Sovereign wealth funds (SWFs) have become the new saviours of Wall Street. These government-owned investment vehicles, bloated with cash from soaring oil prices or huge hoards of foreign exchange reserves, are investing billions of dollars in top-notch Western banks laid low by the American subprime contagion. These include the Abu Dhabi Investment Authority buying a 4.9% stake in Citigroup Inc. for $7.5 billion (Rs29,550 crore), the Chinese investment company’s $3 billion stake in private equity giant Blackstone Llp. and $5 billion stake in Morgan Stanley, and the latest, a $5 billion stake by Singapore’s government-owned investment company Temasek in Merrill Lynch and Co. Inc. After the injection of $8.9 billion by Singapore’s GIC into Swiss bank UBS, that unfortunate bank is now known facetiously as the “Union Bank of Singapore”. These state funds are riding to the rescue of some of global capitalism’s finest firms.
But Wall Street has little time for such ironies. It’s far too busy heaving a sigh of relief that there’s an investor of last resort that will prop up its tottering giants. When the story about Temasek’s investment in Merrill Lynch broke, the street responded with a big rally. Instead of the celebrated “Greenspan put”—the notion that the former Federal Reserve chief would always bail out the markets by cutting rates—we now have the “SWF put”, the comfort that these funds would come in and buy good companies at lower levels, thus providing a floor to the market.
But SWFs have been around for decades, so why the sudden infatuation with them? One reason is that the well-known SWFs so far were from places such as Singapore, Norway and the Persian Gulf states, countries that had little political power. China’s setting up an SWF and its buying into US blue chips has raised protectionist hackles, the worry being that the Chinese government may use these funds as an extension of its state policies. The argument is that political, rather than commercial considerations, could be behind their investments. So far, however, there has been little evidence of that. But it hasn’t prevented the leaders of the G7 asking for more transparency from SWFs, to prevent investments being held as bargaining counters in diplomacy. Given the fact that the carrot of large investments has been extensively used by the West to achieve their objectives, it’s difficult to fault the Chinese if they use similar tactics.
The second reason for the spotlight on SWFs is their size. As a Merrill Lynch report on SWFs pointed out last October, “Assets under management by Sovereign Wealth Funds (SWFs) are set to explode. Under reasonable assumptions we think they will grow by $1.2 trillion a year to reach $7.9 trillion by 2011, from $1.9 trillion currently.” Reports say Saudi Arabia is all set to launch the first SWF worth more than $1 trillion, overtaking Abu Dhabi’s $900 billion fund. A lot of clout goes with such money. Besides, continuing current account surpluses of countries such as China will ensure a steady stream of additional funding for their SWFs.
It’s worth noting that the transfer of funds from the emerging markets and the oil producers to the developed markets, in particular the US market, is not new. Recall that 30 years ago, one of the chief beneficiaries of the rise in crude oil prices in the 1970s were US banks, which the Arabs used to park their petrodollars. More recently, the vast amounts of Chinese money parked in US treasurys have been held responsible for keeping interest rates low in the US, allowing that country’s consumption boom (and its appetite for imports from China) to continue. Economists have for long been trying to explain why, instead of capital flowing from rich countries with abundant capital to poor countries, the reverse has been happening.
The difference the SWFs make is that instead of stashing their money away in low-yielding US treasurys, with yields that turn negative if the depreciation of the US dollar is taken into account, they are now trying to ensure that they earn a decent return. That’s being attempted by diversifying their investments.
What’s the fallout of this change in strategy likely to be? The obvious change, as the Merrill Lynch note pointed out, is that more funds will flow into riskier assets. Equities will therefore be supported, while money will move away from bonds. Norway’s SWF, for instance, has recently raised its allocation to equities to 60% from 40%. Merrill Lynch estimated that “a cumulative $3.1-$6 trillion is likely to be invested in riskier assets over the next five years.” Merrill’s definition of ”riskier assets” includes everything except sovereign bonds. Morgan Stanley’s David Miles estimated last June that “based on our back-of-a-large-envelope calculations, we estimate that the emergence of SWFs could, ceteris paribus, push up ‘safe’ bond yields over the next ten years by 30-40bps and reduce the equity risk premium by 80-110bps. These are not small effects.” Moreover, SWFs are also likely to diversify out of dollar-denominated assets into emerging markets. SWFs have emerged as a new source of liquidity for equities, boosting stock prices in the long term.
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at email@example.com.