Brad Setser

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So a Gulf sovereign fund still has 60% of its assets in dollars? And SAFE is a SWF …

by Brad Setser
July 17, 2008

My initial reaction to Henny Sender’s front page FT article was probably the opposite of most. I wasn’t all that surprised that sovereign funds are reducing their dollar exposure — though cutting their dollar exposure when the dollar is under pressure does suggest that they, unlike central banks, haven’t been a stabilizing force in the foreign exchange market. I was, though, surprised that “one big sovereign fund in the Gulf” had 80% of its assets in dollars a year ago, and still has 60% in dollars now. 60% is substantially higher than I would have expected. It also is a bit higher than the IMF assumed in its modeling of sovereign funds: their well-established diversified fund was assumed to have 38% of its portfolio in dollars (see the appendix of the IMF’s recent SWF paper)

Moreover, if a major Gulf fund is 60% in dollars and the Gulf’s central banks have an even higher share of their assets in dollars (the UAE’s central bank recently indicated that 95% of its assets are in dollars), the Gulf as a whole has even more dollar exposure than Rachel Ziemba and I thought.

Sender’s article is full of interesting tidbits.

The obvious question to ask is which big sovereign fund in the Gulf had 80% of its assets in dollars until recently. I would assume that major excludes Oman and Bahrain — and I would also assume that the reference to “sovereign wealth fund” excludes the Saudi Monetary Agency. If Saudis, who are widely thought to keep most of their foreign assets in dollars — had cut from 80% to 60% that would truly be news. That leaves the funds of Abu Dhabi, Kuwait and Qatar. The Qataris seem to have a lot of exposure to the UK — and a wildly diversified real estate portfolio — so they don’t seem like the most probable candidate. Plus, they have previously indicated that about 40% of their portfolio is in dollars. ADIA’s reported portfolio* is also geographically diversified, and its holdings are pegged “to global economic growth.” It is hard to see how a portfolio linked to expected growth could be so over-weight the dollar, though Sender reports that currency risk is all managed by a central trading desk. Consequently, some of the currency exposure implied by ADIA’s diverse equity exposure could have been hedged. But it is hard to see how ADIA could be anywhere close to its current rumored size if it had that much dollar exposure and thus missed out on currency gains from holding euros and the financial gains from holding non-American equities over the past few years.

That leaves Kuwait — which hasn’t disclosed much about its portfolio. It was also fairly conservative until recently. But even there the fit isn’t perfect — Kuwait has hinted in the past that its large stakes in BP and Daimler imply that its equity portfolio at least is geographically balanced.

* The data in Business Week indicating that North America accounts for between 40 to 50% of ADIA’s portfolio explicitly excludes ADIA’s investment in private equity, hedge funds, real estate, infrastructure and cash. It consequently could understate ADIA’s dollar exposure. And ADIA could have hedged out the currency risk on its European and Asian portfolio.

Sender’s article also notes that SAFE is seeking out European private equity firms — and even encouraging “private equity firms with which it has relationships” to invest in natural resources companies.

China’s State Administration of Foreign Exchange (SAFE) has been looking to strike deals with private equity firms in Europe as a part of a strategy to reduce its dollar holdings. …

By allocating money to Europe-based private equity firms, SAFE could diversify away from the dollar, at least at the margin, without spooking the currency markets and driving the dollar down in a disorderly manner. In addition, SAFE is encouraging the private equity firms with which it has relationships to make investments in natural resources companies in markets outside the US – in part, to hedge its exposure to the dollar.

SAFE, not the CIC. The central bank, not the sovereign fund. PE funds investing in natural resource companies aren’t exactly a standard part of a typical central bank’s reserve portfolio. Here though I would note that the enormous scale of China’s reserves means that even large investments in private equity firms could be overwhelmed by SAFE’s ongoing bond purchases. Still, it is interesting to know that SAFE is looking to invest not just in oil firms like BP and Total but also is encouraging PE firms to invest in natural resources.

But perhaps the most interesting part of Sender’s article is the part suggesting that the United States’ creditors are increasingly frustrated by US policy — and no doubt also unhappy that their investments in US (and European) financial firms have performed so poorly.

Sovereign wealth funds have played a leading role in helping to recapitalise faltering US banks, but have lost money so far on such investments. Continuing market turbulence has further shaken their faith in US policy and policymakers. ….

Behind the scenes, fund officials are questioning the credibility of the Federal Reserve and US Treasury in defending the dollar and maintaining financial stability.

Reacting to last year’s collapse of structured investment vehicles, the head of one Middle East fund said: “I thought the problem of off-balance sheet had gone away with Enron.”

