Sovereign Wealth Fund

3. What were they doing in the past and what have they been doing recently?

5. Past

It has been observed that over the last decade there was a rapid accumulation in foreign exchange reserves by developing countries. IMF data shows that from December 2001 to October 2007, global reserves tripled from US$2.1 trillion to US$6.2 trillion, and more than 80% of this increase is from developing countries and their current reserves have reached US$5 trillion The foreign exchange reserves have been growing very fast in the last several years, remarkably with the growth from China, India, commodity-producing countries and oil-exporting countries based in Middle East. Take the US$1.6 trillion increase in Asian reserves as an example. Three-fourths of this huge increase actually come from China and India. For oil-producing countries, their reserves are no less than US$430 billion which is 2.5 times more than the amount they had five years back. Grouping China, India and oil-exporting countries, we can see that this group actually accounted for more than half of the deviation in international reserves. Another country who is also present in this trend is Latin America with its reserves almost doubled during this period. The two main reasons behind this trend of increase in foreign assets were identified by Aizenman and Glick (2007) as recent boom in commodity prices, particularly oil and the accumulation of international assets by non-commodity exporting countries which are running persistent account surpluses.

11. Growth of SWFs in Emerging Markets: China, Russia, Middle East, Asia

With the rapid accumulation in their foreign exchange reserves, SWFs in developing countries have been growing very fast. The foreign exchange reserves of the Middle East, Russia and China have been increasing rapidly. The total accumulation of current account surplus for oil producers is US$500 billion and US$325 billion solely for China. Because of this, oil producers’ reserve surged to US$3.5 trillion compared to China’s US$1.3 trillion and Russia’s US$425. Out of the largest 20 SWFs, 14 have their main source of income derived from oil or other commodities, which mean 70% of total funds in SWFs are based on oil and gas. And this money stream flowing into investments in developed economies is now a focus of attention from Western governments. Apart from Middle Eastern funds and some more established investment vehicles in Asia such as Government Investment Corporation (GIC) and Temasek in Singapore, the Western attention focused on some newer funds, such as the $200 billion China Investment Corporation (CIC) set up earlier this year.

In addition, accumulation of funds from Eastern Europe, Latin America and Africa has increased. An example of this is Russia’s plan to split its lower return Stabilization Fund into a Reserve Fund and a Fund for Future Generations. The Reserve Fund will accommodate an increase in revenue from oil and gas up to 10% of GDP, and the Fund for Future Generations will be used to invest in riskier assets. Brazil has also made a new move in establishing a state investment vehicle. Even Libya has just set up a fund of $40 billion.

6. Current Trend

1. SWFs invest in emerging markets

With their strong growth as mentioned earlier, emerging markets are now very attractive as a place for investment. Abu Dhabi Investment Authority (Adia), a strong believer in the growth of such markets, is making significant investment, especially in Asia. The amount is known to be far greater than the amount of US biggest pension fund, as stated by Jean-Paul, head of Adia’s investment strategy. Qatar Investment Authority ‘s (QIA) intention to expand its investment in Asia is another example. Kenneth Shen, Head of strategic and private equity of QIA explained that this is because they see the attractive risk/return profiles of these countries. Besides, their portfolio is mainly focused on North America and Europe, thus a further exposure to Asia is necessary. Of all emerging markets, China appears to be most attractive and is now the target for a lot of funds. There would be no better example for this than the record-breaking $19.1 billion IPO of the Industrial and Commercial Bank of China last year, which attracted a number of funds from Middle East including ADIA and QIA to participate. In the end, more than half of the top 15 allocations belonged to Middle Eastern investors. According to Richard Gibb, Asia Pacific Head of financial institutions group at Merrill Lynch, the demand from Middle East investors for US or European IPOs has been historically limited, compared to the huge amount they are putting in Asia. Besides that, it is seen that Asian funds are big supporters of their own region, mostly because of its growth prospects. An example would be Temasek of Singapore. Temasek has considerable investments in Thailand, China, Indonesia, Korea as well as at its hometown, Singapore. Recently, it increased its stake in Vietnam by acquiring a 10% share in Minh Phu Seafood, the country’s largest shrimp processor and exporter. Nevertheless, it is noticed that SWFs are now evaluating its investments mostly based on economic opportunity. Sector or geography do not play as important a role. This assessment method is similar to other major asset managers.

