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Sovereign wealth funds are hot. A senior JP Morgan Chase banker, quoted in Time:
"SWFs ... are the new 'it' girl of global finance. Everyone wants a piece of them."
Almost every investment bank is looking to sovereign wealth funds as a new source for of deals and management fees -- if not for a bit of emergency funding to shore up their existing capital base. Central banks -- which tend to try to minimize the fees they pay on investments in safe assets -- haven't generated half as much as much excitement.
The research arms of the world's investment banks have quickly reached a consensus that sovereign wealth funds will get big fast, providing long-term support for at least some risky assets (Merrill's analysis is typical)
Sovereign wealth funds manage at least $2 trillion now, and perhaps a bit more. We don't know because the biggest fund also happens to be the most secretive. Estimates of ADIA's size are all over the map -- I personally doubt ADIA has $875b (more on that later). Plus the dividing line between central bank reserves and a sovereign wealth fund can be rather thin: Russia's oil stabilization fund and the non-reserve assets of the Saudi Monetary Agency are often counted as sovereign wealth funds even though they have fairly conservative portfolios. The Saudis have some equities, but far less than most investment funds. Russia's oil stabilization fund is managed far more conservatively than say Switzerland's reserves!
But even if sovereign wealth funds will end 2007 managing a sum that is closer to $3 trillion than $2 trillion, they won't grow to $8 trillion by 2011 -- as Merrill now estimates ("By 2011, assets under management at SWFs worldwide are projected to grow almost fourfold to nearly $8 trillion")-- without getting close to a trillion a year in new assets to manage.
Such an increase isn't entirely implausible. Central banks are on track to add at least $1 trillion to their reserves this year, and perhaps substantially more. Sovereign wealth funds will likely be given an additional $150-250b to manage this year, depending on whether China's Finance Ministry uses the funds it raised from its big bond sale to buy an additional $100b of foreign exchange from the PBoC for the China Investment Company in late 2007 or early 2008.If the emerging world's governments continue to accumulate foreign exchange at their current rate and a large share of their burgeoning foreign assets is managed by investment funds that pay juicy investment banking fees and relatively little is managed by cost-conscious central banks, Merrill's forecast isn't at all implausible.
Indeed, scarcely a week goes buy without the announcement of a big new investment by a sovereign wealth fund in a troubled financial institution -- along with a rumor that China's investment corporation will in some way support a large bid for Rio Tinto.
Yet the whole hubbub over sovereign wealth funds seems to miss what strikes me as a crucial point – namely that a key set of countries doesn’t seem nearly as likely to ramp up their overseas equity investments quite as rapidly now as seemed likely six months ago.
- Russia’s new national welfare fund will be far smaller than the budget stabilization fund, and -- at least until a new President is elected and Mr. Putin changes jobs -- will only invest in bonds. It plans to move cautiously. And it may end up investing more at home than abroad (though that raises another set of issues)
- The China Investment Corporation will only have about $67b to invest abroad; the majority -- $133b -- of its initial $200b in funds will go toward buying the Chinese state’s existing stake in Bank of China, China Construction and the Industrial and Commercial bank of China from the central bank and toward recapitalizing the Agricultural Bank of China and the China Development Bank. Those funds likely won’t start to be deployed until 2008 – and there is no guarantee that the CIC will get more funds in the near future. It first has to figure out how to keep the "wolves" from eating up its existing funds.
- The Saudis – who export significantly more oil than Kuwait, Qatar and Abu Dhabi and thus have a significantly larger ongoing “flow” of new funds – have shied away from high profile investments. Most of their oil revenues are still parked with the Saudi Arabian Monetary authority, and SAMA still seems to be managing its funds (relatively) conservatively. No doubt the Saudis have significant “private” investments as well – but so far they have flown under radar screen.
- Japan is once again considering the creation of a sovereign fund, but no decision has been taken. The most serious proposal would use the interest income on Japan's existing reserves to finance the sovereign wealth fund. That implies a very gradual shift in Japan's portfolio. The new fund also would likely invest quite conservatively: it would be more like Norway's government fund than the Dubai funds.