The fact that this frustration is starting to spill over into the press is news. My guess is that a lot of funds are down significantly so far this year, and in some cases the falling value of their existing portfolio may be a big enough drag to nearly offset all the new oil inflows. If the US economy spirals down along the lines that some are expecting — and if the Fed cuts rather than raises rates — there is at least a hint that a few important creditors might balk at providing even more financing to the US than they do now.


  • Posted by Rachel

    KIA claims that its target asset allocation is based on shares of global GDP except that holdings in BP and Daimler make it overweight Europe. However we don’t know much about the timing of this shift.

  • Posted by bsetser

    If it isn’t KIA and it isn’t the QIA and it isn’t ADIA then it has to be SAMA or a smaller fund … or it has to be ADIA, with big currency hedges offsetting its geographically balanced equity portfolio. Tis clear that Sender talked to someone at ADIA for the article, and she previously has done profiles of QIA and KIA …

    inquiring minds want to know.

    wasn’t KIA’s statement about its equity portfolio tho, not its overall portfolio?

  • Posted by Bernardo A


    let me first say that I love your detached and calm style that you display even in these times of trouble. Other commentaries are much more anxiety-provoking and thus annoying. Also, you do more than others by contexualizing more popular news into much a broader picture. This blog is really more stimulating and insightful than many others and much more open-minded as well. And it is a bless, in times like these when alarmism reigns.

    I really doubt though that the FED should be blamed as the main responsible for the crisis. And I think funds know this. By contrast, this crisis shows again that vigilance and regulation system has a talent for letting financial operators do their own affairs ignoring the consequences of their behaviour on the financial system. I was puzzled yesterday when I read (on an Italian newspaper) that the SEC is now introducing a new law that imposes short-sellers to actually have the stocks they want to short-sell. What? This has been the norm in the EU for years, what was the SEC thinking when we introduced that norm?
    Yesterday I went to a meeting about credit derivatives held by a Commercial Bank in Milan. It was mainly about Interest rates swaps. One of the speakers, a professor of finance at Bocconi University in Milan, said that one of the greatest problems that used to affect the market of IRS up to two years ago was the lack of regulation (i.e. too few norms). This contributed to create a Far West halo around the IRS market. Now the situation has changed – said the professor – but we are having exactly the opposite case, that is, too many norms that are slowing down the market of derivatives diminshing the efficiency of hedging strategies. In my view this is fair enough, at least we will have less fraudulent behaviours and more stability instead. Indeed, operators are behaving accordingly: the market of IRS has trimmed down significantly in Italy and there is much more information widespread about this sort of derivatives.
    What a shame then that a new problem has arisen meanwhile. The new problem is called Credit default swaps. Are CDS they being regulated right now? No. Are insitutions aware of the threats CDS carry? Probably yes, but maybe they are not doing much to tackle them.

    The short lesson I drew was that financial operators and financial watchdogs/authorities seem to be playing a game that reminds me of the Achilles vs. the turtle paradox, the one in which Achilles never reaches the turtle because the turtle is always one step ahead. Obviously financial authorities are not being turtles in this game.



  • Posted by ZFC

    Bernardo wrote:

    “I was puzzled yesterday when I read (on an Italian newspaper) that the SEC is now introducing a new law that imposes short-sellers to actually have the stocks they want to short-sell”

    No, the SEC is now saying they are going to restrict naked short selling in a select group of 19 stocks, e.g. Goldman Sachs, JPMorgan, UBS, Merill, Citi, Morgan Stanley, etc.

    In other words, the broker dealers, the ones responsible for naked short selling, will be protected, by law, from being the target of naked short sellers.

    The rule does not apply to celebrated naked shorts like Wachovia, MBIA,, KKD, Delta etc. etc. Feel free to keep abusing those.

  • Posted by Rien Huizer

    There may be many reasons why a global investor wants to diversify FX exposure. And there are also several ways to look at FX exposure (for instance, switching from US stock into stock denominated in a pegged currency like the HKD may not help, if the HK stock is heavily correlated with the US stocks in the same industry>>> what precisely is my FX exposure?). A private investor in a peg country (assuming the peg is credible over the investor’s time horizon) does not benefit from diversification, but could switch his fixed income investments (same quality) to the highest yielding currency/country in the set of simmilarly pegged currencies. Hence a HK investor might be rationally buying USD paper (he would probably prefer CNY paper, if he could get it, but that would worsen his risk for a similar yield).

