Today, and over the foreseeable future, a series of events — call them global megatrends — will have a profound impact on the world economy. Each issue of Point of View will share insight into these trends and how the institutional investment community is preparing to address them.
Sovereign wealth funds (SWFs) have risen — seemingly overnight — to become major players in the global capital markets. In actuality, these pools of assets, owned and managed directly or indirectly by governments, have been around since the 1950s. The cause for recent attention has been the funds’ rapid growth: 24% annually during the past five years. At the end of 2007, SWF assets totaled US$3.5 trillion, more than global hedge funds (US$1.5 trillion) and private equity (US$1.5 trillion) combined.† Global trade imbalances, the primary reason behind the growth of SWFs, are expected to continue, fueling more aggressive investment strategies by these funds. SWFs already account for about 35% of global merger and acquisition activity and 10% of private equity investments worldwide.
†Source: Global Insight Inc
Sovereign-controlled investments have been the subject of growing attention, and concern, among politicians, the media and other investors in recent years. To address some of these concerns, the International Monetary Fund is expected to release a voluntary code of conduct for SWFs by October of this year.
Although SWFs often are associated with oil-exporting countries, Asia represents the lion’s share of sovereign wealth. China accounts for about half of the region’s SWF assets.
There are four sources of sovereign wealth, each with its own investment objectives and strategies.
Official reserves: External assets controlled by finance ministries and central banks for direct financing of international payment imbalances. Reserves are invested in highly liquid and marketable securities, such as highly rated government bonds of industrialized countries.
Public pension funds: Assets set aside by a government to meet future entitlement obligations to its citizens. Public pension funds are denominated and funded in the local currency, usually with relatively low exposure to foreign assets. Overseas investing, however, is expected to increase.
State-owned enterprises: Companies that are significantly state-controlled, through full, majority or large minority ownership. The companies can undertake foreign investment. This category includes a wide variety of entities, including manufacturing and financial firms.
Sovereign wealth funds: Government investment vehicles funded by foreign exchange assets and managed separately from official reserves. SWF managers typically have a higher tolerance for risk and seek higher returns than official reserve managers.
Source: “Public Footprints in Private Markets: Sovereign Wealth Funds and the World Economy,” by Robert M. Kimmitt, deputy secretary of the U.S. Department of the Treasury, Foreign Affairs, January/February 2008, published by the Council on Foreign Relations.
SWF assets are projected to reach almost US$12 trillion by 2015, but the dominance of oil-exporting countries is expected to wane during the same period.