2. Increasing important role in the current financial turmoil

1. Capital providers

In the current market situation with Europe and US stocks stumbling, bad credit markets and M&A activity drying up, these funds’ influencing power has become more apparent than ever. Dino Kos, a Federal Reserve Bank of New York former senior official and a managing director at Morgan Stanley Investment Management in Hong Kong, said “At a time when deleveraging is taking place and potential providers of capital, such as banks, hedge funds and insurers, are reducing their risk levels, sovereign wealth funds, by keeping their powder dry, can undertake a deal when others cannot.”

2. Power brokers in global capital markets

With the emergence of sovereign wealth funds as “power brokers” in the global capital markets, financial institutions are trying to understand their movements. The analysis is toughened due to the lack of uniformity in the way these funds manage their money, which differ from central banks. According to John Nugee, head of the official institutions group at State Street Global Advisors in London, most central banks follow the general principles of reserves management which is to seek security and liquidity first and returns only come in later. On the contrary, there is no common standard about how sovereign wealth funds should manage their money. In fact, treating different funds as if they were the same is one problem in the analysis of these funds. These funds are not an homogenous group moving in the same direction and acting in the same way. As Cynthia Sweeney Barnes, HSBC’s global head of sovereigns and supranational in London puts it, SWFs are not a pack that operates in the same way with exactly the same needs. There are variations in the sophistication and risk levels.

7. How have they been doing lately?

1. Advantages of subprime crisis

With the severe effects of the subprime crisis lasting until now, a lot of companies can be bought at much a cheaper price and this is advantageous to SWFs. There have been tens of billions of dollars flowing into Western financial firms this year, from Bear Stearns and Barclays to HSBS Holdings and Blackstone Group. To be specific, Abu Dhabi bought 4.9% of Citigroup for $7.5 billion, helping the bank finding way out of the subprime crisis. 10.8% of UBS were sold to GIC and $11.5 billion to an unnamed Middle Eastern investor

4. Concerns about sovereign Wealth Funds

Recently, a lot of concerns about SWFs are evolving. These apply to both, the investing SWF countries as well as those countries who receive the SWF investments.

8. Concerns for investing countries

1. Fiscal and monetary policy

Within the investing countries, a poor management of SWF investments could lead to decreasing efficiency and transparency of resource allocation and cash management due to fluctuating availability of money for governmental spending (IMF, 2008). Another negative aspect of badly managed funds would be the increased riskiness of investments related to probable losses. This would decrease assets for fiscal policy as well (IMF, 2008). Moreover, the monetary policy could be affected as currency exchange transactions are involved with the system of investing abroad and repatriating returns (IMF, 2008). So, SWFs impact the demand for and supply of home and foreign currencies which can also be used as a political tool. This concern is mainly valid for the investing countries. But SWFs are a means of increasing government income and hence indirectly supporting monetary and fiscal policy. Consequently, this is a valid but not often fulfilled concern for most SWFs.

2. Risk

As the majority of big SWFs is investing strategically rather than passively to amplify their returns, there is higher risk involved (IMF, 2008). This effect is increased if additional capital is borrowed to increase returns because with loan-financing risk increases. Moreover, the shift of more money out of more secure financial assets into SWFs increases on the one hand the return possibility, on the other hand the risk exposure (IMF, 2008). However, this depends on the objective of the individual funds. For example, there is only a very small percentage of borrowing by SWFs. The validity of this scrupulosity is the same as the one of fiscal and monetary concerns: SWFs are basically generating further income for their home countries so they will not take on risks so high as to outset their investment. Hence, this concern might be valid but not commonly experienced.

