from Follow the Money

Sovereign loss funds ...

December 14, 2008

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Ok, my title is a more-than-a-bit unfair.

But sovereign wealth funds are fundamentally vehicles for investing central bank reserves -- or Treasury reserves from surplus oil revenue -- in equities and real estate rather than in classic reserve assets. And this year classic reserve assets have done rather well. Equities and real estate have not.

The likely result has been large losses. Most sovereign funds remain, despite the efforts of Ted Truman, the US Treasury and the IMF, remain rather secretive, so we don’t know for sure. But it is hard to see how a large sovereign fund could have done well this year.

Take a large fund oil fund, one that started 2007 with maybe $500 billion.

-- Say 60% of the fund was invested in equities. The fund started the year with $300 billion in equities, and probably ended the year with $150-$180 billion. Equities globally are down between 40% and 50% in dollar terms.

-- Say 20% of the fund was invested in real estate, hedge funds and private equities. The fund started the year with $100 billion in "alternatives" and probably ended the year with between $60 and $80 billion. It is hard to tell exactly, as many "alternative" assets aren’t traded in liquid markets, though the fact that some endowments are trying to sell their limited parnerships in private equity funds at large discounts suggests that if these assets were marked to market, they would be down.

-- Say 20% of the fund was invested in government bonds. Setting aside exchange rate moves, they held their value. For simplicity’s stake, let’s say $100 billion remained $100 billion (say mark to market gains on long-term treasuries offset any slide the dollar value of euro-denominated bonds).

The fund would have ended the year with between $310 billion and $360 billion.

Even if the fund received $50 billion from high oil prices (and kept the entire $50 billion in cash, avoiding any losses over the course of the year), it would end the year with between $360 and $410 billion.

This fund, of course, is fictional. But it is meant to capture the dynamics of a fund like the Abu Dhabi Investment Authority.

No one knows how much ADIA manages, though it clearly doesn’t have the $800 billion some claimed. Abu Dhabi’s ruling sheik has said as much. The IIF put ADIA’s assets at around $350 billion in June 2008 (before the sell off); SAMBA put ADIA at around $450 billion before the sell-off. Rachel Ziemba and I are working on a model that suggests that if ADIA had $150 billion at the end of $200, it would have risen to around $450 billion at the end of 2007. I have enough confidence in the model to think that if the starting number is right (a huge if), we probably aren’t off by more than $50-100 billion in either way -- at least so long as ADIA has generated close to market returns on a portfolio that has a lot of equity market exposure.

The Setser/ Ziemba model (which we will be publishing soon as part of a broader paper on the Gulf’s funds) implies that if ADIA’s equity, real estate and private equity portfolio is marked to a (harsh) secondary market price, ADIA (really ADIA and ADIC, as ADIC was spun off from ADIA back when Abu Dhabi was flush) might have as little as $300 billion in foreign assets now. And probably no more than $350 billion.

Remember, ADIA is widely thought to have had between 55-70% of its portfolios in equities, with a substantial chuck in emerging market equities. Stanley Reed of Business Week reports:

While ADIA won’t disclose its total assets or precise allocations, officials at the fund, which is a sophisticated investor knowledgeable about the whole gamut of asset classes, earlier this year provided visiting BusinessWeek reporters with documents showing that the fund’s benchmarks called for having 55% to 71% of its portfolio invested in equities and a further 12% to 28% in so-called alternatives: real estate, hedge funds, and private equity.

The Kuwait Investment Authority had around $265b at the end of March 2008 -- a total that includes some domestic investments. Its foreign portfolio is probably now down to $200-225 billion -- though much depends on how aggressively the KIA moved to emulate ADIA’s portfolio over the past few years and thus the extent of its exposure to the fall in equities and real estate.

The Qatar Investment Authority has taken large losses on its portfolio -- which is much less diversified than the portfolios of the KIA and ADIA. But Qatar has a tiny population and a lot of gas revenue from newly developed fields, so it generates lots of cash -- and that cash inflow made up for most losses. It probably ended the year with $60 billion.

Sum that up and the big Gulf funds likely have a portfolio that is closer to $600 billion than to a $1 trillion now. I have left out Oman (whose fund is small) and Dubai (which will likely need to sell its external assets to raise cash to cover its external debts).

