Sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property or other financial instruments. SWFs have gained world-wide exposure by investing in several Wall Street financial firms including Citigroup, Morgan Stanley, and Merrill Lynch. In its most recent shopping frenzy, Dubai bought an undisclosed stake in Sony, Abu Dhabi acquired stake worth $7.5 billion in Citigroup; China parked $3 billion in private-equity firm Blackstone and South Korea’s, Korea Investment Corp., invested $2 billion in Merrill Lynch. Morgan Stanley estimates that, SWFs have poured nearly $37 billion since April into, mostly Western, financial institutions. SWFs may soon become the most important buyers of stocks and bonds, and oil economies account for about two-thirds of such assets globally. This is a fairly new name for something that has been around for quite a while: assets held by governments in another country’s currency. SWFs are typically created when governments have budgetary surpluses and have little or no international debt. it is not always possible or desirable to hold this excess liquidity as money or to channel it into consumption immediately. Another major motive for the origin and subsequent rise of SWFs is to form a buffer against volatile commodity prices.

In the 1970s, major oil exporters adjusted their expenditures to their enlarged oil revenues, but in the decade of 1980s oil prices plunged, landing them in crisis. Learning the lesson, oil producers like Russia have set-up “stabilization funds”. After the Asian and Russian financial crisis of 1997-98, these governments further recognized that they could not rely upon the IMF to bail them out, highlighting the need for sufficient reserves of their own. Presently, these reserves have reached $450 billion in Russia and $1.44 trillion in China, corresponding to one-third of Russia’s GDP and half of China’s.

SWFs have been around for decades but since 2000 the number of such funds has increased significantly. Currently, more than 20 countries have these funds, and half a dozen more have expressed interest in establishing one. The first SWF was the Kuwait Investment Authority (KIA), a commodity SWF created in 1953 from oil revenues before Kuwait even gained independence from United Kingdom. According to many estimates, KIA’s assets are now worth approximately $250 billion. China, for example, enjoys a huge excess of currency reserves as a bi-product of its attempts to keep the renminbi’s value down. At present, China’s $1.7 trillion (March 2008) in foreign reserves (excluding gold) is growing at a rate of $20 billion a month, while states such as Qatar and Russia are enjoying huge streams of revenue from oil and gas sales. Abu Dhabi now boasts of the largest fund, sized at over $850 billion. In 1990, Norway established a fund for its excess oil incomes. Singapore has accumulated two large funds that are not based on oil income. And more recently, China, South Korea and Russia have instituted large SWFs of their own; India is also pondering over the issue.

Global SWFs grew by 24% over the past five years to $3.5 trillion by end-2007, from the $500 billion held in 1990. Economists forecast that SWFs will grow to $12 trillion by 2015. Assets under management of SWFs increased 18% in 2007. Most of this growth stemmed from an increase in official forex reserves in some Asian countries and rising revenues from oil exports. There was also an additional $6.1 trillion held in other sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations; and $5.3 trillion in official forex reserves not held in other sovereign investment vehicles. US-based economic and financial research company Global Insight, in its Sovereign Wealth Fund Tracker report, said that the sovereign wealth will surpass the entire current economic output of the US by 2015 and European Union by 2016. According to a Standard Chartered October 2007 report, SWFs account for approximately 1.3% of the world’s stock of financial assets (stocks, bonds and bank deposits).

Courting SWFs

The consequences of the subprime mortgage lending crisis have been wide-spread. S&P’s recently estimated they will exceed $285 billion in the US. Japanese financial institutions incurred losses totaling more than $18 billion from exposure to US subprime mortgages in the year ended March 31, 2008. At over 100 of the world’s biggest banks and securities firms, there have been around $379 billion in asset write-downs and credit losses since the beginning of 2007, including reserves set aside for bad loans.

Amid this, SWFs are strategically positioned at what is touted to be the end of the credit crunch, getting ready for fruitful investments, becoming a harbinger of financial institutions that will rescue troubled firms (read banks) in US and Europe. A new concept doing the rounds in the sovereign fund sector is a SWF joint venture fund, where two or more SWFs jointly create an investment fund. One such case is the Vietnamese State Capital Investment Corp. and the Qatar Investment Authority formed a $1 billion investment fund to invest in Vietnamese companies.

To lay things straight, the financial world is motivated first and foremost by financial considerations, therefore courting SWFs makes perfect sense. Borrowing Willie Sutton’s famous reply when asked why he robbed banks - "because that's where the money is". With tens, and in some cases hundreds, of billions of liquid capital to invest, SWFs are where the money is. While many nations’ policy makers cry foul, squads of financial wizards are busily trying to address the question of how to spend all that money.

The Deal Hunters 2007 *

It is said that SWFs now represent the most powerful group of global investors, more than enough to match the total annual economic output of the UK, Germany, or France. Owing to large amounts of debt-free cash, SWFs are the new financial power brokers, replacing combined financial muscle of hedge funds and private equity, and taking over central banks as the international capital providers as last resort. Amid global credit turmoil where many debt markets have buckled, SWFs have been proactive enough to buy up hard-hit firms while in some cases they have been approached for some financial assistance. SWFs have injected up to $80 billion into banking-related stakes in the US alone and are expected to pledge more. Since March, partners from major US private equity players including Boston’s Bain Capital and Thomas H. Lee Partners have boarded jets to Abu Dhabi, Kuwait, Saudi Arabia, and other destinations in the region to court wealthy investors.

Conclusion

SWFs will be the lifeline of many firms who want funds.