3. International Financial Markets

By their nature, SWFs can play a stabilizing role in global financing markets for both, investing and receiving countries. SWFs as long-term investors and mainly unleveraged positions are able to sit longer in the market during market downturns or even go against market trend in recipient countries. Therefore, SWFs’ investments enhance the depth and breadth of markets and contribute to greater market liquidity and lower volatility. In case of the credit crunch, investments of SWFs into banks such as Bear Stearns can be seen as a balancing factor. However, they refused to invest further into these banks so that this stabilizing role is only fulfilled to a certain degree. Moreover, having large and unclear positions in financial markets, SWFs also have potential to cause market disturbance. For example, any actual or rumoured transactions may result in herding behaviour and affect assets’ valuation (IMF, 2008). Furthermore, the shift away from reserve assets to SWFs due to a more strategic than passive investment strategy will affect the future patterns of global capital flows . Firstly, there is estimation of net capital outflows out of US assets due to large reduction in demand for US bonds, which partly offset by an inflow into US equity market. Secondly, there is also suggestions of net capital outflows out of euro area asses due to net inflow into euro area equities is far offset by capital outflow of euro are bonds. Thirdly, the destination of net capital outflows from US and European area are mainly Japan and emerging economies. This anxiety is reasonable considering the strategic investment strategy as well as the current downfall of the US$ and decreasing American economy.

4. Size

With a market capitalization of US$3.3 trillion, the size of SWFs raises concerns about its market moving ability. Although this is a rather small part of overall market capitalization of investments in the world, SWFs are able to considerably move markets, especially smaller or less liquid ones (Cohen, 2008). Because of their size, even rumours concerning SWF investment can influence market behaviour resulting in a procyclical impact despite their already mentioned stabilizing nature (IMF, 2008). Apart from their big impact today, SWFs are growing fast. Reinvestment of today’s returns, further exploitation of resources such as oil and minerals and growing tax and other receipts due to growth of most SWF countries will increase the overall wealth captured in SWFs. Although estimates range widely, they all project a huge SWF growth in the close future resulting in a value of US$12 trillion by 2012 according to the IMF (2008). With their growing size, the impact of SWFs will increase even more stressing the importance of concerns. The issue of big size of SWFs disturbing markets and fortifying other topics of anxiety is valid but only to the extent that SWFs invest without responsibility and view towards the effects of their investments. Considering the mainly long-term investment strategies, markets might not get too volatile in the short time. Moreover, the big size of SWFs is rather a foundation for other concerns than a single concern itself.

5. Transparency

The high amount of secrecy surrounding some SWFs is a further concern. Not only are figures about their size hard to find but there is also a high amount of secrecy about their investment strategy and their operations in some countries (Portman, 2008). This lack of reliable information can create uncertainty for both investing and receiving countries and implies adverse intentions. As secrecy leaves room for interpretation it increases volatility in markets due to rumours as already mentioned. The funds of New Zealand and Norway are ranked to be very transparent because they reveal clearly where funding comes from and where it is invested in, similar to US regulated mutual funds. For example, they publish reports quarterly (Wharton, 2008). In contrast, the information about funds such as the Saudi Arabian SAMA, United Arabian Emirate’s ADIA and most importantly China’s CIC and SAFE, all having assets under management above US$100 billion rank well below a sufficient transparency level according to the Linaburg-Maduell Transparency Index . The level of transparency has a clear relation to the type of state the fund is governed by: democratic states such as Norway are more dependent on their people’s trust and hence give out more information (Wharton, 2008). Another question that arises is how much governmental SWFs make use of sensitive information that is only available to them. This could be for example publicly unknown information retrieved through intelligence agencies (Kimmit, 2008) which would allow the funds to outperform the market due to information asymmetry. In general, it can be said that a visible lack of transparency applies to most SWFs. However, to what extent this has negative effects is insecure and up to now, there have been no reports about large power misuse.

6. National security concerns

The probably most important criticism of SWFs arises from their potential impact on national security in the recipient countries. This issue is mostly considered by the US but also Europe. SWFs gain stakes in equity of firms and hence power to influence foreign economies and politics. This is especially severe for strategically important industries such as energy, telecommunications or similar core sectors. For example, the China National Offshore Oil Company (CNOOC) tried to purchase Unocal, a US oil producer, in 2005. In 2006, the government-owned Dubai Ports World (DP World) attempted to acquire the British-based Peninsula and Oriental Steam Navigation Company (P&O), operating several port facilities in the United States. Both these bids were withdrawn, but raised concerns and awareness (Cohen, 2008). In general, national security concerns are mostly raised with view to China and Russia and the United Arab Emirates. Another issue is the potential harm of SWFs investing in companies where they can extract knowledge or technology and hence undermine the competitive advantage of some countries. However, this is claimed to be hypothetical as no such case appeared up to today. Nevertheless, one should be aware of the fact that the future may not follow the past’s patterns and that there is a potential for power abuse (Cohen, 2008).

