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The Wealth of Nations

7 minute read
Bill Powell

To Financial-services companies starving for cash during the subprime-credit crises, where bailout money comes from is less important than the fact that it’s available at all. Just ask investors in Citigroup. The global banking giant has reported billions of dollars of subprime losses, raising concerns that some of Citigroup’s assets might have to be sold off at fire-sale prices just to keep the company sufficiently capitalized. But on Nov. 26, New York–based Citi was handed a lifeline by an unlikely rescuer. The Abu Dhabi Investment Authority, a $625 billion sovereign wealth fund run by the tiny Persian Gulf emirate, announced it was forking over $7.6 billion to take a 4.9% stake in the company. While Citi still faces difficulties, the cash infusion helped stabilize its plunging stock price and signaled to rattled markets that money was available to help subprime victims survive the turmoil.

The investment by Abu Dhabi, part of the United Arab Emirates, also marked a turning point of sorts for sovereign wealth funds (SWFs). These enormous pools of wealth, controlled by governments in countries that have been getting fat off high oil prices and a booming global economy, are viewed skeptically by those who fear foreign powers might use them to gain competitive advantages or push political agendas. But now, thanks in part to the Citigroup deal, some fears have been allayed; companies in need of capital are courting investments from oil-and-gas-rich states such as Abu Dhabi and Russia, as well as from rising economies like China, which recently formed a $200 billion SWF to help the government invest its burgeoning foreign-exchange reserves. SWFs, says a senior banker at JP Morgan Chase, “are the new ‘it’ girl of global finance. Everyone wants a piece of them.”

The reason for that is clear enough. At a time of extreme stress in global equity and credit markets, many governments have surplus foreign exchange to play with — and because of the falling dollar, they are increasingly interested in investing their cash where it can earn greater returns than U.S. Treasury debt, the traditional safe haven. The largest SWFs — the so-called Super Seven, which includes China, Russia, Abu Dhabi, Kuwait, Norway and two Singapore funds — control up to $1.8 trillion. By 2011, assets under management at SWFs worldwide are projected to grow almost fourfold to nearly $8 trillion, according to Merrill Lynch. By comparison, hedge funds — unregulated private investment funds — control between $1.5 and $2.6 trillion, according to estimates.

With governments becoming more adventurous in the way they invest their surplus wealth, investors ought to “rejoice at the impetus the SWFs will provide to continued growth in global asset markets,” says Alex Patelis, head of international economics at Merrill Lynch. But countries on the receiving end of such largesse remain wary. At a G-7 meeting of finance ministers held in Washington in October, SWFs were a major topic of discussion, partly due to concern about their potential impact on markets. SWF “investment policies, minor comments or rumors could spark volatility,” said Clay Lowery, assistant secretary for international affairs in the U.S. Treasury Department, in a speech last summer. “It is hard to dismiss entirely the possibility of unseen, imprudent risk management with broader consequences.” Even U.S. presidential candidate Hillary Clinton weighed in recently, saying in a Financial Times interview SWFs pose a potential threat to U.S. economic sovereignty. “I think vigilance is in order when the investor is a foreign government,” Clinton said. “My principal concern is to increase transparency so that there is a clear understanding of where these funds are coming from … and what the potential downsides might be of having a foreign government control certain assets in our country.”

Clinton is merely voicing concerns shared by others. In Europe, where the concept of “national champions” in a variety of industries is still taken seriously, some of the countries that have established huge SWFs, such as China and Russia, are not necessarily “friendlies, as far as the West is concerned,” as one U.S. Congressional staffer puts it. Even U.S. Securities and Exchange Commission Chairman Christopher Cox, an avowed free trader, has acknowledged that government investment funds could use “the vast amounts of covert information” that their spy agencies collect, making that “the ultimate inside-trading tool.”

Investments by SWFs can be politically risky, too. In 2006, Temasek Holdings, an investment arm of the Singapore government, bought Shin Corp., Thailand’s major telecommunications company, for $3.8 billion from the family of Thaksin Shinawatra, who at the time was Thailand’s Prime Minister. Public outrage in Thailand over the sale of what was considered an important national asset to a Southeast Asia rival contributed to Thaksin’s ouster as Prime Minister in a military coup in September 2006.

The U.S. is trying to lay down an informal road map for increasing SWF transparency. At the October G-7 meeting, with support from the other participants, Washington urged SWFs to make public their annual reports, to offer detailed descriptions of their investment philosophies, and to provide assurances that good returns — and not murky foreign-policy objectives — are what’s driving them. In other words, it wants the new kids on the block to be more like Norway. Oslo’s Government Pension Fund — International, which invests up to 60% of its $353 billion under management in equities, has money in 3,500 companies around the world, including stakes in Google and General Electric. But it owns no more than 1.5% in any single company, and spells out all its investments in an annual report.

Even with such policies in place, trade hawks in the U.S., Europe and Japan wonder why they should throw themselves open to investment arms controlled by governments that limit foreign access to their own markets. Beijing, they point out, still has strict limits and an opaque review process for foreign companies that seek to buy significant stakes in many Chinese companies. “I’m sorry, they keep us out of their countries when they see fit, so we’re just supposed to roll over and let them buy whatever they want here?” says the U.S. Congressional staffer. “Why would we do that?”

Some SWF officials say they are adjusting their investment plans to match a world where protectionist sentiment is rising. Singapore’s Temasek has already said it is becoming more cautious. “In every country, whether it is in Asia or Europe, there is an increasing tide of nationalism,” Temasek chairman Suppiah Dhanabalan recently told Singapore’s Straits Times newspaper. “We’ve got to take various factors into account, such as whether the company or the activity is iconic for that country, whether it will arouse all kinds of emotional sentiment.”

It isn’t just the prospect of riling trade partners that is encouraging SWFs to curb high-profile foreign investments. China’s fledgling SWF, China Investment Corp. (CIC), earlier this year invested to much fanfare in the Blackstone Group, the big New York private-equity firm, right before Blackstone went public. But Blackstone’s share price has sunk 35% below its June 2007 listing price of $31, costing CIC more than $1 billion. The pratfall appears to have prompted CIC to rein in its ambitions. Instead of splashy investments in the U.S. and Europe, the fund is now looking closer to home. It recently invested in Central Huijin Investment Co., a government agency with stakes in several of China’s biggest state-run banks and brokerages, and will reportedly plunk another $66 billion into Agricultural Bank of China. To the extent CIC looks for investments abroad, its Chairman Lou Jiwei said in a late November speech, it will stick to index funds — equities linked to the performance of entire markets, not individual companies.

That’s a conservative strategy, considering the bargains that may be available by investing in subprime-stressed financial institutions in the West. After all, Abu Dhabi’s SWF will reap an 11% annual yield from its Citigroup stake, nearly double the dividend yield currently available to ordinary shareholders. Having been burned once by Blackstone, the Chinese are now twice shy. But other sovereign wealth funds out there are flush with cash — and fortune favors the bold.

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