Sovereign wealth funds

Q I recently read an article saying that China is poised to launch a new investment agency, which will invest the country's foreign exchange reserves abroad across a diverse range of investments. Can you explain what this means and its implications for investors?

A As of March this year, China's foreign exchange reserves stood at a staggering $1,202 billion. That sum is the largest holding of foreign exchange reserves in the world and more than the annual value of economic activity in all but a handful of the world's largest economies. Also, these reserves are growing at more than $20 billion a month.

This huge surplus is a result of China's success as an exporter to the rest of the world. China's annual trade surplus, the difference between the amount it sells and buys from the world is approaching $200 billion, with the imbalance especially marked with the United States.

Until now, China has mainly invested its foreign currency reserves in long-term US Treasury Bonds and other Government securities.

Other countries with huge surpluses, such as the UAE, Singapore, Saudi Arabia, Norway, Kuwait and Russia, collectively hold over $1,600 billion in Sovereign Wealth Funds, which can be defined as entities that manage national savings for the purposes of investment.

Such entities seek to maximise long-term returns by investing in assets that offer value through a combination of equities, derivatives, commodities, hedge funds and other financial instruments.

For example, a fund owned by Qatar's royal family has taken a 25% stake in Sainsbury in the UK and Dubai International Capital, which is owned by the ruler of Dubai, holds a substantial stake in HSBC Holdings.

To emulate these other countries, last week, China's Finance Ministry announced that a new state Investment Agency is being created which will initially be funded with $200 billion from its foreign exchange reserves to invest in assets abroad other than US Treasury bonds.

The investment agency is expected to start work towards the end of this year but has already spent $3 billion to buy into the initial public offering of Blackstone, the US private equity group (which has in turn just purchased the Hilton Group).

Especially during this millennium, these government-controlled investment funds have become a very big story very quickly and continue to gain significant influence over the equity markets as their foreign exchange reserves continue to increase.

While the other countries have invested their surplus funds over a long period of time, China will be investing a huge sum by 2010 and may even increase the amount available for investment in the stock markets each year.

I believe that such an enormous inflow of funds in global equities and specialised financial instruments will continue to support the present strong bull run that we have seen since 2003. (Source: BBC News and FT.com)

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Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 or e-mail mh@hollingsworth-int.com.

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