9. Counteractions

1. Individual approaches

As individual countries had several concerns about SWFs, they worked against them by national legislation and regulation. Since 2006 countries receiving 40% of all world FDI, have either introduced or are creating regulations and laws that increase governmental oversight over inward investment. Sometimes, this even leads to direct restrictions of SWF activities (Marchick & Slaughter, 2008). The US Senate considered SWFs to be a “major national issue” (US Senate, 2008) and the US Congress passed the Foreign Investment and National Security Act (FINSA) of 2007 to bring past legislation concerning FDI up to date concerning SWFs. France acted already in 2005 by obliging authorization for foreign investments in eleven sectors that may affect “national defence interests” before action can be taken. In August 2007, Japan changed its internal investment legislation as well as Canada did three months later by a broader Investment Canada Act. Australia passed six principles for reviewing foreign investments in February 2008 before Germany introduced laws enabling prior investigation of special investments in April which was tightened in August. Hence, major countries in world trade have taken counteractions and tried to protect their home industries from foreign takeovers.

2. Collective

In addition to the individual actions, there have also been collective approaches. In February 2008, the European Commission officially demanded new investigations of SWF operations by OECD and IMF (European Commission, 2008). Moreover, the G-8 set them under pressure to provide best practices for both sides involved, whereas the IMF should elaborate on the investing and the OECD on the investment recipient side. For the IMF, the way towards a best practices framework was not easy. Initial opposition of countries involved claims of parties that they would only join the development of the GAPP (generally accepted principles and practices) because of fear of negative political implications from the US The GAAP is going to be published in October, but there are concerns that it might lack the ability to set regulations through as they are only mandatory (Martin, 2008). Moreover, restrictions could lead to a change in investment strategy for SWFs with possible negative outcomes for the recipient countries if this source of funding will run dry. The workings of the OECD produced up to now an interim report in April 2008 but no concrete measures where taken yet. This is justified by the fact that there are already regulations existent who are suitable as a guidance in the case of investments of SWFs. Nevertheless, these measures still leave leeway to the single countries for broad interpretations (Cohen, 2008). However, there are many critics of this counteractive policy calling it protectionist. Moreover, this new wave of regulations might invite to exploit the claim of security for their own advantage. Hence, a new big issue arises which can be termed “The Great Trade-Off” (Cohen, 2008): Does fear of takeover and the benefit of national security justify major governmental control and intervention? A balance has to be found between safety concerns and freely operating markets.

10. Further recommendations

An agreement on best practices for both, the investing and receiving countries as developed by the IMF is most sensible for reaching this balance. Nevertheless, countries fear that best practices without the ability to set sanctions for infringements might not be a useful tool, neither for alleviating concerns of recipient countries nor for the investing countries that want to show their reliability and good will. A kind of independent institutions, judging SWF and recipient countries behaviour should therefore be introduced with the ability to sanction. Such a “court” within the WTO seems to be a suitable solution for this as it already is established in similar functions (Cohen, 2008). Moreover, the existing regulations should be improved as to diminish opportunism and increase equality in the way FDI is treated when it comes to interpretability of regulations. This could be done by clear definitions of terms such as “public order” or “economic security” (Cohen, 2008). This transparency should also be reflected in the risk assessment and treatment of SWF investment (Cohen, 2008). The outcome would be a more equal treatment of investments and an easier way for SWFs to plan their strategies because they could avoid justifiably critical investment areas in foreign countries. Moreover, concerns about protectionism could be alleviated as well as other ones diminished. For example, the shift of cash flows in international financial markets cannot be hindered without hurting the principle of a free global financial market. However, the negative impacts could be decreased by a sensible and fair behaviour of SWFs. This is as well true for the market disturbing effects of SWFs due to their size (Martin, 2008). Of course, political concerns about national security and transparency would be tackled by such improved regulations even better. Besides, the concern about risks could be tackled by clear communication of SWFs about their investment objectives stressing their long-term profitability. One good example is GIC that bought a large stake of UBS: They are communicating their belief in the long-term-profitability of this investment because a lot of people were concerned that GIC paid too much. Maybe China’s CIC should do the same, as they lost $840 million in the investment of Blackstone Group in the first three months.

