Global Business

Sovereign Shift

Stability, liquidity and support in times of dire need: Sound like central banks? Today, they seem more fitting descriptions for some of world's fastest growing emerging market governments, thanks to their cash-rich sovereign wealth funds.

Unlike just about everyone else, they're investing in risky assets, from corporate bonds to real estate to banks. Last week, the European Central Bank said sovereign wealth funds (SWFs) could become a stabilizing influence in today's crisis-racked financial markets.

Sovereign wealth funds have been around for years, created from national budget surpluses and huge reserves of oil or U.S. treasury bills. The biggest are the Abu Dhabi Investment Authority, with $875 billion in assets under management, and Singapore's GIC, worth $330 billion.
Slide Show: The World's Richest Sovereign Wealth Funds


All that money can't be pumped back into their respective economies, or they'll ramp up inflation. Nor can governments just sit on the piles of cash. The result: Since May 2007, SWFs have made at least 15 large investments in banks and financial institutions worldwide, totalling more than $40 billion. The majority of those investments have come from sovereign funds of China and the Middle East.

Morgan Stanley announced Wednesday that state-run China Investment Corporation had made a $5 billion investment in exchange for a 9.9% stake, just as the investment bank announced a $5.8 billion loss for the fourth quarter.

And a few days before five central banks teamed together to pump $100 billion into the markets last week, China, Singapore and an anonymous Middle Eastern government had already injected billions of dollars into the biggest financial companies on either side of the Atlantic--Citigroup (nyse: C - news - people ) and UBS (nyse: UBS - news - people )--serving to boost their tier-one capital and shore up their balance sheets.

The attraction is more than bargain prices. SWFs are looking to tap into banks' expertise in trade finance and financial systems--crucial areas for countries like China and the Gulf states, with burgeoning middle classes and developing investment cultures.

China's banks are huge, but lack sophisticated systems of international trade and investment and the impressive global reach of the Anglo-Saxon banking model. When China Development Bank bought a 3.1% stake in Barclays (nyse: BCS - news - people ) in July, for instance, the two lenders detailed the myriad ways they would be working together.

It's also good P.R. "Sovereign wealth funds, until recently, had a very bad reputation," says Stephen Jen, chief currency strategist at Morgan Stanley. "But there was no rebuttal. They said very little in their own defence." Dubai's acquisition of P&O in 2006 sparked uproar in Congress, because it meant the emirate would control a handful of American ports. Dubai gave no official response; it just sold the ports to AIG and kept the rest of the company.

"Going into a sector that is in desperate need of assistance is a form of rebuttal," says Jen. "They are refuting the notion that sovereign wealth funds are going to be a source of volatility or uncertainty, or that they will disturb the market. What they have done is anything but."

SWFs may be opaque and mysterious in their dealings, but some say, in practice, they make ideal shareholders. "The history of sovereign funds--going back to the first major oil price rises in the early 80s--showed Gulf investors are passive, long-term, ask few questions and sit tight when the company is in trouble," said Jan Randolph, head of sovereign risk at Global Insight. Unlike many shareholders (think hedge funds) sovereign wealth funds are with their investments for the long haul.

They're also huge. The European Central Bank estimates SWFs have total assets worth more than $2.2 trillion--larger than the hedge fund industry--and represents about half the world's official reserves. According to Global Insight, these assets are also growing by 20% per year, and Morgan Stanley's Jen says they could be worth $12 trillion by 2015.

Companies who welcome these investments are still worried about a protectionist backlash. Standard Chartered (other-otc: SCBEF.PK - news - people ) Chief Economist Gerard Lyons warned there was a "serious likelihood" Western governments would resist them. In July, for instance, German Chancellor Angela Merkel hinted she might pass new laws blocking state-controlled foreign investments. Lyons warned these actions would threaten global trade and hinder opportunities to work more closely with emerging nations like China and Russia.

Indeed, sentiment toward sovereign wealth funds could just as easily switch back to suspicion once the log jam in money markets eases and the credit crunch is just a distant memory. That's perhaps another reason why these funds are investing in banks so heavily now.

Still, expect to see emerging-market governments like China and Dubai investing in Western companies with sophisticated banking systems and high-tech capabilities. "A relatively small number of very big SWFs, within a rather short period of time, will own large stakes in many domestic and international businesses all over the world," said William Buiter, a professor at the London School of Economics, adding that this would accelerate the shift of geo-political power toward the likes of China, India and the Gulf. As long as companies need the capital, they'll be ready to lend a hand.