Growth of Sovereign Wealth Funds & Implications?
jules4128 asked:
Feedback please- these Funds are exploding in popularity. With Merrill Lynch raising $6.6 billion from preferred shares to investors that include Kuwait Investment Authority, and Saudi Arabian Prince Alwaleed and the Singapore government injecting $7.5b into Citigroup (4.9% stake to Abu Dhabi), not to mention UBS obtaining $9.75b from Singapore’s largest sovereign wealth fund… is this potentially the creation of the next bubble? With banks all across the board getting a good shelacking from subprime, what are the implications of these magical funds? I am skeptical of the nature of these funds… what’s your prediction?
Leroy
Feedback please- these Funds are exploding in popularity. With Merrill Lynch raising $6.6 billion from preferred shares to investors that include Kuwait Investment Authority, and Saudi Arabian Prince Alwaleed and the Singapore government injecting $7.5b into Citigroup (4.9% stake to Abu Dhabi), not to mention UBS obtaining $9.75b from Singapore’s largest sovereign wealth fund… is this potentially the creation of the next bubble? With banks all across the board getting a good shelacking from subprime, what are the implications of these magical funds? I am skeptical of the nature of these funds… what’s your prediction?
Leroy
December 13th, 2008 at 4:41 pm
Excellent question. I think we need to be VERY wary of these funds for many reasons–unclear investments, the potential political ramifications, issues of control of assets, and more.
The Economist has an interesting article you might want to check out:
“A similar approach is now common among oil-producing countries, which, it is estimated, account for two-thirds of the assets in these sovereign-wealth funds, and are keen to diversify their national revenues, aware that their wealth is being pumped away. They have typically invested along similar lines to central banks, holding bonds, dollars and bank deposits. Temasek, a Singaporean entity created in 1974 to pool state-owned investments, started to change the mindset. It subsequently evolved into an even more complex investment vehicle. The heady combination of state-control, success and secrecy, entranced other governments.
Recently, central bankers have also begun wondering whether they have a fiduciary duty to make higher returns from the public wealth under their supervision, which could mean placing at least some part of foreign-exchange reserves in high-yielding, if less liquid, investments. In Asia this question has become increasingly pertinent in the past two years, as reserves have mushroomed.
The result has been a torrent of money into a finite pool of assets. There is no precedent for such fortunes suddenly to find their way into global financial markets, and they help explain the waterfall of liquidity that has driven up the value of risky (and less risky) assets of all descriptions around the world. The world’s entire supply of shares is $55 trillion, and bonds account for a similar amount. Sovereign-wealth funds could soon become the most important buyers of such assets, and many others besides. If so, the world will witness the intriguing spectacle of its largest private companies being owned by governments whose belief in capitalism is often partial.
The last time governments were this involved in sinking money into private assets, the process tended to be called nationalisation. Now the funds are invested both abroad and domestically. A new term will have to be coined: internationalisation, perhaps….
But the kind of assets the funds invest in—big ones—can generate frictions even when run properly. Temasek has been embroiled in controversy in Thailand after it bought Shin Corp, one of the country’s telecoms companies, from Thaksin Shinawatra, the country’s deposed prime minister. China is no stranger to such tensions. In an event that still rankles, CNOOC, the state-controlled oil company, was blocked in America, supposedly on national-security grounds from acquiring Unocal, an oil company. It is quite possible that by purchasing a non-voting interest in Blackstone, China will be able to bypass the restrictions that might prevent it doing Unocal-style deals in Europe and America.
By choosing a private-equity firm, China will also be able to invest directly in a partner that, notwithstanding its forthcoming share offering, can keep many of its operations out of the public eye. But this is where the ironies of the deal are most apparent. “Crony capitalism? It is a marriage made in heaven—a partnership that does not want investors to ask questions with a country whose firms do not want investors to ask questions. I worry about the serious conflicts of interest this generates. More generally, government entities shouldn’t be in the business of investing in private firms,” opines Raghuram Rajan, of the University of Chicago’s Graduate School of Business.”