5. Case Study

11. SWFs in Singapore

1. Overview

Despite being a young city country Singapore has gained tremendous reputation as well as controversy from international financial markets in managing its SWFs, namely GIC and Temasek Holdings. The foundation for SWFs to emerge in Singapore is that after gaining its independence in 1965, the government decided to establish many Government Linked Companies (GLCs) to kick start its investment and key industrial growth which required a huge amount of capital that no single individual company could finance. Hence, Temasek Holdings was established in 1974 as an investment arm of the government with the primary purpose to support local enterprises and key industries. Few years later in 1981, GIC was established originally to manage the government’s official reserves. Currently, Temasek Holdings hold assets of US$134 billion and have seven subsidiaries and representative offices in Hongkong, Shanghai, Beijing, India, Mexico and Vietnam. GIC‘s total assets are US$ 330 billion. It is represented in eight strategic locations of the finance industry, namely Tokyo, Seoul, Beijing, Shanghai, New York, London and San Francisco. In terms of total asset ranking, Temasek Holdings is currently ranked at 10th while GIC is at 3rd position among the top ten largest SWFs all over the world In terms of transparency, Temasek scored 8 out of 10 and GIC scored 6 out of 10 on the Linaburg-Maduell Transparency Index. This high ranking creates a competitive advantage for Singapore SWFs.

2. Performance and portfolio policy

According to the newest performance report released, the fund has a total profit of US$12,976 million and the total share holder returns since establishment is 18%. Its portfolio holdings geographically spread over Singapore, North Asia (China, Korean, Taiwan) , ASEAN, South Asia (India, Pakistan), OECD economies and others. In terms of industry sector, Temasek is holding a diversified portfolio with investments in eight main sectors among of which financial services and telecommunications & media account for the largest percentage. As stated on its website, Temasek Holdings is following four investment themes: Transforming economies, growing middle classes, deepening comparative advantages and emerging champions. Temasek Holdings is currently aiming to transform from a local market focused GLC into a globally diversified investment corporation with its focus on emerging markets (Temasek Holdings Performance review, 2008).

Even though GIC has much larger total assets than Temasek holdings, it reported the return rate for 2008 is 4.5% which it claimed was its objective. In term of geographical spread of its assets, Americas made up 40%, down from as much as 45% two years ago. Investments in Europe rose to 35% from 25%. Asia now accounts for 23%. While Temasek Holdings has already streamed into Asian emerging markets, GIC is just about to invest more into this segment. It is claimed to be the source of potential growth especially in the current context of global financial turmoil. In terms of asset classes GIC holding of bonds has been reduced to 25% from 75% 25 years ago. Equities now make up 44% of its portfolio. Alternative assets like real estate, private equity and infrastructure have risen to 23% (Strait Times, 2008). GIC has three subsidiaries to take responsibilities of investment into different industry sectors, namely GIC Real Estate Pte Ltd, GIC Asset Management Pte Ltd, and GIC Special Investments Pte Ltd. The investment strategy implemented by GIC is not yet publicly disclosed. However, it is kept to be in line with GIC’s objectives and purposes as mentioned in the interview with GIC deputy chairman Tony Koh on Financial Times: “GIC has always had a very conservative policy of investments. GIC is a fund management company. We don’t own the funds which we manage; the funds remain the sovereign funds of the Singapore government. We manage the funds under a mandate given to us by the Ministry of Finance, which is the legal owner of the funds”(Financial Times, 3rd Feb 2008).

3. Recent development and future trends

Both Temasek Holdings and GIC have actively participated in rescuing large commercial and investment banks during the subprime crisis and recent bailouts. Temasek bought up 9.4% stakes in Merill Lynch & Co while GIC pumped US$ 9.750 million in buying stakes of UBS (SWF institute). The announcements of these deals have proved the increasing stabilizing roles of SWFs in general and the significant effects of Singapore SWFs on financial markets in particular. Recently, GIC has also announced its acquisition of 4% stake in Citigroup (Bloomberg L.P.). Despite of serial bailouts, Temasek Holdings shows intensive investment activities such as acquisitions and divestitures of many large firms.

