May 29

Sovereign Wealth Funds and Your Company’s Portfolio

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If you haven’t read about SWF’s lately, you’ve been missing the juicier parts of the financial press.  I guess when general interest newspapers in the U.S. need to goose their circulation, they go for celebrity gossip, alien abductions, or Roger Clemens’ contract.  When financial papers need to goose their circulation they trumpet the latest large numbers.  How about $2.5 trillion and growing at 500 billion per year?  That’s more than the $1.6 trilliion in hedge funds… and that’s what Morgan Stanley has estimated for SWF’s.  What’s an SWF?

A Sovereign wealth fund (SWF) is a fund owned by a country (usual its central bank) composed of financial assets such as stocks, bonds, property or other financial instruments.  SWFs differs from foreign exchange reserves by maximizing long term return and are not created or used for short term currency stabilization.

In other words, our friends in China have grown restive with their investment in US Treasuries and want more.  (They already have currency reserves invested in primarily UST and MBS well in excess of what most economists believe they might need for currency stabilization.)  Their most recent, high profile investment was in the private equity firm, The Blackstone Group

And, it’s not just China.  Here’s an overview:

Monetary Authorities with the largest foreign reserves in 2007
Country Fund Assets, $bn Inception year
UAE Abu Dhabi Investment Authority 875 1976
Singapore Government of Singapore Investment Corporation 330 1981
Saudi Arabia Saudia Arabian funds of various types 300 na
Norway The Government Pension Fund of Norway 300 1996
China State Foreign Exchange Investment Corp. + Central Hujjin Note 1 300 2007
Singapore Temasek Holdings 100 1974
Kuwait Kuwait Investment Authority 70 1953
Australia Australian Government Future Fund 40 2004
US (Alaska) Alaska Permanent Fund 35 1976
Russia Stabilization Fund of the Russian Federation 32 2003
Brunei Brunei Investment Agency 30 1983
South Korea Korea Investment Corporation 20 2006

Note 1: Not yet finalized.    Source: Morgan Stanley(2007).

It’s good to be the popular kid on the block, with the World’s reserve currency, a stable government and legal structure ,and the largest military in history to protect it.  However, how good is it when those other kids are buying parts of your house with the dollars you paid for their baseball cards and chewing gum?  And, those other kids are under no obligation to tell anyone (not even their parents) what they are buying.

This is all fodder for the financial press to moan and grown about  how the U.S. is selling itself to foreigners (true).  But, we should not miss a key point for insurance company investment practices.  If this trend continues (and it does not look like it will halt any time soon), we will see equities (and especially large cap U.S. equities) become more popular and good old fashioned US Treasuries become less so.

Here’s what the Financial Times’ Alphaville Blog (http://ftalphaville.ft.com/blog/2007/05/25/4789/sovereign-wealth-funds-and-the-2500bn-question/?source=rss) said about this trend:

The International Monetary Fund recently cited estimates that central bank buying has depressed yields on long-term US Treasury bonds by between 30 and 100 basis points as prices have risen.  If buying eases, bond yields could rise and prices fall – and a greater share of new reserve accumulation will flow into non-bond assets. 

Yes, we’ve benefited from a strong MBS market as foreign buyers have allocated more USD to this asset class in recent quarters, but where will they go next?  And, how will that impact your company’s portfolio strategy?

I don’t think you can consider an asset allocation strategy without an estimate of what the growth of SWF’s, Hedge Funds and Private Equities will do to the investment landscape and risk/reward expectations.

Join in the discussion on this topic by going to the Insurer Investment Forum Online (www.saai.com/forum).  I look forward to your comments.