Comment: Tackling the future of sovereign wealth funds

They were discreet, they were powerful, and they had the financial muscle to pull banks – even governments – out of the fire. Here were the weapons of financial mass salvation.

The secret giants were sovereign wealth funds (SWFs). Ranging from the giant Abu Dhabi Investment Corporation with $627 billion (£406bn) through China’s $568bn of squirrelled assets to Norway’s $50bn oil fund, they have eluded precise definition – in structure, function, governance and size.

Broadly speaking, SWFs are large pools of national financial reserves or surpluses garnered by governments and available for investment. In the case of SWFs accumulated through oil revenues, the aim is to convert these huge cash surpluses into a stream of diversified revenue-earning assets.

These were the agencies to whom stricken banks and governments turned in 2007-08 to provide desperately-needed capital. Back in the secondary banking crisis in 1972-74 as the stock market plunged, the Abu Dhabi Investment Corporation took large stakes in UK companies such as Commercial Union. The market stabilised and hefty gains were made.

The experience of 2008-09 was different. When the scale and depth of the crisis became clear – and SWFs saw massive losses on their initial investments – SWFs became much more circumspect in their purchases.

Now that some markets have stabilised, and there is a greater prospect for SWFs of profitable investment, talk has revived of a strategic SWF investment. Earlier this year there was talk that an Abu Dhabi-led consortium would take a stake of up to £10bn in Royal Bank of Scotland, buying a combination of shares and “cocos” – the £8bn contingent convertible capital facility the bank is seeking to replace.

Speculation about an immediate entry has since cooled but the bank is not ruling out Abu Dhabi or another sovereign wealth fund becoming an anchor investor when government-held RBS shares come on the market in future years.

Calculating the total assets under SWF management is no easy task. Conservative estimates suggest that total assets by the end of this year will be close to $6 trillion.

Massive though this figure sounds, it should be seen in the context of global pension funds, mutual funds and insurance funds, each separately believed to represent $20trn-$23tn of assets under management round the world.

So are SWFs the force markets believed them to be? Might they still have a role in helping to counter a global economic slowdown? And could there be a role for financial institutions in the UK and Scotland in managing a slice of these portfolios?

These are some of the themes to be explored this week in the Edinburgh Dialogue, the third in a series of annual conferences held in the capital. The conference is being held tomorrow at Edinburgh University’s business school.

The event has been organised by Paul Forrest, director of Sovereign Wealth Focus and Forrest Research, who has more than 20 years’ experience as an economist working in the City for British, Japanese and Russian financial institutions.

He believes there may be opportunities here. He told me: “As a globally-ranked financial centre specialising in asset and fund management, Edinburgh and the wider Scottish financial community has considerable scope to enhance and develop its offer to national reserve fund managers. Norway, Alaska, Russia and China offer distinctive strategies for managing SWF portfolios. Can Edinburgh provide the facilities and structures to meet these aspirations?”

Speakers include: Tom Fearnley, investment director at the Norwegian Finance Ministry, which manages the Norwegian Government Pension Fund; Peter Bekx of the European Commission; Gerald Lyons, chief economist and group head of global research at Standard Chartered; and Gavin Kretzschmar, who undertakes financial market research at Edinburgh University.

Savings glut? Not really

IF ONLY people would save less and spend more, say the Keynesians, the economy would take a big step towards recovery.

Really? On the ground, it doesn’t look as if people are saving much, where they are saving at all. Now comes snapshot research from Legal & General showing how fewer people are saving each month and those that are saving are saving less. In January the average UK household saved £93 a month. By April this had fallen by 24 per cent to £71 a month.

For millions of households debt reduction remains the priority. When it comes to restoring household confidence to go out and spend, this surely lies in a return to more prudent borrowing levels pre-bubble. And for most households, saving remains a beleaguered aspiration, discouraged by ultra-low interest rates. Less saving does not necessarily indicate the onset of economic well-being.