Pragmatique, rationnel, indépendant

Sovereign Wealth Funds

Sovereign Wealth Funds  (SWFs) are state-owned or affiliated funds. The first type (by far the biggest) invests foreign exchange reserves, driven by trade surpluses and exports of natural resources. Most are from Asia, and especially from the Middle-East. The biggest is from the United Arab Emirates, with $875bn under management. SWFs from Kuwait, Singapore, China, and Russia are also among the largest. The second type, also called Sovereign Pension Funds, explicitly invests money to provide pensions for ageing populations, notably in the U.S. and Japan. With more than $300bn, the Norwegian fund is the biggest player in this category – although it derives its resources from oil exports. Overall, oil and gas accounts for 62% of the funding of SWFs, according to the SWF Institute.

Source: SWF Institute, 2008.

These funds recently decided to increase their equity exposure, in order to boost returns. In 2007, they managed $2,500bn – far more than hedge funds. Their clout is growing fast, as $450bn in transfers are being added annually to this amount. Morgan Stanley thus predicts that they will manage $12,000bn by 2015. Remember that the total market value of shares around the world is currently $55,000bn. 

There are two sets of concerns among governments and policy makers regarding the transparency of sovereign wealth funds and their objectives. The first is that local companies, traditionally owned by local investors, might fall into foreign hands. With protectionist sentiments on the rise, people are sensitive to this issue. For example, although Qatar's SWF "only" manages $60bn, it made headlines in the U.K. after buying 20% of the London Stock Exchange and a large participation in the supermarket giant Sainsbury. The second, and in my view more legitimate concern, relates to the objectives of SWFs. Most are still very opaque, neither disclose their investment policy nor their holdings, and build significant stakes in foreign companies. In addition, SWFs may not have purely financial objectives. Public figures are worried that financial flows and financial clout may become another instrument of influence in the hands of foreign governments. The economist Raghuram Rajan of the University of Chicago even went so far as to argue that ``Government entities should not be in the business of investing in private firms.’’ 

These concerns may or may not be justified. For instance, Dubai's SWF explicitly undertakes investments with the objective to promote and support Dubai's economy. The Finance minister of Russia Alexei Kudrin declared in September 2008 that his country was contemplating using his SWF to “support financial markets when necessary.” Probably more the Russian market than the American’s… Again in September 2008, China used its SWF to convince Costa Rica to "sever ties with Taiwan". It appears that SWFs may become another tool of power in the arsenal of authoritarian regimes. The nature of SWFs fundamentally differs from that of private investors. They are investing public money, and are typically accountable to their government. But throughout history, governments have been interested in strengthening their national economies. In this perspective, money and financial returns are only secondary, they are only a means to an end. Sovereign Wealth Funds with significant stakes may easily extract technology and sensitive information, use the companies they hold to reach political objectives and exert pressure on host countries, etc. 

The lack of transparency makes it hard to keep track of the investments of SWFs, and of their motivation. Recently, SWFs have been quite opportunistic, investing in companies in bad shape, such as U.S. investment banks hit by the subprime crisis in 2007 and 2008. Financially speaking, this may be a fantastic investment opportunity. But holding large stakes in banks may also be perceived as a strategic investment... It is often hard to disentangle between these two objectives. However, has recently released the "SWF risk index". It is largely subjective, but gives a good idea of current perceptions – be they accurate or not. 

It should not be forgotten that SWFs bring benefits to the global economy. First and foremost, they are a source of capital. It is well know that money from Japan and China has helped keep long-term interest rates low. More recently, SWFs have not been afraid to invest in troubled but important companies at a time of scarce capital. By keeping these companies afloat, they may contribute to averting a worldwide recession.

This is why governments may need to be more balanced in their evaluation of SWFs. But politicians are neither economists nor businessmen. They are mainly preoccupied with power, and with satisfying voters. Images matter. Since the average voter dislikes "finance", and distrusts foreigners, SWFs are an easy target. Politicians might use them as scapegoats to score political points. Additionally, a popular backlash is possible, especially if the world economy heads toward recession. So politicians' current attitude with respect to SWFs makes sense, and may even get worse – especially if SWFs do not adopt codes of "good conduct" and remain secretive. 

This being said, global regulation is very unlikely. However, individual countries may restrict SWFs, for the reasons mentioned above, but also to address their potential strategic and political objectives. The voluntary adoption of best practices by SWFs (the Norwegian fund is often designated as an example of good governance) may render further regulation unnecessary. In particular, switching to an investment policy of acquiring small stakes in a multitude of companies would help in two ways: not only would SWF not make the front page of local newspapers anymore (this tends to happen when they acquire large stakes in any big company), but concerns about their ultimate objectives would also be alleviated. In the same vein, channeling investments through third party fund managers could help mitigate political tensions, while producing the same returns. 

To conclude, as concerns mount in countries in which they invest, SWFs will have to become more scrutable and more discreet if they are to avoid a backlash and a string of restrictions. In other words, they will be strongly encouraged to turn into "normal" money managers. Any reticence will validate and foment concerns.

Pierre Chaigneau

Editeurs : Pierre Pâris, Bruno Lannes, Pierre Chaigneau.