Sovereign Funds, a Global Challenge

Sovereign funds are the new actors of global finance. According to recent estimates, they manage more than $2.7 trillion worth of assets. They are growing much faster than other institutional investors, such as pension funds, mutual funds or hedge funds, and could get to $7 trillion by 2017. But the expansion of sovereign funds is not only about finance: they signal the reallocation of global economic power toward emerging economies and away from Western economies, with a size and speed that has no precedent in recent economic history.
Data highlight the impetuous growth of sovereign funds over the last decade. They were worth a bit less than $4 billion in 2000 and grew to $52 billion in 2010, thanks to operations made by Gulf funds, which represent about half of the total. Investment has been fed by the accumulation of currency reserves, which in 2010 have surpassed $9 trillion, and by the opportunities offered by the crisis of the US banking industry, which in 2008 attracted $90 billion in investment by sovereign funds.
Beyond the numbers, it's interesting to note how the financial crisis has changed Western attitudes toward sovereign funds. Initially portrayed by media as the new "barbarians at the gate" bent on hostile takeovers of the pinnacles of Western capitalism, they were hailed as white knights by Wall Street as soon as they started providing fresh capital and much-needed liquidity to major banks in the worst phase of the crisis.
This phenomenon proved short-lived, because, having incurred strong losses, sovereign funds have reduced the volume of their investments in the US and at the same time changed the sectoral and international allocation of their portfolios. In 2009 and 2010, they significantly reduced their deals in the financial sector, in favor of diversification toward the energy and raw materials industries, engineering and high tech.
The crisis has also changed the international profile of sovereign investment. Over the last few years, European markets have been preferred, and their weight is now 30% of the portfolio held by sovereign funds, which have also enlarged the scope of their action toward Latin American, Sub-Saharan Africa and Asia, while never ceasing to sustain their national economies during the crisis.
Data show without doubt the present and future relevance of sovereign funds for global finance and the global economy, but the true discontinuity lies in the fact that they might constitute the return of state capitalism after the wave of privatizations at the end of last century. What will be the risks and opportunities of the challenge launched by emergent economies to the very logic of Western capitalism, strongly rooted at least in theory if not in practice to the principles of the free market and private entrepreneurship? Will new sovereign shareholders be able to create value and warrant growth?
From the latter point of view, the scenario is less rosy for sovereign funds: their investments have destroyed, not created value. On average, over the two years following the acquisition by a sovereign funds, the targeted company loses 6-10% of its value as compared to its peers. And the larger the stake bought, the worse the performance. These results are confirmation of the hypothesis that sees sovereign funds as important minority shareholders, having an often passive role and reluctant to control management in the host company.
The fundamental question is whether sovereign funds will decide to play a more active role in corporate governance. This is both an economic and a political challenge, and the future of sovereign funds is predicated on this issue.