With positive investment returns for 2007 and first three quarters of 2008, Temasek Holdings disclosed its intention to continue with emerging markets in Asian region. Similarly, GIC shares this trend and start to shift the focus of investment into this segment. However, despite still being under government’s control, Temasek has shown the dimension to become more independent investment corporation, which might result in a different investment approach compared to GIC. Furthermore, under increasing concerns about SWFs’ transparency, both Temasek Holdings and GIC have played a pioneer role in promoting transparency and tighter scrutiny. GIC has announced that it will make annual results publicly since 2008, which shows a positive approach and movement tailing the concerns about SWFs lacking of transparency.

12. GCC Sovereign Wealth Funds

1. Overview

By the end of 2007, GCC Sovereign Wealth Funds will manage over $1 trillion, GCC central banks manage another $460 billion. Their combined portfolio will approach the Chinese one with a value of $1.7-1.8 trillion. Among GCC Funds, Adu Dhabi (ADIA) is the biggest SWF estimated at $650 billion in 2007 following by Kuwait (KIA) and Saudi Arabian (SAMA).

2. Source of funds

Oil revenue is the most important source of funds. Based on Saudi Arabia’s Budget 2008 forecast, they will spend $50 a barrel on imports, thus if oil price averages $100 a barrel, the GCC countries can spend $50 on investment overseas.

3. Portfolio

1. Currency Composition

GCC SWFs try to reduce the US$ share of their portfolio in recent years. However, the rise in dollar reserves of Gulf central banks far offset the reduction. All GCC central banks are estimated to have US$ shares of at least 70%. On the SWFs side, QIA and Kuwait have a low US$ share of 40%, ADIA is estimated to have one of around 50%.

2. Asset allocation

KIA and ADIA both have over 50% equities in their portfolio. ADIA has high equity allocation of 50-60%, significant alternatives of around 5-10%, a low fixed income allocation of 20-25%, 5-8% real estate and 5-10% in each of private equity and alternatives. Therefore, based on RGE Monitor estimate, ADIA achieved an average return of 16% since the end of 2000 and 20% plus in 2003-2006 compared to average return of Norway’s fund of 7.5% since the end of 2000 and 15% from 2003 to 2006 since the latter is less aggressive in their investment strategy. GCC SWFs are increasingly investing in Asia. On average, their shares in Asia reach from 5 to 20% and it is planned to increase their Asia holdings to 15-30% of their portfolio (2). SWFs in China

13. SWFs in China

Another economy with big SWFs drawing high attention is China. In March 2008, the foreign exchange reserves of China mounted up to US$ 1,682 billion, resulting from its continuously huge trade surplus. This makes China hold by far the largest foreign exchange reserves in the world. The responsibility of managing these reserves is held by SAFE – the State Administration of Foreign Exchange. About two thirds of these reserves are invested in US Treasury and agency bonds (3). By investing heavily in these bonds, China helps the US to finance its trade deficit that results to a significant part from their imports of Chinese goods. Already in 1997, China founded the “SAFE Investment Company”, a Hong Kong incorporated SWF equipped with estimated US$ 312 billion. By the end of 2006, the majority of its funds, around US$ 230 billion, was invested in US bonds while only a fraction of US$ 82.4 billion was invested directly abroad via FDI in companies like Total, Aviva, BP and Royal Dutch Shell (3). As the US$ has depreciated steadily over the last years, Chinas foreign exchange reserves were devalued heavily in real terms. Therefore, China started to set up a mega-SWF, the China Investment Corporation (CIC) in 2007. Its initial funds of US$ 200 billion were raised by the issuance of treasury bonds. Therefore, the CIC has to make an average daily profit of about 300 million Yuan (US$ 43.8m) to meet its required coupon payments. In the first coupon payment in February 2008, CIC paid 12.9 billion Yuan (US$ 1.88 billion) in total. The investments of CIC can be divided into domestic and foreign investments: Domestically, CIC is using the Sovereign Wealth Enterprise “Central Huijin Investment Corporation” as a vehicle to recapitalize and stabilize China’s major state-owned banks, e.g. by the purchase of shares of formerly privatized banks. When it comes to foreign investments, CIC stated that it aims to invest in 50 large-sized enterprises all across the world. Because of the size of its funds and its low transparency, CIC is currently one of the mostly discussed SWFs. Some of CIC’s foreign direct investments received a lot of attention: CIC owns now a 9.4% ownership (US$ 3 billion) of the Blackstone Group that holds e.g. the Hilton-Hotels. They bought a 9.9% stake (US$ 5 billion) of Morgan Stanley and own 80% of JC Flowers PE Fund shares (US$ 8 billion), a private equity fund in the US. Recently, CIC got shares worth US$ 100 million at the IPO of Visa. The third and fourth Chinese SWFs in terms of size are the National Social Security Fund (US% 74 billion) and the China-Africa Development Fund (US$ 5 billion). The National Social Security Fund was funded in 2000 and is financed by the capital that is set free by selling the shares of formerly state-owned companies to public, and by taxes of the central government. They’re investing mainly domestically, but plan to invest around 20% of their total funds in emerging markets and Europe. Like CIC, they are allowed to invest in equity, too. The China-Africa Development Fund was established by the China Development Bank in 2007. They invest in stocks, convertible bonds and other quasi-equity in Africa. Recently, there were a lot of discussions about China’s policy towards African countries, as China tries to reach certain political and economic objectives by using its rising economic power and influence in Africa. The last of China’s SWFs is actually a Hong Kong SWF, the Hong Kong Monetary Investment Portfolio that manages US$ 173 billion. The Hong Kong Monetary Exchange Fund is responsible to stabilize the local currency by investing mainly domestically in companies that are listed in the Hang Seng. The exchange fund can be split into two parts: The so-called ‘Backing Portfolio’ holds assets that are denominated in US$ in order to provide a basis to back the local currency. The ‘Investment Portfolio’ is the actual SWF that uses external managers, too. One third of the exchange fund’s total asset is invested in the Investment Portfolio (4). In general, China’s SWFs rely mainly on external managers, as they have little experience in this area.

