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Sovereign funds set to rule the markets

Ruth Sutherland

They’re bigger than hedge funds and more secretive than private equity. Sovereign wealth funds — set up by governments to invest excess foreign exchange reserves — promise to supply the next big wave of controversy as they mushroom in size and become more aggressive in their quest for higher returns.

The funds have been around for years; the Economist magazine suggests the concept may have begun when the British administration of the Gilbert Islands in Micronesia in the 1950s used money raised from the sale of bird poo — u sed in fertilizer — to set up a fund now worth more than $500 million.

Sovereign funds, swelled in many cases by petrodollars, embody the increased muscle of emerging economies on global markets. Governments traditionally held assets in reserve to protect themselves from a currency crisis; these were gold, bonds or deposits, all low-risk and easy to liquidate.

With more than enough set aside for a rainy day, sovereign funds are now planting their flags in overseas share and property markets, and not everyone is happy.

Apart from Norway’s fund, set up with its North Sea oil money, these investment vehicles are opaque, giving little or no information on their returns or strategy.

The Bush administration has just issued a warning that their lack of transparency is a threat to the stability of world financial markets, saying it wants the IMF and the World Bank to intervene.

The nascent U.S. debate has been stirred further by the Chinese purchase of a $3-billion stake in private equity group Blackstone. There is an undercurrent of protectionism behind America’s ostensible worries about financial stability; the U.S. has already blocked a bid by China for oil company Unocal and prevented Dubai from taking over P&O’s U.S. ports.

But there are concerns. Sovereign funds already control around $2,500 billion of assets, according to Morgan Stanley — more than the $2,000 billion global hedge fund industry — and are growing by an estimated $450 billion a year.

This wall of money will be chasing a finite pool of assets and raises all sorts of questions. What happens when countries which do not believe wholeheartedly in capitalism or democracy become major stakeholders in large companies? Will the funds be used to prop up undemocratic regimes?

Will it provoke a backlash against globalisation? Where should the lines be drawn on foreign governments acquiring stakes in strategic industries? —

Guardian Newspapers Limited London 2007

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