Late on Friday, the US Treasury released the preliminary results of its annual survey of foreign portfolio investment in the US. That always makes for an interesting weekend.

The survey offers the best picture of the impact large central banks and sovereign funds have had on global financial markets. It just comes out with a long lag. And as I will argue later, it is, for all its virtues, it still paints an incomplete picture of the activities of official investors.

But it still reveals a few secrets, not the least about China.

It turns out that China bought significantly fewer Treasuries from the middle of 2007 to the middle of 2008 than I had projected – and a lot more equities. China also was – as expected – a very large buyer of Agencies (particularly mortgage backed securities with an Agency guarantee, often called “Agency pass-throughs”) from mid-2007 to mid-2008.

China consequently entered the “Lehman” crisis with a somewhat riskier portfolio than I thought. The bulk of China’s portfolio, to be sure, was in Treasuries, Agencies and comparable European bonds. But it now looks like well over 10% of SAFE’s portfolio was invested in “risk” assets of various kinds — equities and corporate bonds.

That likely explains why China reversed course and fled to safety this fall. China got burned. SAFE (not-so-SAFE?) especially.

The survey data indicates that China had $521.91 billion of long-term Treasuries at the end of June 2008 (up $53.4 billion from June 2007) and $527.05 billion of long-term Agencies at the end of June 2008 (up $150.73 b from June 2007). China consequently entered into the crisis with more exposure to the Agencies than to the Treasury.

Read more »

From a Tuesday Wall Street Journal story on Citigroup’s efforts to raise common equity:

Citigroup officials hope to persuade private investors that have bought preferred shares — such as the Government of Singapore Investment Corp., Abu Dhabi Investment Authority and Kuwait Investment Authority — to follow the government’s lead in converting some of those stakes into common stock, according to people familiar with the matter.

Emphasis added

There is a difference between a minority stake held the investment arm of a government that doesn’t regulate a bank or backstop the banks’ liabilities and a large stake held by a banks’ home government. But it is striking that none of the “private investors” mentioned in the Wall Street Journal are actually, well, private investors. Sovereign wealth funds are at best a hybrid.

China for example has made it clear that it hopes that the US will protect at least some of its investments from the risk of losses. China’s Vice Premier Wang Qishan told Hank Paulson:

“We hope the US side will . . . guarantee the safety of China’s assets and investments in the US”

He may have just been thinking of the Agencies … but he also may have had a few of China’s other large stakes in mind. The classic response is that the only investment that is guaranteed by the full faith and credit of the United States government is a Treasury bond.

Yet, it increasingly looks like the US is inching toward severely diluting the common equity of a set of banks where sovereign funds have substantial stakes,* if not wiping out the existing equity entirely. That potentially — as Larry Summers warned in a former life — is a foreign policy issue. Summers pondered this topic at last years Davos session on sovereign funds:

Read more »

The UAE’s central bank will apparently use $10 billion of its foreign exchange reserves to buy $10 billion of a (planned) $20 billion Dubai debt issue. That will provide Dubai with $10 billion in foreign exchange (Dubai gets the UAE’s dollar reserves in exchange for an IOU, the UAE gets a dollar-denominated claim on Dubai … ) to repay $10 billion of its external debt. Lex writes:

Dubai’s $10bn cash injection from the United Arab Emirates’ central bank has eased concerns about the struggling emirate’s ability to make good on $13bn in debt payments due by the end of this year. Just as important as the deal’s dollar figure, however, is the political message it sends. After weeks of uncertainty, Abu Dhabi, the Emirates’ oil-rich sugar daddy, has demonstrated its willingness to stand behind its poorer relation. … Strictly speaking, the UAE central bank’s purchase of $10bn of five-year Dubai bonds – part of $20bn in new bonds priced at 4 per cent interest – was agreed at the federal level. But at its core, the move amounts to a bail-out by proxy of Dubai by its wealthier neighbour, Abu Dhabi, which is the biggest contributor to the UAE’s federal budget thanks to a quirk of geography that left it holding 8 per cent of the world’s oil reserves.

