Sovereign Wealth Funds – Countering a deeply prejudiced debate

I have been thinking a lot about the sovereign wealth fund debate and decided to make my response in the form of a letter to the Federal Reserve Bank of San Francisco in response to a very prejudiced letter/article posted on their website. (if the links provided to the original article are bad, you can still go into the websites by using their main names and search for the article, I checked it is there).

Dear Sirs

I refer to the paper paper published by two advisors to the Federal Reserve Bank of San Francisco, Joshua Aizenman, visiting scholar, FRBSF, and professor, University of California at Santa Cruz and Reuven Glick, Group Vice President, Federal Reserve Bank of San Francisco, and published on your website I wish to respond to several unhelpful allegations made by the writers as well as to provide some perspective that should factor in any discussion on the topic in the US.

Given the fact that the US dominates practically every other type of fund in the world today – mutual funds, pension funds, private equity funds and hedge funds – the idea that governments of other countries should develop their own formidable SWFs by managing their assets (utilities, infrastructure and state-owned businesses) prudently, must make it a bit difficult to discuss the topic objectively.

The writers of this article make the onerous allegation that the SWFs of other countries have been set up at the expense of “trade imbalances” with the United States. The writers then go on to make the assertion that SWFs are the “unintended consequences of countries that run persistent current account surpluses. These assertions are inaccurate, deeply patronising and very unfortunate because they do not give credit to the fact that the countries that have the largest and most successful SWFs built them intentionally as part of a national objective of protecting their own future.

Building national savings through SWFs that are more than two to 11 times larger than the annual national GDP takes years to build. The UAE SWF was set up in 1976. Singapore started in 1974 and the Kuwaitis go as far back as 1953. The US government, at all levels, federal, state, county and city, know only too well how difficult it is to keep a government budget balanced, let alone have the mechanisms to set aside funds as a strategic investment for the future. Because so much of the discussions on the management of public funds in the US have become too focused on deficit budgetss, that the US is really caught flat-footed on a development that has made considerable progress in selected countries abroad.

(Table #1: The size of selected SWFs relative to their GDPs)
Click to enlarge the image

Understanding the origins of SWFs is a first step to an enlightened discussion. The SWF of a small country like Singapore are from revenues generated from government linked companies like its national airlines and port working in a very competitive global marketplace. The retained earnings of these businesses have been squirreled away over the past 30 years. The SWF of countries like the UAE and Kuwait are also derived from retained earnings from their non-oil businesses and astute investments over the years.

Yes, the oil boom years of the 1970s did provide the impetus to these countries to being able to start these saving funds for the future. In the same way that the equities boom years of the 1990s made it possible for countries like Australia and Malaysia to set up their own funds. But all these economies are built around very strong fundamentals of a functioning economy.

To say that their SWFs are an “unintended consequence” is not to recognise that the enormous national will and skill required to build a SWF. Malaysia and Australia are examples of two countries with rich natural resources, but which did not have SWFs until the fund management discipline take root in the public sector. You will notice that their SWFs are small relative to their economies because of a previous history of squandering national wealth over petty political pursuits. It took these countries years to build the national will to set up and manage such funds prudently.

Then for every Malaysia and Australia, there is a long list of well endowed countries from Burma to Nigeria that we don’t even talk about when discussing SWFs because these countries are not configured with the political stability and structures to manage their wealth professionally. SWFs are the “fully intended consequences of countries that worked for their money and thought about their future. The quality and professionalism of the individuals who manage them are the same as that of any upper middle class American parent thinking about the future of their family.

Only in the case of China can we argue that it’s SWF is set up largely from profits from its currency account surpluses with the US driven mostly from the imbalances caused by strong foreign direct investments. Most of the writers arguments can be fairly levelled against China. The Chinese government does not as yet own the kind of globally profitable assets pool that contribute to its national coffers and therefore can be set aside.

The fact that Chinese SWF’s initial forays into global assets have proven to be far less astute than that of the other more mature SWFs, is another iteration of the point that constituting and managing SWFs require skills at the national level that can only come with time and experience. Money came too easily and quickly to China, and much of it from American investors.

Although several Chinese businesses have been re-capitalised, the Chinese still do not have a track record of running profitable state-owned enterprises whether they are banks, airlines, steel mills or retailers. Running budgets across several economic cycles and maintaining national assets at commercially productive levels are all prerequisites for government executives to develop the internal shrewdness and skills to become astute global investors. You can almost design a university degree around this. It is not possible to jump start the process.

