Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


I guess sovereign funds use leverage afterall

by Brad Setser
August 13, 2008

Via SWF Radar comes news that two of the smaller sovereign funds in the Gulf want to gear up.

Abu Dhabi’s Taqa looks more and more like a sovereign fund specializing in energy, and it too uses leverage.

Some sovereign funds also are interested in a bit more than returns — they also look to invest abroad in ways that will further the economic development of their home country. Or try too.

The closer you look, the harder it is to generalize about sovereign funds. Some are unleveraged and focus on returns, in much the same way as a typical pension fund. Some are leveraged. Some have a mandate that extends beyond financial returns, looking more like industrial policy vehicles than a typical pension fund. And some don’t disclose enough for anyone to know what they really do …

Incidentally, while I don’t agree with every argument that George Abed makes, I do think he did a good job of summarizing the debate over sovereign funds. His FT oped is certainly worth reading closely.


  • Posted by guest

    Wouldn’t be better some sovereign vacations for all?

    Let’s rest in peace!

  • Posted by ndk

    This is hilarious. If only it were so easy for banks to raise funds these days. Perhaps a little quid-pro-quo equity investment’s in order.

    The most interesting aspect to me is the subtle shift in the balance of power between multinationals and governments. We’ve got legion corporations too big to regulate. Imagine if this theme spread! We might witness the reincarnation of the dead regulator: your government, your voting shareholder.

  • Posted by Guest

    G.I.C. (Singapore) is thought to be at about 3 to 1 leverage- think they are used as a bench in the region… C.I.C. is anticipated to be about that as well by many in the trading community in the region. Hope this helps.

  • Posted by Rien Huizer

    It is not ridiculous for a conglomerate to use debt and it may be useful for a SWF to borrow (how about SWFs that borrow from their own government) from the market. As a banker I would like to know quite a lot before I would lend to a SWF..

    Brad, you are entirely right when you say that the term SWF stand for an increasingly heterogeneous group of financial institutions. Perhaps we should do away with this term altogether. What matters is that state has a policy of running a structural surplus and uses those funds for investment abroad. What kinds of structures and what kinds of investments (incl leveraged ones) is immaterial, unless the state uses this “wealth” to pursue several additional objectives, i.e. not only to save ( intergenerationally because private households would not do it themselves) , but also, for instance practice currency manipulation and protectionism. Those are matters for trade diplomacy, not markets.

  • Posted by bsetser

    guest — thanks.

    any more information on how the GIC gets leverage? CIC shouldn’t follow suit in my view , as it is already leveraged domestically (it is funded by borrowing … ) and well it intrinsically is running huge risks.

    Rien — in the past countries running stuctural surpluses typically haven’t also borrowed from abroad to increase their external purchasing power. that strikes me as new. and most SOEs had more of a domestic than an international footprint — so there are significant changes afoot. and I don’t see how external investments that are derived from the pursuit of a protectionist exchange rate policy can be viewed as apolitical … or how they won’t be used in some instances to support multiple objectives.

  • Posted by Rachel

    It now seems that almost all the Gulf countries have at least one investment vehicle whose capital is levered up as well as contributing capital directly to projects that are leveraged.

    In addition to funds like Mubadala, QIA, Istithmar and DIC, even some of of the classic funds like KIA – and GIC are likely levered up.

    Which all seems to explain why external debt of countries like the UAE is on the rise and more Sovereign funds might face some of the challenges that QIA has regarding deals done with the expectation of persistent cheap credit.

  • Posted by RebelEconomist

    There is leverage and leverage. I can understand why some SWFs might consider that their expertise in their particular type of investments gives them a good chance of making a few selective shorts pay (eg like a 130:30 fund). I would however question whether SWFs should be in the business of borrowing money to expand their holdings, especially when they already have a lot of real money to find a home for. I would advise plan sponsors for such official funds (eg finance ministries overseeing SWFs) to be sceptical of fund managers’ motivation for asking to be allowed to use such strategies. There is a danger that they can be driven by a sense of adventure more than performance.