    So with stories like these the first question is what do these people define as FX exposure?
    Using a typical private sector asset allocation model one goes from currencies (and their shadows) to asset classses within currencies and then to industries. However that model is undermined by two things:(1) enormous macroeconomic divergence between countries with linked currencies (your BW II, and without the Maastricht prospect of the former DM peggers in Europe) , with the attendent risk of peg breakdown (2) institutional factors and transaction costs limiting access or exit, as well as differences in product range, liquidity and disclosure in most of the pegged currency countries.

    If official investors want to shift large amounts of exposure, there is basically only the choice between short term interest rate instruments denominted in USD, EUR and JPY. But there are product range limitations. Europe does not have large amounts of high quality short term paper, so one would have to invest in repos or bank deposits (which is what the ECB would love to see, despite the upward pressure on the EUR), JPY is even more difficult.
    So exiting the USD generally also means entering asset classes with risk return chacteristics very different from short UST paper.
    I would suspect that stories like these are either part of an internal debate between professional (and probably frustrated) portfolio managers and their more or less political, usually conservative bosses or attempts to create market sentiment (in favor of one’s own position?)

    So, how on earth could this creaking world financial system handle a shift towards, say 50% USD, 35% Euro, 15% JPY (probably more or less the weight distribution of currencies if one groups most of the peggers with the USD and ignore the inflation targeters (AUD, NZ. UK) and baskets (Spore etc). What would be the effect on exchange rates of a shift in six months, in what instruments would you invest(especially short term, low risk, liquid) your EUR and JPY?

    In addition to the big question of how to avoid exchange rate losses (a matter of monetary policy for the peggers: do nothing > no loss) and keep domestic inflation low (also a matter of fiscal policy, oversterilize) , the “weatlh” countries have the distinctly non keynesian problem of how to achieve a decent real return, that is in domestic currency terms. The only way to deal with all of these objectives more or less well, is to have a tight fiscal policy, exchange controls (sorry), and remain small enough to be able to invest more or less efficiently. Something only a highly sophisticated authoritarian government of a fairly small country with no need for goodwill with international investors can execute. I know one, but that does not really peg, it targets a basket. China and the GCCs (especially Saudi) cannot escape the current situation and may well be breeding a class of rent seekers who feed off this problem. Once that is entrenched, the USD has nothing to fear anymore, I would say. This could change if/when europe and Japan would start issuing suitable short term government paper. But that would compete with the struggling banking system at precisely the wrong time. Derivatives cannot solve that either.

    Equity and real estate are interesting (especially when the investing country has a culture of opacity and market abuse by well placed people) but volume wise no solution for large currency diversification needs.

  • Posted by RebelEconomist

    Denomination is not the same as exposure, even in the absence of hedging. I presume that it is possible to buy Daimler shares on a US exchange (ADRs?) denominated in dollars. If so, the value of these will be tied to the German shares by arbitrage and would follow the euro more than the dollar.

  • Posted by Rien Huizer


    Absolutely, and tht is the problem with thse statements, s well as the statistics..

  • Posted by Pallj

    Fascinating post and comments.

    I would have guessed the USD content of most of these SWFs to be much closer to the corresponding central banks’ ratio…

    One significant dynamic interests me. SWFs and such are developing their portfolios with similar aims as other funds would, but without the fundamental pressure to maximize the short term value of their own stock. Real returns on their portfolio aught to be more interesting that the fluctuation in the stock value of their investments.

    It’s like with butter, cream or whipped cream; the net fat content is the same.
    While I’m sure it is galling to have the calculated value of your portfolio decrease, it does not matter in the same way as it would for a publicly traded fund where the goal is to maximize the perceived value of its own stock. Only the real returns are significant.

    (Oh, and knock on wood… perhaps oil has peaked already?)

  • Posted by Dave Chiang

    China Tightens Scrutiny of Foreign Investment to Curb Hot Money

    By Li Yanping

    July 18 (Bloomberg) — China’s top economic planning agency said it tightened scrutiny of foreign direct investment to prevent fake ventures that are being used to channel speculative capital “endangering” the world’s fastest-growing major economy.

    Money is flowing in through sham joint ventures, fake investments and shell companies, the National Development and Reform Commission said in a statement on its Web site today.

    To contact the reporters on this story: Li Yanping in Beijing at

    Last Updated: July 18, 2008 05:20 EDT

  • Posted by koteli

    Hi Brad,

    It’s been a long time keeping myself silent while reading all your posts.

    Congratulations, for a good post following the foreigners money.

    But I have lots of buts about your work… Where is Japan in your map? Or they don’t manage any money?

    Piss-takers, using MM words, could change a lot in an ideal world, but where is US of A, and playing what in this game?

    I’m very pleased that your ex-boss is talking about the economic frame of the USA, not just about recession.

