Sovereign Wealth Funds are believed to manage funds up to $3 trillion and are becoming increasingly important part of the investment landscape. What does this mean for private investors?
A year on from the start of the credit crunch, and the presence of Sovereign Wealth Funds (SWFs) on the shareholder lists of many major banks is very noticeable. They've been buying into other strategically important businesses too, including the London Stock Exchange (LSE: LSE). But who are they, what's their agenda, and what does it mean for the private investor?
Firstly, there is no agreed definition of a SWF. They can generally be described as investment funds owned and controlled by government, holding foreign assets, and operating independently of their respective central banks and finance ministries. It's on that last point that the classification becomes more difficult; the extent to which SWFs and official foreign exchange reserves are distinguishable, in terms of autonomy and availability to the central banks, is often unclear.
To the extent that there is a 'typical' SWF, it is usually funded in one of two ways: from commodity revenues (either state-owned, or taxed), or from other trading imbalances, as in the case of China. Commodity-funded SWFs make up the majority, usually based on oil revenues.
How big are they?
SWFs collectively are believed to manage funds in the range $2-3 trillion. To put that in context, it's roughly the size of the combined FTSE 100. According to some sources, that would make SWFs more powerful than the hedge funds and private equity.
At that size, they'd account for about 3.5% of the world's capital markets, but various estimates show SWFs increasing to over $10 trillion within four to five years.
Who are the big players?
With assets in excess of $850bn, the Abu Dhabi Investment Authority is the king of the sovereign wealth funds, with Singapore, Norway, and Saudi Arabia next in line with about $300bn each.
The question of definition is important here too. China has approximately $1.5 trillion in foreign exchange reserves, at least some of which could potentially be considered available for investment via SWFs.
Concerns
The combination of their financial clout and their lack of transparency has caused much concern on the part of investors, regulators, and unions. Currently, the IMF is drawing up a voluntary code of best practice for SWFs, while in parallel the OECD is drafting up guidance for recipient countries.
There have also been worries about control of strategic or sensitive assets by foreign governments whose agendas may be wider than the simple maximisation of profit. A study last month by the European Central Bank found no evidence of non-commercial agendas on the part of the SWFs, but concerns remain regarding potential conflicts in future.
Independently, the US Treasury reached agreement with Abu Dhabi and Singapore in March on a set of policy principles that may form the template for IMF discussions.
What does it all mean for private investors?
If the estimates are correct, these SWFs will provide a wall of money to the capital markets in the coming years. A recent report by State Street calculated that allocating 60% of these new funds to equities would enable them to own more than 5% of the major stock-market indices.
As shareholders, SWFs appear to take a long term perspective. And as they tend not to be geared up, they are less likely to be forced sellers when the going gets tough. For those reasons, they may prove to be a stabilising influence on markets.
Given their size, it might be reasonable to expect them to simply buy into the broad market, matching global stock market performance in the manner of a tracker fund, rather than attempting to outperform.
If, on the other hand, they are more selective in their purchasing, then it's likely to have an effect on the relative performance of countries and sectors. While investors might want to keep an eye on their behaviour, it's worth noting that their forays into banking over the past year have, on a short-term measure, been less than successful. Imagine how the banking sector would look today without that funding from SWFs.
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