In all likelihood, we will see the real calibre of Chinese state-owned enterprises that have been so enthusiastically invested in by the West later this year in 2008. I believe that many will be reporting lack lustre results based on their organic businesses. But even if there is a failing back for China, as I think there will be, it will be only one in a series of steps that China has to go through from which they will learn and improve. Having said that, it is curious that US commentators in general have not been as critical about Chinese investment skills in Blackstone as they have been about Arab investors in the investment banks, who have hitherto proven to have been structured far more prudently.

The more mature Asian and Middle Eastern economies that do manage SWFs are only too aware that current account imbalances are too volatile and shallow, being required to finance short term trade. Some set aside as much as one year of surpluses to fund their current account needs, and these do not appear anywhere in their SWFs. If the writers of that article wanted to make a case against China, then they should have written an article specific to China.

The trend of governments managing their own investible assets in a professional manner is spreading to countries without natural resources. Taiwan, and South Korea, which we would assume should have amassed considerable national by now are both new to SWFs. Again, because it takes that long for countries to develop the national will for these things. It is a concept that is only one step removed for many American cities that have left their dark years of budget deficits behind to understand. They have only just invigorated their inner cities, created asset enhancing domestic economies that are revenue positive and are thinking about sustainability for the people that live in them for which they are accountable.

Is there then an irrational fear that rogue states like Iran or Syria might set up SWFs and insidiously control the global economy? Just running through the list of all the governments that have been able to garner financial resources that are several times the size of their economies, all prove to be very stable nation states. All act in the long term interest of their citizens over and above the self interest of personalities in their domestic politics.

Many in the US do not realise that the first check and balance for accountability comes from within the countries themselves. The governments that have chosen to manage their savings in a public manner can be overthrown if they squander their national assets, now that the size and investments of these national assets are transparent to their own population. This is saying more than we are able to about the accountability of many democratic countries in the world. The interests, intentions and vagaries of the personalities of the fund managers who run private equity or hedge funds do not come anywhere close to the scrutiny and considerations of the leaders of the countries with SWFs.

The criticism that the size of some SWFs are not transparent enough depends on the way these are constituted. Where they are constituted as funds managed separately from the national accounts, they have almost all been transparent. Every American investment banker who walks into the offices of the Kuwait Investment Authority is told just how large the funds are and where they are invested as the opening part of the conversation. Where the figures are not published, it is often because they are managed loosely as reserves set aside in the national budget, and governments like the freedom of calling these in to meet other contingent liability, although the ones I know never have.

Conceptually, it can be argued that the world’s largest SWFs are in fact American. If we can argue that the mandates governing US pension funds such as CALpers, requiring them to be profitable and sustainable for the long term for the employees of the state, make state-owned pension funds sovereign assets of that state (and California is arguably a top ten economy in its own right) then they have the same mandates as SWFs. In fact, the Norwegian SWF is a pension fund, the Australian SWF is an extension of its super-annuation funds, and so are many others. In fact, this is often the raison detre of SWFs: the retirement needs of large segments of the population that the state is responsible for are supposed to be paid from these SWFs.

If concerns in the US is that SWFs can be activist and take positions around the world that serve national causes, aren’t some of these US pension funds the same? CALPers manages about US$260 billion worth of funds, all fully divested around the world in stock, bonds, funds, private equity and real estate. CalSTRS (the California State Teacher Retirement System) alone manages funds in excess of $180 billion.

Some pension funds are activist regarding the environment, others have positions on democracy, others on human rights, and others still on corporate governance. Not that these are not altruistic, but they are still biased to a western worldview that maybe not everybody shares. In 2002, CALpers made the very public announcement that it was going to withdraw its investments from Malaysia, Indonesia, Thailand and the Philippines. The stock markets in these countries tumbled on the news.

The work that these governments had to put in to regain CALPers favour went far beyond that which any sovereign state would do for another sovereign state. The article posted by the Malaysian Industrial Development Authority (see, and the more poignant press statement by no less than the Acting Secretary of Foreign Affairs Rafael E. Seguis (see shows how far governments were willing to go for the sake of a mere pension fund.

Although CALPers insisted all the time that it was not being activist, its considerations in making its investment decisions go far beyond return on equity. I do believe that all investors should have a moral dimension that they truly subscribe to. As many of the largest SWFs are from Muslim and Asian countries today, they too will have their investment considerations that might go beyond return on investment. This is where the unspoken titanic fear that is shaping much of America’s resistance to SWFs.

