Sovereign wealth funds are rapidly becoming a huge force in global markets and economies, as the world is seeing in China’s move to kick off its own SWF with a $3bn investment in the IPO of private equity group Blackstone. But equally compelling issues lie ahead in the nature and operation of these often opaque investment vehicles, says the FT.
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, amid mounting pressure to earn better returns by putting the money with specialised investment agencies.
Morgan Stanley estimated in March that total funds held in SWFs may be as high as $2,500bn, 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 International Financial Services London, an industry body. 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.
Under current trends, these funds will grow by roughly $500bn a year, says Morgan Stanley, noting that the total size of the SWFs could equal official reserves in only five to six years’ time.
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 is a case in point, with its surprise move to invest $3bn in Blackstone’s forthcoming IPO as part of plans to manage more aggressively a portion of its $1,200bn in foreign reserves. Its new SWF is still taking shape, but is expected eventually to have a kitty of up to $300bn.
As significant as the size of the global 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.
Now, that is changing - and the global SWF club of countries taking a more active approach to investing foreign reserves has broadened to 25 members, including nations as diverse as Botswana, Australia, Iran, Singapore, Brunei and Kazakhstan.
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.
A big question, however, is the impact on bonds. The IMF 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 – and 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.
This raises issues about potential systemic problems if SWFs assume a greater role in markets. Many newer SWFs, moreover, lack management experience and systems of the established funds such as Adia, 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.
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.
