• World Affairs: Q&A

Sovereign Wealth Funds Flex Their Muscles

The Financialist: Kuwait established the first sovereign wealth fund in 1953, a half-century ago. Why are we hearing so much about them today?

Eliot Kalter: Because more than half of the sovereign wealth funds in the world have been created since 2000. As countries like the United States have accumulated large fiscal deficits, countries on the other side of the trade equation have built large surpluses. International reserves have grown 1,300 percent in non-Japan Asia since 2000 and by 900 percent in the Middle East and Africa. For a majority of those countries, that’s due to commodity exports, such as oil in the Gulf states or copper in Chile. In other countries, such as China, high domestic savings rates and low levels of consumption created the surplus.  Sovereign wealth funds were created to invest these external surpluses.

 

TF: Why do countries establish a sovereign investment fund instead of doing something else with it, like spending it on infrastructure or education?

EK: It’s another way to manage the inflow of capital. In developing countries, it may seem counterintuitive not to spend it on domestic needs, but these economies have to keep inflationary pressures in check and guard against “Dutch disease”—when the commodities sector comes to dominate the local economy. Dutch disease can also result in higher real exchange rates. So the funds send some of the money back out again – in fact, the mandate of many sovereign wealth funds is to invest abroad. Sovereign wealth funds can also invest in much more diversified portfolios than central banks, and hopefully earn a higher risk-adjusted return.

TF: Is there any particular type of investment that these funds favor?

EK:  Not really. On one extreme is Chile’s Social and Economic Stabilization Fund (SESF), which is designed to smooth government revenue shortfalls and therefore makes very conservative investments. The SESF holds about 70 percent of its assets in fixed income, and 30 percent in cash. On the other end of the spectrum, you have the Alberta Heritage and Savings Trust Fund, which has about a quarter of its investments in alternative assets.

Other funds exist specifically to fund pension plans; some take advantage of the liquidity premium that comes from alternative investments, while others have less appetite for risk. China’s National Social Security Fund is one of the latter; it allocates 60 percent of its assets to equities and 40 percent to fixed income. The New Zealand, Irish and Australian funds, on the other hand, all had more than 20 percent of their assets in alternative investments such as real estate and infrastructure in 2010. Investment reserve funds, including the Korea Investment Corporation, the China Investment Corporation (CIC), and the Government Investment Corporation (GIC) of Singapore, aggressively diversify their portfolios both geographically and by asset class. The GIC, for example, puts a sizable amount of money into real estate and private equity, as well as hedge funds and commodities.

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In this BLOG we will look at pensions and their impact on what are called Public Private Partnerships or P3’s.  IT will also deal with other pension matters, such as Defined Contribution Plans (DC) vs Defined Benefit (DB) PLANS, the weakness in private plans, the need for pension reform in public pensions to have shareholder rights, directorships and ethical investment directives and policies.