Wednesday, August 19, 2009

Return of The Sovereign Wealth Funds

Sovereign wealth funds squirreled away like frightened dogs feeling the full effects of the financial meltdown. Many have been ridiculed as having overpaid for many of their purchases, jumping on the financial bandwagon with abandon. Well, they are bound to be back. The return of foreign exchange reserve accumulation and the increase in commodity prices suggest that sovereign wealth funds may again receive more capital as sovereign governments seek a higher return on their assets. The reduction in foreign exchange reserve growth and low returns on risky assets has reduced the inflows to and value of sovereign wealth funds, government investment funds.

    How Much New Capital?

  • Central banks manage about $7 trillion in assets, mostly fixed income. China accounts for over $2 trillion of that total, Japan $1 trillion and Russia, $400 billion.
  • SWFs now manage under $2 Trillion in a range of asset classes with Oil funds accounting for 3/4. Launch of several new funds, increase in assets, changing strategies of others contributed to SWF prominence in 2007. High oil revenues, exchange rate, reserves policies meant they received even more funds this year (mostly commodity funds). Yet losses on investments eroded their assets under management in 2008
  • Petrodollar investors (including the private sector) faced an asset decline of almost 2% in 2008 from 2009 as investment losses subtracted from record inflows. Asian sovereign investors, central banks, sovereign funds added to their holdings by about 8%, mostly due to record Chinese accumulation. Both stood at close to $5 trillion at the end of 2008.
  • Reduction in the oil price and slowing capital inflows to emerging markets reduced inflows to sovereign wealth funds after August 2008 while equity and alternative asset class losses likely eroded past investment gains meaning sovereign wealth funds may actually manage less today than they did a year ago despite record inflows to oil funds for much of this year. Going forward, the rate of growth of sovereign investors might slow considerably.
  • In Q1 2009, Sovereign funds had the lowest level of foreign purchases since late 2005 with the funds from Abu Dhabi being most active. In Q1 2009, there were already signs that the trend of funds investing at home is beginning to subside.
  • Central banks are switching to treasuries from agencies. Central bank purchases in q109, look to exceed central bank purchases in the Q104 when Japan was investing what then was considered a huge sum in the Treasury market.
  • Even as governments receive fewer inflows they may privilege liquid assets needed to support their financial sector and provide stimulus to other sectors, thus diverting diversification plans. However funds that privilege domestic economic development may continue to make significant purchases.
  • Future Growth Patterns

  • SWF portfolios will reach $10 trillion by 2015 (previous estimate $12T) . The funds saw around 18.0%- 25.0% paper losses by mid Q4 2008, suggesting the current value of SWF assets under management may have declined to $2.5T, from $3.0T.
  • Assets under management by SWFs are projected to grow to $8.5 trillion by 2012 if central banks transfer a significant share of their existing funds to SWFs (plus new flows) and $5 trillion if SWFs receive only new flows. Both estimates were revised down from that of 2007.
  • About three quarters of SWF investments were in developed countries, mainly, the United Kingdom, the United States and Germany, and 73% were in the services sector at end 2007. Developing countries (esp in Asia) received $10.5 billion, or 27% of the total but SWF activity was limited in Africa and Latin America. Business services made up 24% of the total, with much less going to the primary and manufacturing sectors and financial services.

p/s photo: Eri Otoguro

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