Personally, I am a firm believer in the power of open markets. Even if there are SWFs that are as powerful as the largest pension funds in the US, all of them have to balance a consideration of moral values and return to shareholders. Market forces will require them to act rationally. Funds can bully small countries but not robust, open and profitable ones. But it is a universe that the US must be truthfully willing to participate in.

As for the case for regulating SWFs, it is curious that the sentiments in the US is that hedge funds, which are so much more risky and volatile then SWFs for being leveraged through borrowings from the banking industry, should not be regulated at all costs. SWFs are held substantially in blue chip equities and are hardly leveraged and so do not touch the banking system. Hedge funds are managed by unlicensed individuals. SWFs are owned and managed by nation states. Why the double standards? A fear of things foreign?

I am also uncomfortable with the way that numbers are being brandied around in the “developed world” to discuss the potential size of SWFs. It appears that the only number floating around at the moment is the one published by the IMF and also used in the paper. The total size of hedge funds today is reported as being just short of $1 trillion, and it comes across as a respectable size relative to SWFs at about $2 trillion. But the leveraging on these hedge funds and the exposures they take on are many-fold larger to the point of being dangerous.

The prospects of SWFs rising to $15 trillion in the short term is not that straight forward, because whoever put the figure together was working on the assumption that governments are fund managers managing hard cash. All governments deal with budget deficits, foreign exchange risks, trade imbalances, infrastructure spending, education and health, wars, famines and any number of things that can distract them from a linear growth.

(TABLE #2: Current funds that would qualify as SWFs globally (notice conspicuous absence of US funds )
Click to enlarge the image

Also, the terminology of what actually constitutes a SWF needs to be pinned down. The writers say that they fear that SWFs might repeat “the alleged role that large private hedge funds played in coordinating speculative attacks on the British pound and other currencies in the early 1990s”. SWFs, by definition, are not high risk investors. If they were, they would have to be highly leveraged to have the wherewithal to mount a currency attack. If they were leveraged just to trade dangerously, then we can drop the word “wealth from the description and call them Sovereign Attack Funds. All of the nations with SWFs that are two to 11 times the size of their GDP know only too well how difficult it is to build them over many years.

SWFs must demonstrate the political will of a country to treat savings as savings in the face of many other priorities. There is no evidence that the countries with SWFs more than 10 years old have had to dig into their savings to use as a “financial stabilizer when commodity prices declined and depress tax revenue even if these were the stated aims as claimed by the writers. These are seriously wealthy and still financially prudent countries. Most of the oil-producing countries do not even raise funds through taxation.

Countries that need to worry about financial stabilizers generally cannot afford to save. The writers fear that “the growing current account surpluses of commodity exporters and Asian countries is cause for concern is exaggerated because there is no evidence whatsoever that these countries will ever have the political will to set aside the huge funds to be invested in the US on a long term basis.

The Chinese case proofs the point for the need of definitions. China is suspect because there is no proof as yet that it will not easily redeploy its so-called SWF to combat trade imbalances, or currency attacks if it becomes vulnerable if the reminbi is floated. The Chinese executives managing their incipient fund are very articulate, middle-aged, western trained and even competent managers. But inexperience is inexperience and it showed from day one of their investment decisions.

Yes, other Asian countries that find themselves suddenly laden with a budget surplus may be tempted to set up what they would call a SWF for want of respect. But the manner in which they will deal with such wealth will be a class apart from those with the long term discipline of a real SWF, and it will show in short term nature of their investment decisions. The funds themselves will evaporate at the turn of the economy and time will proof that these were not even starters in the game that the writers needed to fear.

Whatever the size of SWFs, it is unregulated hedge funds that have become far more entrenched in the US public securities markets. Hedge funds constitute approximately 30 percent of all U.S. fixed-income security transactions, 55 percent of U.S. activity in derivatives with investment-grade ratings, 55 percent of the trading volume for emerging-market bonds, as well as 30 percent of equity trades. Hedge funds dominate certain specialty markets such as high-yield derivatives, and sub-prime debt as the world found out to its detriment.

A large percentage of hedge funds are domiciled in off-shore jurisdictions, paying little or no tax, and are outside scrutiny. I might add that many new hedge funds are in fact activist and even boutique in their investment focus. Yes, they may want to control all the flour mills around the world and from there the value chain of the flour business and from there fix prices.

