With the all of the problems suffered lately by sovereign wealth fund, here is a backgrounder written before the crisis in Dubai:
Sovereign Wealth Funds (SWF)
There is nothing new about a sovereign wealth funds. The first major fund was created in Kuwait in 1953. The goal was to invest for the country’s future, and to stabilize the economy as the price of oil changed dramatically.
But the shift in the world’s economic reality made these kinds of operations suddenly more powerful, more important and, in some countries, more feared.
What gave them such importance?
As a result of great growth in their economies, sovereign wealth funds in Russia, Asia and the Middle East grew and gained notice. They largely used their funds to invest in the U.S. and the West. They relied on hedge funds and investors to also use the largest forms of investment to reap higher profits.
Their arrival was unique for two reasons.
One: It marked the shift of wealth from the traditional global powers that had built their wealth on manufacturing and dominance of global trade to some newcomers. And the newcomers benefitted from either the growth in markets for oil or gas or because their sales of products and services to the Western and other countries had seen a dramatic expansion. China is one country that benefitted as it sold more of its products, and built great wealth.
Two: these funds represented economic concentrated in the hands of governments, not private companies or individuals. The fact that decision-making now rests with governments raised the fear that the funds would use their new powers for political and not economic reasons.
The lack of openness about the funds and their investment goals also raised concerns in the West. Though their investment decisions lack transparency, the fact that many funds have relied upon riskier investments raised concerns. The fear was that they would add to the forces that have created greater instability in the financial markets in the West.
“The majority of state-owned funds are highly secretive about their portfolio allocations and investment strategies, even as they control increasing amounts of the world’s largest traded assets.”
Sovereign wealth funds, according to one estimate in early 2009, managed as much as $2.9 trillion. The United Arab Emirates reportedly had the largest fund in 2009 with as much as $900 billion, the Abu Dhabi Investment Authority and Corp. There are over 30 sovereign wealth funds.
The other countries with large sovereign wealth funds, according to experts and news reports, are:
Norway, Singapore, Kuwait, Russia, China, Qatar, Australia, Algeria, United State, Brunei, Korea, Kazakhstan, Malayasia, Venezeula, Canada, Chile, New Zealand, Iran.
But the funds reportedly lost large amounts with the sudden collapse of stock markets across the globe. The funds that have relied upon gas and oil resources for their wealth have reportedly also avoided invested in these areas to protect themselves against the kind that began taking place in 2008.
How can they influence world markets?
If the sovereign wealth funds shift their investments from a market or a country’s investments that can led to a rapid decline in its stability because of their powerful presence.
For example, sovereign wealth funds from the Middle East are ranked among the top six buyers of the U.S. government bonds. These bonds are the how the U.S. government pays for its debt. With the declining economy in the U.S., there were fears that the Middle Eastern sovereign funds would transfer their investments to other economies.
How has the crisis affected the major Arab funds
It was estimated that the major Sovereign Wealth Funds in the Gulf lost 27 percent of their assets in 2008. In most cases, the funds have reportedly used their finances to help their local stock markets. Some have also sought out less risky investments.
What is the future for Sovereign Wealth Funds?
Here is a suggestion from Rami Khouri, a commentator based in Beirut:
“This would seem to be the moment for Arab SWF managers and their political leaders to take advantage of the probably momentary leverage they enjoy globally and regionally, to help rewrite the prevailing rules of international financial investment flows. Three areas seem ripe for serious reappraisal.
First, the ultimate owners of these funds – the citizens of the energy-producing states – should be provided with more information on how the funds are accumulated and invested, rather than leaving this task to small groups of specialists. Second, inter-Arab investments in truly strategic industries like food production, water technologies, and solar energy should be considered much more seriously, now that basic infrastructure is in place in most Arab countries (which was not the case when the first oil boom hit in the early 1970s). Third, Arab investors should use this unique moment to negotiate better, more equitable, terms of global financial flows with the leading Western powers. This is a moment when some Arabs should be thinking more in terms of enhancing the wealth of their sovereignty, rather than bemoaning the erratic performance of their sovereign wealth.”