Sovereign Wealth Funds: Two Safe and Easy Ways To Profit From This Mega Trend
by David Fessler, Capital Markets Specialist, Investment U
Tuesday, January 15, 2008: Issue #752
When I bought an abandoned farm back in the '80s, over the course of a summer, I accumulated quite a pile of brush, assorted junk and tree branches, which I pushed out into a field with my bulldozer.
I figured I'd pour on a half-gallon of gasoline, just to give it a head start, and then throw a burning emergency flare at the pile from about 50 feet away.
Let's just say that when that much gasoline ignites under a pile of stuff, there's a VERY loud noise, immediately followed by flaming debris hurling in all directions... and much, much farther than 50 feet. After an embarrassing call to the volunteer fire department, everything was okay.
Lesson learned: Use too much gas and you could get burned.
This story reminds me of the dilemma China and other countries face with regards to their burgeoning cash reserves (now totaling over $1.34 trillion for China, and growing by over $1 billion every day). Most of their reserves are in U.S. dollar-denominated instruments.
How do these countries get rid of all those U.S. dollars without causing an explosion (or implosion, in this case) of the U.S. and the world's economies? Very carefully, and a little at a time.
But where's the best place for them to get rid of it? The answer to this one may surprise you: Right back here in the good old USA through Sovereign Wealth Funds. It's already happening, actually. And there are two ways you can profit...
Sovereign Wealth Funds - The World's Most Exclusive Club
China, the United Arab Emirates, Norway, Singapore and a dozen other countries are members of the world's most exclusive (and expensive) club: countries that have taken their vast wealth and pooled it into Sovereign Wealth Funds that consist of mostly U.S. dollar-denominated instruments.
And while China has initially cashed up its fund to the tune of $300 billion, it pales in comparison to that of the United Arab Emirates' $875 billion, which amassed its wealth from pumping black goo. It's estimated that the total amount of Sovereign Wealth Funds was around $3 trillion by the end of 2007, but this figure could rise to $12 trillion by 2015 as more and more countries seek higher returns for their national savings.
And think about this: It's estimated that the total value of the available shares of all companies in the world is roughly $55 trillion, with a like amount attributable to bonds. In a few short years, Sovereign Wealth Funds could be the largest shareholders and bondholders in the world.
And as the assets of these Sovereign Wealth Funds grow, make no mistake about it: the countries that run them will be calling the shots in the world of international finance. All this cash injected into the global markets will provide a torrential flood of liquidity, increasing the value of every imaginable asset, both good and bad ones.
Sovereign Wealth Funds = Diversification on a Grand Scale
Of course, the main reason these Sovereign Wealth Funds are on a buying spree has a familiar ring to it: diversification. These governments are simply trading in huge piles of U.S. dollars and dollar-denominated instruments for physical, tangible assets or shares of U.S. and foreign companies with valuable good will. It's no different than what an investor does when he or she buys shares of stock in a company.
Ironically, most large Sovereign Wealth Fund money pools are being amassed by authoritarian governments, which tend to be lousy investment managers. And while it's easy to imagine a scenario whereby a rogue nation with a big Sovereign Wealth Fund stash may decide to invest for political gain, its citizenry are the ones who need to worry the most, as failed investments by their government could directly impact their country's standard of living in the future.
Fortunately, the International Monetary Fund and other organizations have stepped in. They're developing guidelines to guard against the threat of politically motivated investments and/or a rogue state meddling with the global economy for nefarious purposes.
So how will the Sovereign Wealth Funds affect the world's stock markets in 2008 and beyond? Let's take a look...
Two Ways to Profit from Sovereign Wealth Funds
Remember, the managers of these Sovereign Wealth Funds want higher returns and, therefore, will be focused on bargains, scooping up shares of big companies at fire-sale prices - just as they are now doing with financial and brokerage firms.
- The easiest way to ride their coattails in the financial sector is through shares of the Financial Sector SPDR Fund (AMEX: XLF). This ETF is trading near its 52-week low right now. It could be a great time to start accumulating shares.Of course, the ride for the next 6-12 months could be a bit on the hair-raising side. XLF contains shares of some of the largest financial institutions. Some of these companies may have to take additional write-downs from the sub-prime mess.
- A more conservative, and potentially less volatile, way to play the Sovereign Wealth Fund card is by investing in the same large-cap, global blue-chip companies that they do. This is easy. All you have to do is pick up shares of the Dow Jones Global Titans Fund (AMEX: DGT).The fund holds shares of the world's 50 biggest companies. And you'll collect a sturdy 2%-plus dividend along the way.
There are certainly other ways to play Sovereign Wealth Funds, but the funds above represent two of the easiest (and safest) ways to hop on this mega trend early.
Today's Investment U Crib Sheet
- With nearly $900 billion at hand, experts believe Abu Dhabi of the United Arab Emirates is the world's largest Sovereign Wealth Fund. But maybe not for long... If Saudi Arabia establishes its own Sovereign Wealth Fund, as expected, it could dwarf Abu Dhabi's assets.
- As Dave mentioned, troubled banks are getting most of the attention from these funds. Foreign governments have poured about $27 billion into Merrill Lynch, Citigroup, UBS and Morgan Stanley."Sovereign Wealth Funds," according to Dow Jones, "are an obvious source of capital for banks because high commodity prices have swollen the amount of cash these funds have available to invest." Citigroup's looking for more... The company wants to raise about $12 billion. And China Development Bank has already proposed to take a $2 billion stake. Citigroup, Morgan Stanley and UBS are all holdings of the Dow Jones Global Titans Fund (AMEX: DGT).
- To find learn more about why foreign governments are making the switch from currencies to equities, take a look at The Rise of State-Controlled Funds.