The rules for avoiding such a scenario are in the anti-competition laws that many countries have set up, not in tying the hands of the fund manager. SWFs are invested mostly on-shore and in real performing assets that are constantly under the scrutiny of investment analysts. Very simply, any argument to regulate SWFs should be first applied to regulating hedge funds.

The writers also assert that “there is rising opposition to controlling stakes of sensitive assets being taken by SWFs. Firstly, the examples given by the writer were all US, so yes, the US does have a situational problem with its national assets being controlled by foreigners, especially in the wake of September 11. I am in full sympathy with these sentiments. Any other country in the world where national icons are destroyed by enemies of the state will not even discuss it.

But this is an emotional argument and one that global investors are only too familiar with, whether investing in Korea or Kazakhstan. There is rising opposition to US private equity players trying to take stakes in Korean and Japanese banks today, exactly as there was opposition to a Singaporean SWF investing in Thailand. So, should private equity be regulated? The short answer is no, because national sentiments are just as powerful as free market forces in keeping any investor honest, by ensuring that their intentions are always scrutinised.

The writers couch their argument in such as manner as to limit the many reciprocal possibilities for US businesses to profit as well. What if an Unocal or the Port Authority of New York and New Jersey (PANYNJ) become such world class players that they go on to acquire ports in other markets? I think it is a desirable scenario and one that must be encouraged. We don’t speak in such language in the US currently because it has been a while since US-based infrastructure players were world class enough to be invited to run a Dubai or Singapore port.

These are ports that are fully automated, where the port authorities work with the unions to maximise productivity, where huge container ships get turned around in two hours and not two days, where there is no pilferage and which are, by the way, very profitable. They pass on their retained earnings to the state. Countries other than the US with better airports, ports and telephone companies have been setting up companies to acquire, manage or build, own and transfer these sensitive assets in other countries.

In the industries where the US provides global leadership, in technology, medicine and finance, it continues to forge ahead, working hand in hand with the US government to force small nations to “open their markets” to the benefits of “globalisation” and create “value add”. All the same and familiar terminology used in the other direction. But when a Temasek or the Abu Dhabi fund takes a position in Citi or a Morgan Stanley, it is supposed to be different?

I do believe that the rejection of Dubai Ports proposed investment two years ago was a rejection in a moment in time. The prospects of an Arab investor running operations in the very same organisation that owns the World Trade Center’s twin towers that were destroyed is really not palatable. Under different circumstances, it could have been considered very differently on its merits, but at that moment in time it was repugnant to the national psyche. But the sentiment is no different when Koreans feel violated by foreign investors profiteering from their distressed companies. It is in moments like these that any investor, whether private equity or SWFs, simply have to take into account public sentiment, money does not drive everything.

The fear that governments can gain long term and substantial interests in global businesses that may lead to distortions of global markets is an irrational one because of these many considerations already at play. Again, we must ask, what can SWFs do to global markets that the free market has not done as yet? Will they be able to buy up businesses globally and form mega-industries like a Dr Evil from the British parody Austin Powers?

Well, if the largest businesses in the world today, whether WalMart, Exon Mobil, General Motors or Chevron, just to name the top names from a Fortune 500 list, are just that difficult to manage in the midst of competition, we get our ideas from fiction to think that any of these countries will also have the managerial bandwidth and astuteness that extend beyond managing their own statehoods to managing global businesses. As all investors know, equity carries its own enormous risks and limitations. The best protection for SWFs is to be well diversified in order to protect the future of their often small countries.

But we can and must avoid some of the potentially negative consequences in the long term by insisting that governments or private investors must all be held to the same level of scrutiny, transparency and accountability. Yes, SWFs should become very transparent in the manner they are constituted (conforming to anti-money laundering rules so that terrorists do not infiltrate them) and managed (just as any private equity fund and in any case never more than the way hedge funds are managed).

As long as the incentives are primarily financial, the world becomes a more open market place with that many more players, disciplined by market forces. Financial astuteness is a desirable goal as it provides governments with a new business language with which they could relate with each other.

In writing this response, I was mindful of the very controlled academic language that the writers used to couch their arguments. You would almost believe that their arguments were kosher. But insinuating that SWFs “pose a challenge” and are a “stumbling block to the world financial order, and that these should invest in a “global fund” managed with the guidance of “international financial institutions” through “well-diversified indexed instruments, in plain English, these writers are saying “we like your money, but leave it there on the floor by the door. We are Americans, you can trust our international financial institutions and our indices but we can’t trust you. It is needless to say how deeply patronising these sentiments are, especially to Arabs and Asians coming from very responsible states with long proven histories of astute investments globally.