    About a year ago, Bruce Springsteen was singing in Bilbao and in the middle of a great concert he asked pardon for being in USA under Bush presidiency, wars and injustice.

    Two days ago he was singing in San Sebastian in front of 40.000 people, he just stopped singing for two minutes to say that next song would be “Living in the future” and to ask to everybody in perfect spanish “fight for your civil rights, fight, please”.

    Now that your ex-boss Nouriel Roubini is clearly speaking his mind, after years of being laugh at, I think it’s about the time that a Kansas man like you should speak his mind more openly.

    And be thankful of having the best ambassador of the USA in a very famous singer like Bruce Springsteen, singing for three hours while giving his best in front of foreign people in a measure that makes anyone think that if we were able to work as he does, this world would be a very different place to live in.

    As you are working in the Council of Foreing Relations, I give a very important reference to remember in next years about the opinion of USA people in foreign countries.

    Few times we feel in our skin songs like “Because the night belong to lovers, belong to us” with so much strength…

    The ten million debt man is a sheet of president you voted for with a little help of US of A justice system and some military help.

    The world doesn’t finish in China or the Gulf. The toxic waste of USA spread across the world has been a milestone in economic history.

    The Fed’s 2% policy is bringing to starvation and death lots of millions of people in this little world.

    But, with a big sorry, Apple is running out of iPhones made in China, in the middle of the summer! What a disaster, DC should be scratching his face under the disaster of American Hegemony…

    Maybe, it’s about the time to say to the people when the next kick in the balls will come in US economy. And who are the directors of the kick!

    But don’t worry, they will speak about arabs in very distant lands inflating the gallon of gas…

    Between piss-takers and piss-makers could be done a clear arrangement, but where is the sheriff?

    This little monkey going out would have less value than a donkey in Marrakesh square

    Maybe, it’s about the time for the ruskies and Grazprom to stablish a serious business capitalist model in US of A

    Time will tell

    Good morning

  • Posted by koteli

    Sorry, a big mistake,

    It should say

    The ten “trillion” debt man

  • Posted by theeconomicfractalist

    The World’s Greatest Economic Crises

    Few understand the interconnectivity of the wage and debt economy. Few now appreciate the severity of the coming implosion which will exponentialize in a nonlinear fashion over the next 17-19 weeks. Equity and commodity asset valuations will rotationally and later synchronously decline in value. Money will flow into US debt instruments with a profound drop in interest rates. Even most pessimistic speculators look no further than profits to be made in a cascading, debt defaulting, massive asset devaluation environment. While there is consideration of nationalization of the GSE’s 4-6 trillion dollar mortgage debt industry, rapid nationalization of much of the private and local governmental economy may be necessary to preserve social order as nonessential jobs rapidly disappear and as community and state tax bases are unable to support the manpower needed for the likely security risks at these local levels. Just as the bankrupt GM defaulted on its health benefit promises to its retirees, so too may the US government default on its fiscally impossible promises to its entitlement beneficiaries – and decades sooner than predicted by the past Comptroller General of the United States. The US dollar after falling in a 12/30/24/18-19 X/2.5x/2x/1.5-1.6 monthly Lammert fractal series is at another critical area with a 26/64 of 65-68 day x/2.5x (averaged) day first and second fractal series with a nonlinear drop expected during the terminal 21-24 July 08 second fractal time frame. This corresponds to a likely final secondary high in the Swiss Franc and in gold with the likely final secondary high in oil. The other western and eastern economies and their associated fiat currencies which are at historical highs with respect to the dollar are undergoing and will undergo implosion at the consumer level. The US guarantees on savings deposits of up to 100.000 may provide the seed corn monetary base for new American banks to begin the private credit cycle again after a protracted depression. Over the next 17-19 weeks, US treasuries will approach zero in yield and the US ten year bond less than 2 percent in yield.

  • Posted by Rien Huizer

    Fractalist, looks like you’ve been spending some high-powered money. Wealth is and will be, sovereign.

  • Posted by satish

    Oil at 130 is a buy llr to what i said in early
    2007 when oil was at 50. We are never going to see oil at 130 barring a huge global depression. A peak oil awakening!

  • Posted by Matt

    Fractalist – re-launch your website if you want some voice during the crisis, not just post occasionally. You’ve got some interesting material, so why not update and share?

    As a gloss on Rien’s comment, I’d have to agree that the applied mathematics, or economic theory, or observed behaviour, or whatever make for no great explanatory power in dealing with sovereigns. They have their own epidemiologies and pathologies.

    For Koteli, I thought donkey hawking had been banned from Marrakech, too much crap for too little return, and they took up space from the real business of taking money from rich foreigners. Which leads me to consider some metaphors….