The big splashy deals have come from the existing funds of the small gulf states, Singapore's GIC (which is acting more like Temasek by the day -- even if India considers them separate funds rather than different parts of Singapore's government) and the Chinese banks. The Emirates and Qatar have roughly $115b a year in oil revenue (based on 3.5 mbd of exports) with oil at $90 a barrel -- and, given that these countries import bill is rising fast, their aggressive funds will have something like $50 to $60b to invest in global markets in 2007 if oil stays around $90b. The Kuwaits and Norwegians will have comparable sums to invest -- though they will likely be invested a bit more conservatively.
Libya -- another state with few people and lots of oil -- is set to join this club. The Libya investment authority will soon have $40b to invest (mostly from existing reserves). If oil stays high, it could get far more over time.
But the ultimate size of sovereign wealth funds will be limited if the far larger potential flows from Saudi Arabia and Russia are managed primarily by the central banks.
The really big oil revenue streams are not currently being handed over to aggressive sovereign wealth funds.
And the really big sums coming out of China is still being invested fairly conservatively. Say the CIC places $67b in global market next year, and the Chinese banks – who are likely to be more aggressive than the post-Blackstone CIC – do another $50b in deals. That still works out to about $120b – or somewhere between a quarter and a fifth of a conservative estimate of the 2008 increase in China’s foreign assets.
On current trends, the true super-powers of global markets will remain the big central banks -- those with $100b or more to place every year.
The central banks of China, Russia, India, Brazil and Saudi Arabia will combine to add roughly $850b to their reserves this year -- far more than that the five largest sovereign wealth funds will add to their portfolio in 2007. Much of the increase in the assets of the investment will come in the fourth quarter, and likely won’t be invested until 2008. ADIA, KIA, the CIC and Norway’s government fund should all have around $50b to invest next year. That is a lot -- but it doesn't add up to anything close to $1 trillion either.
For all the attention sovereign wealth funds have attracted over the past few weeks, their investments are still a fairly small share of total official asset growth.
The Wall Street Journal reports the sovereign funds and state banks have invested about $20b in US and European financial firms this quarter:
In the fourth quarter alone, sovereign-wealth funds and banks from Asia and the Middle East invested $18.9 billion in Western financial firms, according to Morgan Stanley research.
Let's assume that these funds have invested another $10b in non-financial firms, bringing their total investment up to around $30b. That is still only about 10% of the total increase in official assets in the fourth quarter.
Unless something changes -- whether a big fall in private capital flows to the emerging world or a dramatic change in the way China, Russia, India, Brazil and Saudi Arabia manage their state assets -- 2008 will probably be roughly similar. Central bank reserves will grow far faster than the funds managed by sovereign wealth funds, and decent chunk of the funds managed by sovereign wealth funds will be invested relatively conservatively.
Frankly, that is something of a relief.
I don’t think the US or Europe are ready for a world where emerging market governments do $1.2 trillion of “deals” rather than buy $1.2 trillion of bonds. $1.2 trillion is the equivalent of 3 Citi/ ADIA sized deals a week every week of the year, or two UBS/ GIC/ unnamed Middle Eastern investor deals a week. It is equal to a CNOOC-Unocal sized transaction every week of the year.
I understand the desire of many emerging market governments to hold a more diverse portfolio. Holding low-yielding bonds denominated in depreciating dollars cannot be a fun – even if such holdings are a necessary component of a development strategy based on using the central bank’s balance sheet to support exports.
I also suspect that their desire for a significantly more diverse portfolio is incompatible with a world where they are adding to their assets at their current rate.
There is one additional -- and quite controversial -- angle that is worth mentioning.
The majority of the growth in official assets is coming from countries that are not democratically governed. China and the Gulf combined will likely add around $700b to their "official" portfolio, broadly defined. Russia, which is a bit more transparent and a bit more democratic, will account for another $175b. Other less-than-fully democratic governments (Libya for example) will account for another $50b.
Sum it all up and the foreign assets of non-democratic governments could rise by close to a trillion dollars in 2007. That worries me.
The rise of state capitalism doesn't just represent a shift in financial power from the market to the state, and from the US and Europe to the emerging world. It also represents a shift in financial power away from democracies.