30 November 2009

Sovereign Wealth Funds

Source: SWF Institute

Today’s report that the Dubai Government will not guarantee Dubai World’s debt has finally provided me with the necessary catalyst I’ve been waiting for to write about Sovereign Wealth Funds (SWF). I’ve been mulling the strategic implications of these funds, and their potential for future conflict, for quite some time. It is difficult to fully determine, but there is roughly $1.8 trillion invested in SWFs worldwide. The figure in 2008 was closer to $3 trillion, but the SWFs apparently suffered the same fate my portfolio did during the recent economic downturn, only on a much grander scale.

The US Treasury defines SWFs as a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities (the Central Bank and reserve-related functions of the Finance Ministry). These funds are used extensively by commodity-driven nations as a means of asset diversification for their economy. At first glance this all seems like a good thing, and in theory it is, as a diverse economy equals a more stable and risk-averse economy.

Where’s the danger?

The first is that governments will essentially disown their SWFs when things turn sour, like Dubai has done with Dubai World. This episode has sent tremors throughout the financial world, punishing companies (especially Financials) that do business in Dubai. It is also going to affect the flow of capital into other governments, making it more difficult and expensive for nations to finance their debt.

Now let’s look at the Linaburg-Maduell Transparency Index chart (shown at the top of the post) from the SWF Institute. The scores show each SWFs score and relative ranking with higher scores being the best, or most transparent. It is little surprise to see the list of nations at or near the bottom of this chart. Why does SWF portfolio transparency matter? Internal populations and international governments alike need to know what the long-term investing goals of another nation are in order to avoid misunderstandings that could lead to military conflict. What could conflict centered around an SWF look like? What if Venezuela’s fund was used to steal industrial technology from neighboring Columbia for use in its own endeavors, resulting in a significant setback to the Columbia economy? An Algerian SWF-funded joint venture in Mali was suddenly nationalized, essentially eliminating a previously unreported $20 billion investment (roughly half of Algeria’s estimated fund value)? Would it be more politically astute for one country to invade a neighbor in order to avoid domestic turmoil? Without explicit government backing and greater transparency in developing nation SWFs, the likelihood of military conflict is much higher. For more on the rise of the SWF, and the need for an international SWF economic policy, click here.



  1. While your points about SWFs are sensible, let's just be clear that Dubai World is a government-owned holding company - which is a different animal.

  2. Yes, technically DW is a government-owned holding company. But is it that different from a standard SWF? As a refresher, SWF Institute defines an SWF as a state-owned investment fund composed of financial assets such as stocks, bonds, real estate, or other financial instruments funded by foreign exchange assets. The reality though, is that there is no worldwide legal definition for exactly what an SWF is, or what it can and cannot do. They are unregulated beasts, which is why the necessity for transparency is so great.

    DW has 8 key Sovereign Wealth Enterprises in DP World, Economic Zones World, Leisure Corp, Nakheel, Limitless, Istithmar (the primary source of DW's current issues), Dubai Natural Resources World, and Drydocks World. SWE's are typically seen inside SWF's as a means for providing added flexibility. These 8 SWE's, i.e. subsidiaries, operate worldwide and generate significant assets in foreign currency.

    DW has a corporate entity structure vice a fund entity structure. This, obviously, is a difference...probably more in semantics than practice.

    Whether you define DW as a non-traditional SWF or a GOHC, the bottom line is that there was implicit government backing until DW over-extended itself.