Sovereign Wealth Funds (SWF) are saving funds consisting of mostly foreign assets that are controlled by sovereign governments. When central banks or governments accumulate a surplus of reserves (assets), often they transfer the surplus to a managed fund. The International Monetary Fund (IMF) estimates global sovereign wealth to be in excess of $2.5 trillion, which is 5 times greater than it was in 1990, and is expected to grow to $10 trillion by 2012. Many funds were developed following the oil shocks of the 70’s, such as funds in the
Size of the funds
The exact worth of many SWF (a notable exception is
Sovereign Wealth Funds derive wealth primarily from two sources: commodity sales such as crude oil and natural gas (
Where is the money going?
The recent SWFs’ portfolio allocation strategy has been to diversify away from the high levels of liquidity (treasury notes, currency, etc.) and toward nonliquid assets. For several economies, the U.S. Treasury monitors certain flows of assets (e.g., U.S. Treasury bonds and notes, corporate bonds, and equities), but the flow of less-liquid assets, such as commercial real estate or corporate buyouts, is not well known. Several SWF have hired external portfolio managers, such as
The big corporate deals, though, are represented in the media. In November, Abu Dhabi Investment Authority agreed to buy $7.5 billion stake in Citigroup. Singapore Investment Corporation paid almost $10 billion for a stake in UBS. In December,
Implications for world financial markets
SWFs are not unlike private hedge funds or pension funds and often compete in the same asset markets. The incentives and strategies of the SWF managers, though, may differ greatly when compared to the private funds (pension, hedge, etc.). The extreme secrecy of many of the SWFs, with the exception of
First, the incentive structure of managers at a government-run SWF may be different from that at a private pension fund or hedge fund. Government employees on fixed salary often manage part or all of many SWFs. A private manager (hedge fund, pension fund) receives bonus income based on the performance of the fund. This leads to a lower cost of management on the part of the SWF, and smaller incentive for its portfolio manager to maximize expected return. Thus, the SWF may be willing to accept a smaller expected return. It is becoming more common for SWFs to hire external private managers; the incentive structure is, at best, mixed.
Second, the risk exposure that the SWF is willing to be subject to may be higher than many private hedge and pension funds due to the relative magnitudes of the funds themselves. Economic theory posits that risk aversion falls as wealth levels rise since the marginal utility of each extra unit of wealth is falling. Thus, when you compare the new Saudi SWF valued at > $900 billion to a private fund worth $50 billion, the $900 billion dollar fund is willing to incur more risk. Thus, the SWF is willing to accept higher risk exposure at a lower expected return.
Third, the SWF appear (in the media, at least) to be long-only investors. They are willing to buy up stake in struggling firms (high risk) at an undervalued price. So, if a pension fund or hedge fund is based on long positions, then it will be in the same market as the SWFs.
In the end, commodity prices are driving much of the wealth. If the price of crude oil continues to rise, the surpluses earned by a few net-saving countries may impact global economic markets. The asset markets will change, global economic investment will change, and the imbalance of global saving rates may be further exacerbated. It is hard to predict the impacts, as the SWFs’ worth are essentially unknown, the investment strategies and asset purchases are essentially unknown, so we must wait to see.