  • Posted by Guest

    No worries… leverage achieved through repo mainly. I have little doubt that CIC will be leveraged in the same manor- huge risks? Dollar exposure is the huge risk and this fund will be a vehicle to reduce it while securing scarce resources for China’s future. In my opinion, what’s lost on many is the inflationary nature of the rapid reserve growth in China and the middle east- demand destruction in the US will ultimately have little impact…

    One point for Rien; if I was a banker, I would want to be as tight as possible with these SWF’s as they may be a capital lifeline at some point in the near term. Questions would come sparingly.

  • Posted by Twofish

    Guest: I have little doubt that CIC will be leveraged in the same manor.

    I have a lot of doubt that CIC will be leveraged. If it leveraged then it strikes me as a profoundly stupid thing to do since there is already defacto highly leveraged with 1) the treasury bonds that the Chinese government has issued to pay for CIC and 2) the liabilities that the holdings of CIC (primarily financials) already have. With the high degree of leverage CIC already has, it should be really conservative in its strategies, and if it tries to have leverage on top of what it already has, then it’s this huge house of cards that is going to fall down at the worst possible time.

    If you have a crisis then CIC is going to need cash at the very moment that the Chinese government can’t borrow and the banks that it holds are in trouble.

    Guest: if I was a banker, I would want to be as tight as possible with these SWF’s as they may be a capital lifeline at some point in the near term. Questions would come sparingly.

    The job of a banker is to ask tough questions and to refuse to do business with a client if you don’t get good answers. It’s kind of silly not to ask tough questions in hopes of getting a future capital lifeline because if a client can’t answer tough questions, then it’s likely that when you are in trouble, they are going to be in trouble.

  • Posted by bsetser

    first apologies if you couldn’t post a comment this afternoon; the comments were down for a while.

    Guest — the CIC’s raison d’etre is to take currency risk and support China’s exchange rate regime. that policy goal trumps any consideration of returns. And I don’t see why the CIC, which already is buying dollars with borrowed RMB, should necessarily go out and borrow more dollars to be able to take bigger positions and potentially make more money.

    yes, the CIC might make more — and be able to offset its currency losses — by borrowing more and investing more. but is also might lose more. the CIC’s portfolio shouldn’t be driven by a need to offset exchange rate losses associated with China’s exchange rate regime. that is a recipe for taking large risks — too large a set of risks in my book.

    as importantly, China’s external portfolio is already large, and large enough to influence other countries markets. making that portfolio even bigger would only add to the associated concerns.

    I agree tho the i-banks have no real incentive to criticize the governments with big SWFs. you see a bit of this in the gulf — where they don’t necessarily issue a lot of hard hitting research on the region’s economic troubles. Why highlight inflationary monetary policies if that might mean losing money?

  • Posted by RebelEconomist

    Guest at #8,

    You should be a little more precise. Both of the two forms of short I mentioned could use repo. The difference is that there is a bigger mismatch in the case of leverage using a loan (collateralised to minimise cost, hence repo in this case) than using a short in a similar instrument (eg short one stock against another). If what I said about governance is correct, I would expect to see more use of the riskier strategy involving loans by the less transparent SWFs. I would be surprised if Norway do this.

  • Posted by Rien Huizer

    Guest and Twofish, bankers stay in business by fewer mistakes than their customers, making enough money to not be acquired by someone else and by reading the business cycle in such a way to never have to beg for capital from people they know very little about..Lending money to SWFs can be OK if it is structured properly and that would probably be the case, in the current environment of enhanced regulatory scrutiny. So, Guest, Twfish is right

  • Posted by Rien Huizer

    Brad, re GIC’s leverage. I believe that GIC borrows from the Central Providence Fund (the gvt sponsored forced savings vehicle), and I would expect that their real estate investments are partially financed by local boroqings in the markets they invest in. That may have local tax reasons, partnership structures etc. But I do not believe -and would not expect ever to see- that GIC borrows as a corporation, more or less publicly, from the international market.
    But, leverage can have many reasons and be entirely functional. The situation mentioned in your introduction seems very different from that type of financing and may be a way to establish the creditworthiness of that specific fund. There may be collateral involved or some sort of reciprocity over and above the fes and interestmargin. Who knows?