Sovereign Wealth Funds: The Rise of State-Controlled Funds & How to Play Them

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

Sovereign Wealth Funds: The Rise of State-Controlled Funds and How to Play Them

by Alexander Green, Chairman, Investment U

Friday, July 13, 2007: Issue #692

I recently spent a weekend with my old high school buddies at the Tide's Inn in Virginia.

Tide's Inn, of course, is one of the world's leading small hotels. It sits on its own peninsula overlooking Carters Creek with a spectacular view across the Chesapeake Bay. (You could practically hear the blue crabs scuttling off for their lives as we pulled into the parking lot.)

It was my friend Scott Whitmore's 50th birthday and we were there to celebrate his semi-centennial. Despite his sliver mane, however, Scott insists that he doesn't feel old yet, or even middle-aged for that matter.

"When is middle age supposed to start, anyway?" he asked, looking a bit apprehensive.

"I'm not sure," I told him. "I think it's the day you decide you prefer Jose Feliciano's version of 'Light My Fire' to the original version by The Doors."

Scott said he still likes The Doors' version better. "Good," I told him. "You're safe for now."

Besides being an old high school friend, Scott and I worked together on Wall Street for over a decade. He's since gone on to ply his trade at Morgan Stanley.

A few weeks ago, he sent me one of his firm's research reports, "Sovereign Wealth Funds and Bond and Equity Prices." (While most wire house literature I receive goes immediately into File 13, this one caught my eye.)

The report, by Morgan Stanley's European analysts David K. Miles and Stephen Jen, argues that the rise of sovereign wealth funds is likely to drive asset prices higher. And they make a persuasive case.

In last Friday's column, I pointed out that high-octane hedge funds using massive leverage with a couple trillion dollars are posing an immeasurable risk to world financial markets. But here is a very different group of funds that should have a positive impact on global equity markets.

Sovereign Wealth Funds: Controlling $7 Trillion Worldwide

So what is a sovereign wealth fund?

Simply put, sovereign wealth funds are the financial assets of a country - usually part of the national savings - that are owned and organized into a state-controlled fund and put to work to earn a higher return on investment.

(Sovereign wealth funds are not the same entities as foreign exchange reserves, which are often used for short-term currency stabilization and liquidity.)

In the past, most countries put their liquid assets to work in foreign currency deposits, government bonds or gold. (The hard-working Japanese and Chinese, for example, have kept our interest rates low by maintaining a steady appetite for U.S. Treasury obligations.)

But world central banks and other government agencies have been getting fidgety lately. And who can blame them? With the dollar moving steadily lower and interest rates moving higher, U.S. government bonds are not generating the kind of returns you write home about.

So many world governments are increasingly moving money into global equity markets. And the sums involved are fairly staggering.

According to The Economist, sovereign wealth funds may control as much as $7 trillion today. The exact amount is impossible to ascertain due to lack of transparency.

But China, Saudi Arabia, Singapore and the United Arab Emirates alone are known to control more than $2 trillion. And more money is being allocated to these funds all the time.

Here's How To Profit from Sovereign Wealth Funds

As Miles and Jen write in their recent research piece, "As sovereign wealth funds grow substantially in importance, the overall global degree of risk tolerance rises [increasing] the attractiveness of riskier, higher-yielding assets - equities."

What does this mean for you as an investor?

Expect to see world governments steadily accumulating shares of the largest, most liquid blue-chip firms around the globe. Quite frankly, they are the only companies that can absorb buying on this scale.

These stocks will almost certainly be the very first stop for sovereign wealth funds - and the growing trillions they control.

Good Investing,


Today's Investment U Crib Sheet

Twenty-six of the 50 stocks in the Dow Jones Global Titans Fund belong to U.S. companies. Here are the fund's top 10 holdings outside of the U.S.

Company Ticker Sector YTD Return
BP BP Energy 6%
HSBC Holdings HBC Financial 7%
Toyota TM Autos 27%
Total TOT Energy 34%
Vodafone Group VOD Telecom 68%
Nestle NSRGY.PK Consumer Staples 29%
GlaxoSmithKline GSK Health Care -2%
Shell RDS-B Energy 22%
Novartis NVS Health Care -1%
Siemens AG SI Industrials 91%

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