The Saudis --whose conservative portfolio did well this year -- have about $500 billion in disclosed assets. $32 billion of reserves, $412 billion of non-reserve foreign assets and another $67 billion or so of foreign assets that the Saudi Arabian Monetary Agency seems to manage for the government pension funds (see SAMA’s bulletin, table 8a, memorandum items, independent organizations). And then throw in $85 billion in central bank reserves in the other GCC countries (a total that is a bit dated, it is probably lower now)

All told, that leaves the GCC governments with a bit over a trillion dollars (say $1.1 to $1.2 trillion) in foreign assets by my count.

This is still a huge sum for a region with only 40 million or so native born inhabitants. But it is somewhat smaller than the numbers that were circulating not so long ago.

The "somewhat over $1 trillion" total leaves aside the no doubt substantial private assets of the region’s ruling families. It also leaving aside the now substantial debts of many of the region’s private (or quasi-private) firms, as well as their foreign assets.

This analysis has another corollary: the large sovereign wealth funds have a rather less than many estimate. Here is my (rough) math:

ADIA/ ADIC: $350 billion

KIA: $200 billion -- we should know better in April.

QIA: $60-70 billion.

Norway’s government fund: $308 billion (end November data, down from $400 billion at its peak)

Temasek: around $70 in foreign assets before the market meltdown, no doubt much less now.

Singapore’s GIC: $200 billion, though I don’t have a great deal of confidence in this estimate. The GIC manages a substantial chunk of Singapore’s foreign exchange reserves ($165 billion) as well as Singapore’s accumulated fiscal surplus and some pension fund assets.

China Investment Corporation (CIC): $100 billion -- counting only its foreign assets and ignoring any mark to market losses on Blackstone and Morgan Stanley. Or $200-300 billion if the CIC and the foreign assets China’s state banks (which the CIC owns) effectively manage for the CIC -- as these are funds that the banks received as a result of their recapitalization -- are aggregated together. But only a small fraction of that has been invested in equities and similar assets. The CIC claims to be 90% in cash -- and China’s state banks mainly hold debt securities.

Korea Investment Corporation: $30 billion (The KIC’s web sitereports that it manages $17 billion in foreign exchange reserves and $3 billion from the Treasury -- but the web site doesn’t look to have been updated for the additional $10 billion the KIC received earlier this year). That sets aside the losses on the KIC’s investment in Merrill. And that isn’t likely to grow soon -- not when Korea need cash.

All told, I get a total in the $1.3 to $1.5 trillion range for the large funds with substantial foreign equity investments. That total leaves out a host of smaller funds with some external exposure -- as well as a lot of funds that are managed by central banks that some count as sovereign funds (see Truman for a comprehensive list)

That’s down substantially for the year, as one would expect. And perhaps as importantly, it is down relative to the world’s traditional foreign exchange reserves, which now -- counting SAMA’s non-reserve foreign assets as part of reserves -- exceed $7 trillion.

So much for forecasts that sovereign funds would emerge as huge forces in global markets, and would provide permanent support for risks assets. If oil stays at its current level -- and China doesn’t add to its sovereign fund -- I have a hard time seeing how sovereign funds reach $2 trillion anytime soon, let alone a much larger number.

A lot though hinges on the definition of what constitutes a sovereign fund.

If SAMA and Russia’s stabilization and future fund are counted as sovereign funds even though their portfolios that are closer to classic central bank reserve portfolios, it is easy to push up the total assets of sovereign funds.

Conversely, some large central banks that invest primarily in bonds and other assets with limited credit risk have (or perhaps had) substantial equity portfolios.

It is possible, for example, that both SAMA had around $60 billion in foreign equity investments (if not more) and SAFE had about $100 billion invested in global equities before the market crashed. That would be about 20% of SAMA’s securities portfolio in July* and 5% of SAFE’s portfolio. Any assessment of the impact of sovereign investors on the market should take into the investments that some large central banks made in risk assets.

But it isn’t obvious that central banks will have as much appetite for these assets in the future as they had in 2007. If SAFE put $100 billion into global equities (5% of its portfolio) and if it marks that portion of its portfolio to market, it has a lot less than $100 billion now --

* SAMA was thought to have had about 20% of its portfolio in equities. At the end of June 2008, it had $297 billion in securities in its portfolio. If 20% of those had been in equities, it would have had about $60. Some thought it had a higher equity share. It is a little hard though, to reconcile a higher equity share with the subsequent strong growth in SAMA’s total assets. Since the end of June, SAMA’s deposits are up by $46b and its securities holdings are up $16b -- a $62 billion increase through the end of October. Either the Saudis got even more money from high oil than I anticipated, offsetting equity market losses -- or they had a smaller equity portfolio. There are still plenty of mysteries in the Gulf ...

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