First there were rumours. Rumours became murmurs. And over the summer, we heard the first chatter on the rise of the sovereign wealth fund. Time to put some figures to paper.
In a report released on Friday, Merrill Lynch predicts the already massive $1,900bn sovereign wealth fund industry will quadruple. In the next four years.
By 2011, says Merrill’s global economics team, sovereign wealth funds will hold $7,900bn of assets under management. That’s about 12 per cent of global GDP.
But perhaps more significantly, Merrill predicts “the share of SWFs in riskier global assets to double or triple by 2011.”
Indeed, how could it not. The nursery for SWFs has been the safety of the global sovereign bond market. But that’s only worth $14,900bn - too small a pond for $7,900bn of SWFs to play in.,
Whichever way you look at it, it is hard to escape the conclusion that we are likely to witness enormous inflows into riskier assets:
- The share of SWFs in global riskier markets is projected to double or triple over the next five years
- A cumulative US$3.1-US$6tn is likely to be invested in riskier assets over the next five years, on our estimates
- Initially inflows into sovereign fixed income assets persist; however, a net as high as US$1.8tn could flow out of these assets by 2011.
- In total, we project net inflows of US$3.9-US$4.2tn, an amount equivalent to about 7-8% of current global asset capitalization or current global GDP.
The massive inflows of money from SWFs will completely change the nature of “riskier” asset class markets - equities and corporate bonds, for example, and will have a big impact on sovereigns - especially the US Treasury, which according to Merrill will “suffer most”:
Government bond yields would face upward pressure as curves steepen. Undoubtedly, as assets are channelled away from government bonds toward other assets, bond yields would face upward pressure. Since the short end of the curve is anchored by central bank target rates, this would imply a curve steepening, all else being equal.
“Riskier” assets, meanwhile, will see rises:
A shift in SWF portfolios affects the relative liquidity of different assets, and hence their relative prices. So, if SWFs are to shift their portfolios from safer assets to riskier investments, a relative gain in the prices of these assets would follow.
In the near term
- Inflows into “safe” sovereign assets will continue.
- The Middle East will dominate inflows into “riskier” assets
In the medium term
- A “massive shift” into riskier assets
- A shift out of government and into private sector assets
- A shift out of USD and into non-USD assets
- The centre of SWF gravity moving from the Middle East to Asia and Russia