I am dealing with this topic for a more fundamental reason. We take so much of our world view and global agenda from the so-called “developed world”. We view the Middle East as an intractable problem because that is what the “developed world” says it is. We view Africa as an intractable problem, not realising our world view of that continent is couched in a deeply patronising Western model influencing everything from state-hood to leadership to exploitation of natural resources to food cultivation and distribution in that continent. When the Chinese offered the Africans an alternative, simpler and more direct model for development, we were immediately taught to be suspect, even as we were taught not to be suspect about the waves of Western governments and businesses that have ravaged the continent previously.

This debate on SWFs is one that gives us the moral high ground to counter instinctive biases that are based on the deepest of prejudices about people who are different. Can the US accept that best practices in financial markets can develop from outside the US and find its way back to the world’s largest capital markets? In essence, that is what SWFs are, best practices in statecraft that developed over the past 30 years. Not overnight.

These writers also do their own country a grave disservice. There is really no need to guess what wealthy investors do when they are made to feel unwelcome. They go somewhere else. It’s very simple. Wealthy investors have no respect for terminology used by intellectuals that are designed to tell the “developing world” where we can sit and where we cannot stand in this debate. The SWF phenomenon cannot be discussed outside of their defining characteristics. Their views have to be countered rigorously and vociferously for their own good.

Emmanuel Daniel
The Asian Banker



  1. I would like to clarify two points of fact in your article above.
    1. Your source Asian Banket has valued GIC assets at US$330bil and Temasek at US$100Bil. Only about a month ago in Indonesia the Minister Mentor Lee Kuan Yew in a reply about SWF has put GIC at US110 bil and Temasek 80-90bil. He is the chairman of GIC. There seem to be such a huge discrepancy in the figures ( 430 bil vs 200 bil ).

    2. You also state that Temasek was started in 1974. Shld it have been 1984. I would think that GIC was started earlier(1981). Moreover I would not think that Singapore had built enough reserves to have such a fund.

    The spectacular performance of GIC and temasek have a lot to do with the timing of their initiation. The Dow itself had originally reached 1000 in 1969 but would only revisit it again in 1984. From then, it climb to 10000 as we all know in 2000.

  2. Dear James, my research mgr confirmed tt our figure for Temasek was taken straight from their AR – and yes, their yr of incorp was 1974. But your question did make me think – there should be a GIC before a Temasek… Our figures for GIC however, were taken from several international sources. A famous StanChart report (must read) in Oct 2007 cites the est size as US$215b. The BIS cites from an Aug 2007 rpt fm a DC-based think tank Peterson Inst for Int. Econs saying GIC should be US$100-330b. Our talk-around the investment bk research hss also use figs in that range. I genuinely can't speak for the Minister Mentor's figures. But I wd read it as his prudent “working number”. Also, there is considerable double accountg in the greedy investmnt bkg community, so the “working numbr” there will necessarily be much larger. I did allude in my ltr GIC-type insts draw their assets directly from national budget which can change in time, definition or govts – and that is why a GIC and a Temasek shd be defined differently.

  3. Dear Sir:

    May I know why the Source does not reveal the actual source of the figures you cited in your table? Instead, your research team merely uses “Asian Banker Research,” rather than backing up the numbers. Surely you refer to other places (Bloomberg,Reuters, various news) for this information?

  4. Dear Katya, as in my response to James before you, I cited the several sources that my staff looked at. But for this set of data, we alone take responsibility for the final numbers we decided were correct. If we took wholly from any other source, we would have attributed it to them. We were making our own estimates. In this instance, Bloomberg and Reuters were not sources at all – actually they are not even in the business of publishing apocryphal research. They publish hard market data, which they purchase from the different exchanges around the world but brand as “Reuters” or “Bloomberg”. At this stage of assessing the SWF industry, ALL sources are apocryphal and subjective, including ours, hence the debates. Yes, of course, where possible they are from different primary providers, but we still need to normalise data from different primary providers to build the charts that we do. That is why unless we were quoting wholesale from someone else, we alone take that responsibility to make our own judgment, even if others disagree with us. This is normal practice in research.

  5. another good read.

    good point on calpers.

    how did our friends, or more accurately YOUR friends, at the fed in sf reply to that?

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