I was discussing via email this with another investor and I’d copied two pages from a book that included the issue with some good research–Cassandra Nathan’s Save America, Save the World:
“Pat Buchanan in “The SWFs Are Coming!,” 31 July 2007, townhall.com raised a good point about another economic threat. The SWF is a huge capital fund created from our trade deficits that Trump and Kiyosaki also find worrying. Buchanan says that in 2006, we had an $836 billion trade deficit; currently it’s $857 billion, equal to 6.5 percent of our Gross Domestic Product. Some nations which have massive amounts of cash reserves have decided that instead of investing in U.S. Treasury bonds yielding around 5 percent that they would take their money and put it in SWFs hoping for higher yields but also “corporate assets to advance strategic interests.” What if foreign countries invest in our strategic companies? He notes that major players in SWFs are China with nearly $200 billion in SWFs, but $1.2 trillion in reserves they could invest; United Arab Emirates $500 billion, and Saudi Arabia $200 billion, as examples. They could become majority stockholders in companies such as Boeing, Microsoft, and GE. Buchanan notes that ex-Treasury Secretary Larry Summers wrote: “’ In the last month we have seen government-controlled Chinese entities take the largest external stake … in Blackstone, a big private equity group that indirectly, through its holdings, is one of the largest employers in the U.S. …’” Given that SWF funds according to Summers are $2.5 trillion now and expected to double to $5 trillion by 2010, that is significant capital. What changes would such majority shareholders make in companies critical to our nation?
Judith Klinghoffer picked up more of Summers’ concerns in her article, “Must Disaster Precede Action on SWF, Too?,” 6 August 2007, politicalmavens.com. She notes these comments were published in FT—Financial Times—one of the more respected financial publications in the world. “The most plausible reasons – the pursuit of objectives other than maximizing risk-adjusted returns and the ability to use government status to increase returns – are also most suspect from the viewpoint of the global system. . . .” What if the SWFs demand special privileges for “their” companies or want to extract technology or frankly, even handicap the foreign company so their own domestic one can take the lead economically? Worthy of consideration are Jeffrey Garten’s suggestions that ran in the Financial Times Klinghoffer notes in “Good news,” 13 August 2007, politicalmavens.com. He says that ownership guidelines and transparency are essential. He states that: “SWFs should not own more than 20 per cent of any company in the US or Europe, without a decision of the host government to go higher. The under¬lying premise must be that SWFs are political entities and should be treated as such.” China, which holds around $900 billion in mixed U.S. bonds, has already threatened to liquidate its position in our funds if we try to force a yuan (their currency) revaluation, (Evans-Pritchard, “China threatens ‘nuclear option’ of dollar sales,” 10 August 2007, telegraph.co.uk). Why should they stop there if they had a controlling share in major U.S. companies?” pp. 333-334
The implications of SWFs are massive. I hope people who watched the irresponsible actions of what’s covered under the title of “subprime mortgage” crisis are paying attention. The role of largely unregulated and somewhat shadowy hedge funds (soundling like SWFs in some ways only SWFs are that on steroids) rings a bell to me. I’d read this and see that it’s not a crazy notion:
I firmly believe we will rue the day when these things got so popular just as we SHOULD rue the day when EVERYONE went off the gold standard–part of the reason these kinds of insanity can exist. (Nations used to invest in precious metals and the like.) We are unmoored from any manner of fiscal sense or responsibility.
December 15th, 2008 at 12:34 am
These funds are US dollars that we’ve sent overseas to buy oil, cars or other exported junk. Those economies can’t absorb all of the cash we are throwing at them and must deploy it somewhere to get a return. (The Arabs can only buy so many 747s and exotic cars.) So as a “safe haven”, they are bring the money back to us in the form of investment; think of it as money recycling. Short term those funds are preventing the collapse of some really stupid businesses (Citi, Merrill, etc) and dumb decisions by shoring up those companies. Long term we have sold some of our best companies on the cheap. Longer term, this will be a stabilizing force for this reason, we are running huge unsustainable deficits ($9Tril.) and it will implode our economy if we don’t stop. If foreigners are as invested into the US as we are, they will have less incentive to tip our economy into oblivion as they will get killed in the process. The old adage is if I owe you a $1000, I have a problem, but if I owe you a $1billion, you have a problem.
My biggest concern is that this just accelerates the erosion of US dominance and power in the world. We have also given other nation’s a huge economic weapon, if they ever wanted to use it.
My advice if you are under 50 is to make certain that a portion of your portfolio, like 30-50%, is invested in a broadly diversified international fund. For the rest of your life, the greatest growth in the world will be outside the US, as they catch up to us. Some like the Chinese, will be the dominant power in 20-30 years.
We have one hope. Invent new industries and sources of energy and take another step up the technological ladder and continue to raise the world standard to a new level. We have done it in the past, so there is a glimmer of hope.