6. Conclusion

Increasing from total assets of US$500 million to US$3.3 trillion from 1990 until now, SWFs show a large potential to grow rapidly and participate more deeply in financial markets. By employing different investment strategies, SWFs in general have generated positive returns on diversified asset portfolios since their inception. Nevertheless, from what SWFs have done to help stabilize the recent financial turbulence, market participants become more convinced of their significant roles in the financial markets. However, on the other hand, there are still many concerns about SWFs which leave much room for further improvement especially in terms of transparency and management. Hence, while the role and its effect on financial market are undeniable, there is a need for an international collaboration in setting a standard regulation system and guideline to make it a healthier and more efficient financial institution.

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7. Appendix

14. Appendix 1- Geographical distribution of SWFs

15. Appendix 2 – Asset Comparison

Total assets of SWFs all over the world in comparison with other type of financial institutions (2008)

16. Appendix 3 - Ten largest SWFs in terms of Assets under management

Source: Amadan  International ( )

17. Appendix 4 – SWFs Characteristics

Source: Stephen Jen, “Definition of a Sovereign Wealth Fund”, Morgan Stanley, October 2007

18. Appendix 5 - Investment activities of Temasek Holdings in 2008

Source: Bloomberg L.P.

19. Appendix 6 – Investment Strategy

 

20.  Appendix 7 – Global Reserve Accumulation

21. Appendix 8 – Global Reserve Accumulation – Selected Groupings and Countries

22. Appendix 9 – Emerging Markets Foreign exchange reserves

23. Appendix 10 – Sovereign Wealth Infusions for Banks

24. Appendix 11 – Forecast of Future Global Capital Flows

Table 4 shows that the magnitude of excess reserves is indeed substantial, estimated to exceed USD 3 trillion or more than half of total official foreign exchange reserves to date.

As for the portfolio allocation of reserves and SWF assets, we assume that foreign exchange reserves are allocated across currencies as reported in the IMF’s COFER database (Table 5, Panel A). As a long-run benchmark portfolio for SWFs, we take a ten-year average of global market capitalisation weights, broadly in line with the available evidence discussed in Section 2 (Table 5, Panel B) A further rationale for taking market capitalisation as a benchmark allocation for SWFs follows the argument, discussed in detail above, that in principle SWFs aim to follow a portfolio allocation strategy similar to that of private asset managers, which in turn is broadly mirrored in market capitalisation shares, provided that the assumptions of the traditional international Capital Asset Pricing Model (CAPM) hold.15

A comparison of Panels A and B allows a simple back-of-the-envelope calculation of the capital flows resulting from a potential shift out of foreign exchange reserves into SWFs to be performed. In a first step, we estimate the amounts invested in the various markets by applying the shares reported in Panel A to our estimate of global excess reserves. In a second step, we compute an alternative asset allocation by applying the benchmark weights of Panel B. The difference between the amounts invested in each market under the two allocations yields a back-of-the-envelope estimate for potential net capital flows. Our benchmark results are presented in Scenario A of Table 6.

