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Sovereign funds overeign funds create political leverage, jobs

Sovereign funds overeign funds create political leverage, jobs
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First Published: Tue, Oct 23 2007. 11 04 PM IST
Updated: Tue, Oct 23 2007. 11 04 PM IST
The rising prominence of sovereign wealth funds is a boon for the asset-management industry. Sovereign wealth funds are foreign currency assets held by nation states over and above the reserves held by their central banks. If the rise of these funds is as spectacular as anticipated in the estimates currently doing the rounds, and if rich nations keep up the pressure on these mostly opaque institutions to become more transparent, the private sector fund-management industry could expect billions of dollars in additional revenue.
In fact, the longer it takes for the US current account deficit to narrow and the harder China resists the currency appreciation that a weakening dollar entails, the bigger may be the payoff for the global asset management industry. Analysts can’t agree on the numbers. No one knows for sure just how large Asian and West Asian sovereign wealth funds will become in the coming years. Or, for that matter, how big they already are. According to Morgan Stanley economist Stephen Jen’s estimates, foreign currency assets held by nation states, minus central banks’ official reserves, will swell to $12 trillion (Rs477.6 trillion) by 2015, from about $2.5 trillion now.
Merrill Lynch & Co. Inc.’s forecast is for $7.9 trillion in 2011, compared with $1.9 trillion currently. Standard Chartered Plc.’s chief economist Gerard Lyons reckoned these funds will have $13.4 trillion in assets within a decade, a six times increase from the current level of $2.2 trillion. Although the projections differ, they all suggest that an enormous sum of money will be channelled into global assets through sovereign wealth funds. And that’s giving rise to concerns in the West about both the likely investment strategy of these funds and their style of functioning. Will these funds pursue a hidden agenda dictated by their political masters? Will they seek strategic dominance of key resources (such as oil) and infrastructure (such as ports), exploiting the developed world’s openness to international capital to further their national foreign-policy objectives?
“The scale of sovereign wealth funds could give them unprecedented scope for foreign political influence over private corporate behaviour,” Richard Portes, an economics professor at the London Business School, wrote on the website realIR.net, an European investor relations portal.
It doesn’t help that many of these funds are also opaque.
The Abu Dhabi Investment Authority, set up three decades ago, has never disclosed the size of its assets, estimated to be anywhere between $250 billion and $1 trillion, research by Standard Chartered and Oxford Analytica Ltd revealed.
The recently created China Investment Corp., which is taking over management of part of the country’s $1.4 trillion foreign reserves from the central bank, “will be run purely on commercial principles,” Lou Jiwei, the chairman of the state agency, told reporters last week during the Communist Party’s congress in Beijing. “Political considerations will have no bearing on the investment choices,” he said.
Mere assurances won’t be enough; Western politicians, such as German Chancellor Angela Merkel, want clear rules.
“We see merit in identifying best practices for sovereign wealth funds in such areas as institutional structure, risk management, transparency and accountability,” the finance ministers and central bankers from the Group of Seven industrialized nations said after a meeting in Washington, DC last weekend. That’s effectively a nudge to Asian and West Asian governments to copy the Norwegian model.
Norway’s $357 billion global pension fund is transparent about performance and costs, owns small stakes in thousands of companies, and parcels out business to 50 external asset managers. While 78% of assets are managed directly by employees, internal managers are only responsible for 39% of the overall risk, according to a Merrill Lynch study.
“Using external managers shields the sovereign wealth fund from protectionist measures and accusations of market manipulations,” Merrill economist Alex Patelis and his team noted in the report. Sovereign wealth funds have traditionally been formed to deal with a temporary surfeit of petrodollars: As many as 14 out of the top 20 of these have commodities as their main source of income, says Standard Chartered’s Lyons. Oil-importing Asian nations, such as China and South Korea, have also joined the fray, as their reserves exceed the levels required for purely precautionary motives. Led by China, Asia now owns two-thirds of global foreign exchange reserves—up from one-third a decade ago, Lyons said.
Asian nations have relied on the expertise of central banks to recycle current account surpluses into safe and liquid developed-currency debt securities. Sovereign wealth funds are different. They must take higher risks to fulfil their mandate of earning a higher return than is possible on official reserves.
Global asset managers can potentially make as much as $8 billion a year in additional revenue from managing sovereign wealth funds, the Merrill study said.
That’s thousands of new jobs every year for money managers and analysts.
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First Published: Tue, Oct 23 2007. 11 04 PM IST