Sovereign Wealth Funds

So if you've been reading the financial press over the last couple months, you've inevitably heard about sovereign wealth funds and their impact on the American and world economy. Many of the pundits have decried the influx of these SWFs into the American economy. In essence, SWFs are state-owned entities that manage the savings of a country or the country's pension fund. In recent months, SWFs from all over the world have been investing in American companies. Most notable amongst these are the American financial institutions that have been forced to take billions of dollars in writedowns on the balance sheet.

Now, you might ask... so what? Well, there is more of a connection between subprime and Singapore than you think. You see, all of these banks and financial institutions have to keep their capital ratios intact. That is, they must keep a certain amount of Tier 1 Capital (common stock, preferred shares, and retained earnings) on the balance sheet relative to certain assets like cash and other short-term securities (can you say ABCP, CDOs and other subprime-tainted instruments?) So, as the capital ratios of these banks and financial institutions have fallen with the steep drop in the value of these assets. Thus, these banks have been forced to seek capital to make sure they meet the requirements.

Morgan Stanley, Merrill Lynch, Citigroup, and UBS - amongst others - have all sought capital from SWFs. Citigroup (C) got $7 billion from Singapore Investment Corp and $3 billion from the Kuwait Investment Authority, on top of $7.5 billion from Abu Dhabi. In December, Morgan Stanley (MS) received a $5 billion injection of capital by selling almost 10% of itself to China Investment Corp. Merrill Lynch (MER) received a $6.6 billion investment from Kuwait, Korea and Japan.

Now, you may think that SWFs are sort of a foreign innovation, you know, created out of the oil-rich countries in the Middle East, or the U.S. dollar rich exporting countries like China. However, Canada has our very own SWF - the Canada Pension Plan Investment Board (CPPIB). The CPPIB has over $121 billion in assets, and invests around the world. Basically, it takes the money from the pension plan and invests it, earning a greater return on the investment than would otherwise have been achieved if the money had just sat around in low-yielding investments. The CPPIB operates like a private equity firm in some respects, and you might have read about its struggle to purchase a stake in Auckland International Airport.

So, SWFs have become the 'in-thing' for the past while, and I'm sure you'll hear about them more in the future. Keep your eyes out for political bias and posturing as well, as many people are concerned about the backlash that may occur due to the optics of foreign companies snapping up large stakes in American companies (read up on the Dubai ports deal for more).