Sovereign Wealth Funds
Wednesday, November 25, 2009 , Posted by Team Niveshak at Wednesday, November 25, 2009
Santosh Anil Patil
IMT, Ghaziabad
Introduction
There has always been a debate on saving an economy in distress, which nearly went unanswered during the early 2000. But now there is a saviour for such economies. Developed economies did not realize the potential of developing ones, which formed funds of nations called Sovereign Wealth Funds (SWFs). These funds have flown to the rescue of capitalism’s finest. This established the flavour of a new type of investment fund, which otherwise would have gone unnoticed.
These funds have existed since 1950s, but their total size has increased dramatically over the last 10-15 years. In 1990s these funds probably held about $500 billion, but the current total is estimated about $3 trillion. SWF is a state owned investment fund composed of financial assets such as stocks, bonds, property or other financial instruments. SWFs are the most sought after funds these days and come to play to bring in market stability, liquidity and support in times of dire need and have comfortably taken place of central banks. SWFs have been around for years, created from national budget surpluses and huge reserves of oil and US treasury bills. The governments do not have an option since they cannot pump in the entire amount into their respective economies for the fear of inflation and they cannot just pile up the cash and stock it. So the alternative is SWF.
Concept
The idea that governments should mitigate the risk in the future has a long and respectable history. Kiribati, a pacific island country that mined guano for fertilizers set up the Kiribati Revenue Equalization Reserves Fund. Now the guano is long gone but the pile still remains and boosts the GDP of the island by a sixth. Many oil producers run similar schemes. Oil Producers have realized that it is too extravagant to spend everything in one go and it is wiser to save for times when oil prices are low or for the generations when oil production will start depleting. Kuwait Investment authority is also one amongst the oldest SWFs created in 1953 from oil revenues even before Kuwait gained independence from Great Britain.
Trading
SWFs trade using funds earned from
• commodity export revenues
• foreign exchange reserves
Commodity funds can be used
• For fiscal revenue stabilization
• As a check to prevent foreign exchange funds for fanning inflation
The non-commodity funds are used to make stand alone investments.
SWF – Relative Presence
Although SWFs make up only 2% of the world’s $165 trillion worth of traded securities, they come up with enormous potential having more equity than private equity and more funds than hedge funds. The growth
curve is fascinating with the expectation of SWFs crossing
$10 trillion dollar mark. But even with such a growth potential, the funds account for only 3% of global traded securities.
Leading Nations
Assets under management of SWFs increased by 18 % in 2007 itself. Most of this growth resulted from an increase in official foreign exchange reserves from Asian and Middle East countries. Amongst these funds, the top seven are classified as “Super Seven Funds” all of which have assets over 100 billion dollars. The Abu Dhabi Investment Authority, established in 1976, is the world’s largest sovereign fund. The Norwegian SWF is receiving great interest these days. The fund is acknowledged for its transparency ever since its inception in 1996. The fund has invested in low risk non-strategic assets and the investments aim to follow environmental and human rights standards. Along with these major funds, smaller funds are held by Azerbaijan, Trinidad and Tobago, Ecuador and Nigeria which account for around 100 billion dollars.
Investments Made
The SWFs can invest in each and every corner of this world and can function just as an independent investment fund. Since the investments are not revealed, it is always difficult to sense the strategies employed. But the reasonable assumption would be that Sovereign wealth funds invest towards long term investment strategies while at the same time speculating and gaining in the face of short term market volatility. These funds do not borrow money from investments and hence are not highly leveraged, which sets them apart from other funds.
Recently there have been investments in big businesses across many corners by various SWFs. China’s Investment Corporation (CIC) hit headlines recently for investments in major U.S financial firms. In 2005, a United Arab Emirates owned company, Dubai Ports World stirred a controversy in the United States by purchasing a British owned shipping company which gave it a control over certain parts of many US port facilities. Although Dubai Ports World is a state owned business and not a sovereign wealth fund, the incident reflects parallel concerns over the purchasing interest of the SWFs. Recently Singapore, Kuwait and South Korea aided in bailing out of two companies, Citigroup and Merrill Lynch which had lost their lifeline in the financial crisis that had plummeted the financial health of many big firms in America.
Future
The financial stability of a company entirely depends on the efficiency with which its assets are managed and here the investment strategies play a key role. This has become a trend in the recent developments of the financial world. But when it comes to Sovereign Wealth Funds, there is a lot to be known since very few countries publish the information about the investment strategies, assets or liabilities which causes a growing concern in the minds of people all over the world. The solution is simple in the form of transparency which would go a long way to ease the growing concerns. Disclosure of certain information about the investments or assets in one form or other will serve as a proving factor from the investors. Investments through other funds like hedge funds can mitigate the risks and provide a layer of protection against the money laundering schemes. The diversification can be achieved by investment across various indices anytime. Moreover a scandal of one sort or other is inevitable. When there are stakes of trillions, involving hundreds of fund managers who invest in hundreds of investments employing various strategies, there is every possible chance of a blunder as corruption or foolishness creeps in. Hence it is always advised to sense the risk involved in such profound investments and try to mitigate the risk of conflict in every possible manner. It always boils down to the decision of the sovereigns as to make these funds a future or a past, while staying out of controversies which can tarnish their brand image.
On the whole, Sovereign wealth funds have been in the spotlight in the 21st century having set their footprints right into the heart of wealthiest nations and the gargantuan businesses in not more than a decade. The flow of investments with an unregulated ease backed up by the global rise in the economy is a clear indication of their growth. However, with lots of speculation surrounding these funds on ethical issues and the influence of Middle East, the future of SWF remains a mystery. Nevertheless the opportunities that lie ahead are growing at such a pace that these funds can be on top of all funds by 2050.
