Actually, they might just want the farm. Despite the current media hysteria, sovereign wealth funds (SWFs) have been around for quite a while (Kuwait started one in 1953): they are simply an accumulation of assets held by governments in another country's currency which is actively managed. Driven by trade surpluses unequalled as a percentage of the global economy since the beginning of the 20th century, official reserves held by some governments are now astronomically high amid mounting pressure to earn better returns than passively available in US Treasuries. China alone has accumulated $1.7trn as of March, up 40% in a year. SWFs currently directly control about $3 trillion and, based on estimates by Morgan Stanley and others, could reach $12 trillion by 2015. Currently, more than 20 countries have these funds, and half a dozen more have expressed an interest in establishing one. What does $3 trillion buy you these days? Well, U.S. GDP is $12 trillion, the total value of traded securities (debt and equity) denominated in U.S. dollars is about $50 trillion, and the global value of traded securities is about $165 trillion, so not as much as you might think; however, SWFs promise to be probably the single most important pool of risk capital over the next decade and will soon be bigger than hedge funds and private equity combined. More importantly, the new SWFs in countries like China and Russia are fundamentally different in nature and scale from their predecessors, notably being highly politicised. Although there has been much market sneering at poorly timed SWF investments into the global financial sector, it would be a huge mistake to underestimate their ambition and savvy. The SWF agenda is quite simply fundamentally different to those of short-term Western institutions.
In many cases their priority will be to plug strategic national deficiencies in resource availability or technology as much as generating an immediate financial return. Personally I think the definition of official SWFs is too restrictive; Gazprom in Russia acts in many ways like a SWF to the extent that its overseas investments are driven not by strict shareholder value considerations, but national strategic imperatives. So too are many state controlled Chinese banks and investment companies. An instructive report on the phenomenon is the one issued late last year by the Merrill Lynch Global Economics team entitled "The overflowing bathtub, the running tap and SWFs". The five key trends forecast by ML for SWFs are:
1) A massive shift into riskier assets
2) A shift out of government into private sector assets
3) A shift out of USD into non-USD-denominated assets
4) A shift out of internally-managed towards more externally-managed assets
5) The centre of gravity of these shifts moving from the Middle East to Asia and Russia
I wouldn't expect to see SWFs buying the Chrysler tower or trophy gold courses, the kind of naive investing we saw with the Japanese investment wave in the late 1980's. Generally, the evolution from official reserves to SWFs should be positive for emerging market assets and positive for riskier, long term return assets in general such as infrastructure. A wholesale move from bonds to equities by the world’s central banks should also boost the yen, but be negative for bonds: the IMF has estimated that central bank buying has depressed yields on long-term US Treasury bonds by between 30 and 100 basis points. If in the future the recycling of trade surpluses into world bond markets slows sharply, long bond yields should rise, particularly in the US which has been the biggest beneficiary of these flows. Resources and infrastructure will continue to see major flows from SWFs, and the aggressive investments we have seen in major blue chip resource companies like Rio and BP by the Chinese are just the beginning, both to secure key commodity flows and to gain expertise for their indigenous industries; the SWF financing of resource developments discovered by smaller Western mining and energy companies will also become common, supplanting Western banks and pension funds. Resource rich regions such as Africa and Latin America (especially Brazil, soon to become a top 10 oil producer) will likewise see huge inflows, particularly from China and India, to develop their commodity export potential. Already a million Chinese work on such projects in Africa and this will likely be 10 million within a decade or so. India and China are now being played off by many investment hungry African governments in an echo of Cold War rivalries. For the long established Mid-East investors who are seen as less politically controversial, the US will be a key target due to market size, liquidity and familiarity, and they will almost certainly play a key role in the ongoing re-capitalisation of the US banking sector.
Don't be surprised to see SWF's buying huge chunks of commercial farmland and large scale agribusiness to guarantee food supplies as they face growing domestic deficits (eg Saudi has stopped subsidising domestic wheat production and will buy capacity abroad instead). This list of strategic targets would include companies offering technologies and expertise to enable a rapid improvement in local agricultural productivity, from drought and salt resistant GM seeds for example to advanced machinery. Russian, Chinese and Indian productivity in agriculture is currently between 15-20% of US levels in yield terms and will inexorably move to a more commercial footing.
Overall, expect SWF firepower to be focused in relatively few key areas including emerging markets led by Asia, natural resources (including water and farmland), key global infrastructure like ports and and to an increasing degree, advanced technology related to the resource shortage theme. These are all good long term investment themes fundamentally, that will be turbo charged by SWF interest.
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In many cases their priority will be to plug strategic national deficiencies in resource availability or technology as much as generating an immediate financial return. Personally I think the definition of official SWFs is too restrictive; Gazprom in Russia acts in many ways like a SWF to the extent that its overseas investments are driven not by strict shareholder value considerations, but national strategic imperatives. So too are many state controlled Chinese banks and investment companies. An instructive report on the phenomenon is the one issued late last year by the Merrill Lynch Global Economics team entitled "The overflowing bathtub, the running tap and SWFs". The five key trends forecast by ML for SWFs are:
1) A massive shift into riskier assets
2) A shift out of government into private sector assets
3) A shift out of USD into non-USD-denominated assets
4) A shift out of internally-managed towards more externally-managed assets
5) The centre of gravity of these shifts moving from the Middle East to Asia and Russia
I wouldn't expect to see SWFs buying the Chrysler tower or trophy gold courses, the kind of naive investing we saw with the Japanese investment wave in the late 1980's. Generally, the evolution from official reserves to SWFs should be positive for emerging market assets and positive for riskier, long term return assets in general such as infrastructure. A wholesale move from bonds to equities by the world’s central banks should also boost the yen, but be negative for bonds: the IMF has estimated that central bank buying has depressed yields on long-term US Treasury bonds by between 30 and 100 basis points. If in the future the recycling of trade surpluses into world bond markets slows sharply, long bond yields should rise, particularly in the US which has been the biggest beneficiary of these flows. Resources and infrastructure will continue to see major flows from SWFs, and the aggressive investments we have seen in major blue chip resource companies like Rio and BP by the Chinese are just the beginning, both to secure key commodity flows and to gain expertise for their indigenous industries; the SWF financing of resource developments discovered by smaller Western mining and energy companies will also become common, supplanting Western banks and pension funds. Resource rich regions such as Africa and Latin America (especially Brazil, soon to become a top 10 oil producer) will likewise see huge inflows, particularly from China and India, to develop their commodity export potential. Already a million Chinese work on such projects in Africa and this will likely be 10 million within a decade or so. India and China are now being played off by many investment hungry African governments in an echo of Cold War rivalries. For the long established Mid-East investors who are seen as less politically controversial, the US will be a key target due to market size, liquidity and familiarity, and they will almost certainly play a key role in the ongoing re-capitalisation of the US banking sector.
Don't be surprised to see SWF's buying huge chunks of commercial farmland and large scale agribusiness to guarantee food supplies as they face growing domestic deficits (eg Saudi has stopped subsidising domestic wheat production and will buy capacity abroad instead). This list of strategic targets would include companies offering technologies and expertise to enable a rapid improvement in local agricultural productivity, from drought and salt resistant GM seeds for example to advanced machinery. Russian, Chinese and Indian productivity in agriculture is currently between 15-20% of US levels in yield terms and will inexorably move to a more commercial footing.
Overall, expect SWF firepower to be focused in relatively few key areas including emerging markets led by Asia, natural resources (including water and farmland), key global infrastructure like ports and and to an increasing degree, advanced technology related to the resource shortage theme. These are all good long term investment themes fundamentally, that will be turbo charged by SWF interest.
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