Thursday, March 27, 2008

Sovereign Wealth Fund

Existence of Sovereign wealth funds (SWF) goes back to 1950s, the interest in their magnitude and workings have gained interest only recently. The first SWF was the Kuwait Investment Board, a commodity SWF created in 1953 from oil revenues. SWF is a special purpose vehicle of the government, funded by foreign currency assets, mandated with high return expectations. Unlike official reserves, which are usually held in short duration treasury bonds serving short term currency stabilization and liquidity management, the SWF portfolio has a product mix of different fixed income, equity, commodity and realty instruments. The management of assets under SWF is separate from the management of the official reserves. Since the investments are in foreign markets, there would be no inflationary pressures due to sterilization (which would be the case with use of the reserves for infrastructure funding). SWFs are mainly the national foreign asset funds often termed as stabilization fund, petroleum fund, investment authority, pension fund and likes.

The SWF club has over 30 members and dozens others have shown interest, including India. Media reports that in a move to better utilize its $300 billion of foreign exchange reserves, the government of India is considering a SWF with an initial corpus of $5 billion. SWF expected to reach $15 trillion by 2015 from its current level of $2-3 trillion, are larger than all the world’s hedge funds combined. Abu Dhabi Investment Authority with $875 billion of assets is one of the super funds, all of which have assets over $100 billion. These funds are The Government Pension Fund of Norway ($380 billion); Government of Singapore Investment Corporation ($330 billion); Kuwait Investment Authority ($250 billion); China Investment Corporation ($200 billion); Singapore's Temasek Holdings ($160 billion); and the Stabilization Fund of the Russian Federation ($155 billion). As a proportion of GDP the five largest funds are ADIA, Brunei ($30 billion), Kuwait, the Qatar Investment Authority QIA ($60 billion) and Singapore's GIC.

The debate about the risks and opportunities of sovereign wealth funds is similar to that of hedge funds. Concerns are that their operations are opaque and not regulated by any single authority. Most of SWF are non-transparent and do not report their holdings or strategies to the public (except few like Singapore and Norway). However, the question is whether any authority other than a multilateral organization can meaningfully regulate a sovereign who owns the funds. Some believe they are passive investments, while others fear they are a matter of national security. These are causes for concern for many people, investors, and governments; and may fuel the fires of financial protectionism. There are reports about Germany drawing up plans to stop strategic assets falling into the hands of “giant locust funds” controlled by Russia, China and West Asian governments. This turnaround is surprising as, till recently, the developed world were the advocates of globalization with capital freedom and foreign investment as its centerpiece. Sympathetic to emerging economies were cautioning about ‘excessive’ build-up of reserves and investing them in low-yielding US Treasuries.

The current observed trend is that these SWF buy into private equity firms thereby giving them an indirect presence in the countries where these PE firms invest. China Investment Corporation (CIC), China’s SWF, with an initial corpus of $200 billion (almost 87 per cent of India’s total forex reserves) made an indirect foray into India through its substantial $3 billion stake in US-based private equity group Blackstone. Among the top three private equity funds active in India, Blackstone already has stakes in even defense supplier MTAR Technologies and was in the race for the troubled public sector financial titan Industrial Finance Corporation of India (IFCI). Singapore government’s Temasek has been the largest investor in Bharti Infratel deal.

While, the argument continues that the Indian government should float such a fund or not, there are various sovereign wealth funds that have already forayed into the country!

List of SWFs compiled from various sources: