In Praise of Foreign Investment: Best Practices for the Sovereign Wealth Funds

By Kimmitt, Robert M. | The International Economy, Spring 2008 | Go to article overview

In Praise of Foreign Investment: Best Practices for the Sovereign Wealth Funds


Kimmitt, Robert M., The International Economy


International investment in the United States fuels the U.S. economy by creating well-paid jobs, importing new technology and business methods, and providing healthy competition that fosters innovation, productivity gains, lower prices, and greater variety for consumers. President Bush reiterated the longstanding U.S. commitment to open investment in his May 10, 2007, "Statement on Open Economies," where he affirmed that "[O]ur prosperity and security are founded on our country's openness."

Sovereign wealth funds have attracted significant attention recently, due in large part to their rapid growth in number and size. This growth undoubtedly brings with it implications for the international financial system. However, it is troubling that these developments have also stimulated protectionist pressures that threaten the important open investment policies that allow for greater prosperity throughout the world.

Sovereign wealth funds, as large pools of government-controlled capital invested cross-border in private markets, do raise legitimate policy questions. While greater vigilance is appropriate, it is necessary to ensure a clear understanding of sovereign wealth funds, and consider carefully the implications of their growth, before prescribing a policy response.

WHAT IS A SOVEREIGN WEALTH FUND?

The U.S. Treasury has defined sovereign wealth funds as government investment vehicles funded by foreign exchange assets, and managed separately from official reserves. Sovereign wealth funds generally fall into two categories: commodity funds, which are established through commodity exports, either owned or taxed by the government; and non-commodity funds, which are typically established through transfers of assets from official foreign exchange reserves. Large balance-of-payments surpluses have enabled non-commodity exporting countries to transfer "excess" foreign exchange reserves to stand-alone funds.

It is important to distinguish sovereign wealth funds from other sources of sovereign investment, as many have often confused the activities of sovereign wealth funds with those undertaken by state-owned enterprises or other entities. While there are similarities among these entities, there are some important differences.

* International reserves are external assets that are readily available to and controlled by finance ministries and central banks for direct financing of international payment imbalances. Reserves are by definition generally invested in highly liquid and marketable securities.

* Public pension funds are investment vehicles funded with assets set aside to meet the government's future entitlement obligations to its citizens. They differ from sovereign wealth funds in that they are denominated and funded in local currency, usually with relatively low exposure to foreign assets.

* State-owned enterprises can be defined as enterprises where the state has significant control, through full, majority, or significant minority ownership. State-owned enterprises may undertake foreign direct investment and occasional portfolio investments, but the majority of state-owned enterprises do not invest abroad.

THE SIZE AND GROWTH OF SOVEREIGN WEALTH FUNDS

While sovereign wealth funds have been around since the 1950s, their recent and rapid growth has created a great deal of interest, and raised some concerns. In 2000, there were about twenty sovereign wealth funds managing total assets of several hundred billion dollars. Twenty new funds have been created since 2000, more than half of them since 2005. Those funds currently manage total assets of between $2 trillion and $3 trillion, and their assets are projected to grow in the range of $10 trillion to $15 trillion by 2015.

Total sovereign wealth fund assets are only a fraction of the estimated $190 trillion in global financial assets or the roughly $62 trillion managed by private institutional investors. …

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