managing as much as $875bn. But where this money is deployed is a matter of conjecture.

This raises issues about potential systemic problems if SWFs assume a greater role in markets. Many newer SWFs, more­over, lack the management experience and systems of a fund such as Adia. “Many governments do not have the wherewithal to manage risk [in SWFs],” says Ms Johnson-Calari.

The IMF also warned recently of the risks arising from the fact that public sector institutions such as SWFs are now large players in world financial markets. “A single institution could make sudden portfolio adjustments that could have significant price effects on certain asset classes. Market rumours of such adjustments may lead to volatility as previous announcements by central banks have shown,” it said in its global financial stability report.

“Furthermore, if raw material and energy prices fall ...countries may intentionally run down their funds and international reserves, reversing past outflows.”

The operations of SWFs can also raise political issues. Even if they are set up as independent bodies, they still face questions over whether funds are operating on a purely commercial basis or to fulfil broader government aims. “In some cases, assets may be shifted for political-strategic reasons rather than economic and financial reasons,” said the IMF.

Given the size of the funds to be deployed, SWFs also could go on a buying spree of corporate assets. This could inflame nationalistic sentiment if they acquire foreign companies seen locally as having strategic importance. That may be one reason why some SWFs channel their investments through discreet secondary managers.

One foretaste of the potential for controversy came when Temasek, the Singapore state investment company that is a model for many other SWFs, faced a painful backlash in Thailand over last year’s acquisition of telecommunications group Shin Corp. A senior Temasek official recently warned that similar problems may be brewing in China, where the group bought stakes in two state banks at a discount.

In response Temasek, which has faced long-running questions over its transparency, plans to set up a $330m fund to finance regional development – an apparent effort to blunt criticism from other Asian countries about its buying of strategic assets.

Such moves may not be enough to satisfy the critics. As they grow more powerful, SWFs will face increasing pressure to be more open.

More information about the lbo-talk mailing list