Three main findings stand out:

First, a reallocation of excess reserves would trigger net capital outflows out of US assets at an order of magnitude of around USD 500 billion. This net outflow is entirely due to the large reduction in demand for US bonds, which currently are still the main investment target of most official foreign exchange reserve managers. However, as SWFs shift capital from less risky bond markets to more risky equity markets, the outflow out of the US bond market is partly offset by an inflow into US equity markets, given the large size of US equity markets, which currently account for roughly 45% of world stock market capitalisation.

Second, this simple exercise also suggests net capital outflows out of euro area assets. As Table 6 shows, the net inflow into euro area equities of around USD 200 billion would be more than offset by net outflows from euro area bonds of around USD 400 billion. In other words, official reserve assets are currently more overweighted in euro area bonds than underweighted in euro area equities, when taking portfolios based on market capitalisation as a benchmark.

Third, the counterpart of these net outflows from the United States and the euro area are mainly Japan and emerging economies, reflecting the relatively large weight of these countries in global capital markets compared with their negligible role as reserve currencies. In fact, aggregating net capital flows of developed countries (i.e. the United States, the euro area, the UK and Japan) shows that capital would flow from developed to “other”, i.e. emerging and developing, countries.

25. Appendix 12- Transparency Index

26. Appendix 13 - Key portfolio return indicators of Temasek Holdings 2008

Source: Temasek Holdings Performance Review 2008

27. Appendix 14 - Temasek portfolio by geography (2008)

Source: Temasek Holdings Performance Review 2008

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28. Appendix 15 - Temasek Holdings portfolio by sectors 2008

Source: Temasek Holdings Performance Review 2008

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29. Appendix 16 – Size of GCC Funds

Source: RGE Monitor Report

30. Appendix 17 – GCC Imports and Current Account Surplus

31. Appendix 18 – Current Composition of GCC Official Assets, end 2007

Source: Setser and Ziemba, “Understanding the New Financial Superpower – The Management of GCC Official Foreign Assets”, RGE Monitor, December 2007.

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32. Appendix 19 – GCC Asset Allocation, end of 2007

8. Bibliography

1. Sovereign Wealth Fund 2008. London : International Financial Services London, April 2008.

2. Understanding the New Financial Superpower- The Management of GCC Official Foreign Assets. Ziemba, Setser. December 2007, RGE Monitor.

3. SWF Institute. [Online] 05 10 2008. http://www.swfinstitute.org.

4. Roland Beck, Michael Fidora. The Impact of Sovereign Wealth Funds on Global Financial Markets. s.l. : European Central Bank, July 2008.

5. International Monetary Fund. Sovereign Wealth Funds Report. s.l. : Monetary and Capital Markets and Policy Development and Review Departments, February 29/ 2008.

6. The definition of a sovereign wealth fund. Jen, Stephen. October 2007.

7. A lot to Learn: Many Sovereign Wealth Fund Managers Come up Short in Measures of Sophistication Published. Knowledge@Wharton. August 2006.

8. International Monetary Fund. Sovereign Wealth Funds - A Work Agenda. 2008.

9. http://www.swfinstitute.org/research/transparencyindex.php. Linaburg-Maduell Transparency .

10. European Commission. Commission puts forward proposals to the European Council on sovereign wealth funds and financial stability . 27 February 2008.

11. Current and Projected National Security Threats. Washington DC. : Hearings before the Senate Select Committee on Intelligence, 5 February 2008.

12. Marchick, Slaughter. [Online] 3 October 2008. http://www.cfr.org/content/publications/attachments/FDI_CSR34.pdf.

13. IMF draws criticism over code for sovereign wealth funds. Matthew, Martin. 9 May 2008, MEED: Middle East Economic Digest, p. Vol. 52/Issue 36.

14. Ocampo, Stephany Griffith-Jones and Jose Antonio. “Sovereign Wealth Funds – A developing country perspective”. September 2008.

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