Submitted for review and approved 21 March 2008
Sovereign Wealth Funds: A Critical Analysis
Bryan J. Balin
The Johns Hopkins University School of Advanced International Studies (SAIS), Washington DC 20036, USA
Abstract: In recent months, sovereign wealth funds have received much attention and criticism on the world stage. This paper analyzes these funds from a multidimensional perspective, showing their relative size, origins, history, strategies, and what regulatory oversight they have. Next, it examines why countries create sovereign wealth funds, and the criticisms of these funds. Thirdly, it projects the likely behavior of sovereign funds in the near term, explaining that they will create more liquidity and lower costs of capital in emerging equity markets and raise the demand for the services of existing investment managers. These funds will not, however, contribute to higher interest rates in U.S. treasuries or cause direct confrontations between the U.S., the UAE, Russia, and China over fund holdings. These funds may, on the other hand, increase the volatility of developed and emerging markets and create greater demand for openness to foreign direct investment among sovereign wealth fund-holding countries. Keywords: sovereign wealth fund, international capital movement, Abu Dhabi Investment Authority, China Investment Fund, capital flows, Russian Stabilization Fund, open investment.
1 I. Introduction and Description of Sovereign Wealth Funds
In the last six months, the subject of sovereign wealth funds (SWFs) has created much discussion in the halls of the Treasury, the German Chancellery, and the Chinese Politburo. With over $3 trillion in assets, these vehicles have the possibility of revolutionizing the financial services industry, and having strong influences on international capital flows. The formation of new funds in China and Russia, moreover, has sparked a heated debate in the West: some see these funds as an opportunity for additional foreign direct investment (FDI), capital formation, and ultimately, growth, while others see sovereign wealth funds as threats, where hostile, authoritarian regimes can perform “sneak attacks” of corporate espionage or economic turmoil to undermine open, democratic nations. A. What are they? Sovereign wealth funds are defined by the U.S. Treasury as “government vehicles funded by foreign exchange earnings but managed separately from foreign reserves” (Lowery, 1). Along with financing, sovereign wealth funds also differ from other government vehicles in their objectives, terms, and holdings: while foreign reserves have historically invested in sovereign fixed income notes for the purpose of intervention on the foreign exchange market, SWFs typically take a longer-term approach, where international equities, commodities, and private fixed income securities are used to achieve the long-run strategic and financial goals of a sovereign. It should be strongly noted that sovereign wealth funds are not the only vector through which sovereign entities make foreign private investments. Another way through which countries invest in foreign entities is through purchases by state-owned enterprises. Examples of this method include the attempted acquisition of the Peninsular and Oriental Steam Navigation Company (P&O) by the stateowned Dubai Ports World Corporation, and the purchase of IBM’s computing business by the Chinese government-controlled Lenovo Group. Additionally, governments can make foreign private investments directly through their existing foreign exchange stocks. For example, the governments of India, Thailand, and Indonesia have either investigated or implemented plans to diversify their foreign exchange holdings into private fixed income products or liquid international equity securities. B. Is this a recent phenomenon? The first sovereign wealth funds were established alongside the initial oil strikes in the Persian Gulf states in the 1950s—the Kuwaiti...
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