I find it interesting that the financing for Dubai came from the Emirates (the confederation), not Adu Dhabi (the richest emirate). As Lex notes, it arguably is the same thing: Abu Dhabi’s oil ultimately backstops the federal government. But it nonetheless suggests:

a) Abu Dhabi – meaning the large investment funds of Abu Dhabi — itself may not be all that liquid. Abu Dhabi may be kind of like Harvard: very wealthy, but caught between ambitious plans to invest some of its resources at home (Harvard is planning a new science campus, Abu Dhabi is a lot wealthier and is planning a lot more … ), falling inflows, falling asset values and growing calls on its capital from various illiquid funds it has invested in.

B) Abu Dhabi doesn’t want to sell its existing foreign assets at distressed prices to finance Dubai. Tapping on the central banks existing liquid reserves is a way to avoid selling other assets …

Of course, financing Dubai through the central bank means that the quality of the assets on the Emirates central bank balance sheet will deteriorate. The central bank has traded $10 billion of liquid foreign assets for $10 billion of Dubai’s illiquid bonds. Dubaican notes that the coupon on the bonds looks well-below market, adding to their illiquidity. And, well, if other demands for liquidity materialize, Abu Dhabi could well have to meet them out of its own resources.

This post is by Rachel Ziemba of RGE Monitor where this post first appeared. Thanks to Brad for letting me fill in.

Recently,  Reuters reported that the assets under management of Kuwait’s sovereign wealth fund fell to 49b Kuwait Dinar ($177.6 billion) at the end of December from 58 billion Kuwait Dinar ($218 billion) in March 2008. – a face value decline of about $31 billion. Given that Kuwait had record oil revenues in 2008 (and a record fiscal surplus even if revenues tailed off in the second half) and KIA likely received record new capital, this implies that investment losses were even larger. It is significant for two reasons. One it shows that the estimates of fund performance (including those released in a recent paper by Brad Setser and myself) are on track and two, it could suggest that within limits there may be increasing amounts of transparency among sovereign investors. It also will provide an interesting test case of how the population and opposition react to the losses on the national wealth. Read more »

Note: This post is by Rachel Ziemba of RGE Monitor, filling in while Brad is off in the mountains.

Many thanks to Brad for letting me fill in again.  I pay attention to macro events in China and several  oil exporters and the whole portfolio of sovereign investors for RGE monitor where this post first appeared. I’ll chime in on a few things related to sovereign investors (including their role in financing the US) this week while Brad is out.

In recent weeks CDS spreads on the debt of Dubai’s largest State-linked vehicles like Dubai Holding etc shot up dramatically after Abu Dhabi announced a unilateral recapitalization of its banks. The cost to buy prrotection on the 1 year bond has doubled since late January and now stands at 1073bps. The jump in the 5 yr has been less sharp but stands at over 1400bps. Since Dubai has limited sovereign debt (about $10b and maybe climbing given the likely fiscal deficit) so these large state-linked companies provide a proxy for the perceived credit worthiness of Dubai’s government. Given Dubai’s debt stock ($80b or 148% of GDP), its vulnerability to global liquidity and the worsening outlook for its domestic property market despite the ability to control supply, it is perhaps not a surprise that the outlook for the emirate seems much more precarious, particularly in contrast to its cash rich neighbour, Abu Dhabi. Given the links of these debtors to the government, and the effect that their vulnerabilities could have on the UAE federation, it has widely been assumed that the UAE govt (or rather Abu Dhabi) would come to the aid of Dubai when the crunch came. However, there has been more uncertainty than some expected. Key tests are ahead in coming months as Dubai adjusts to a world where leverage remains scarce. Read more »

It takes a bit of courage to put out a paper that is sure to get a few things wrong. But when it comes to the Gulf’s sovereign funds, the alternative to getting a few things wrong is not writing much at all. The funds cloud themselves in secrecy. Educated guesses have to substitute for analysis based on hard data.

The large Gulf sovereign funds are financed out of oil revenue, so the amount of new money they have to invest abroad is presumably linked to size of the fiscal and current account surpluses of key Gulf states. If – and it is a challenge – the path of spending and investment can be estimated, the size of that surplus will be largely a function of the price of oil. Production volume matter too, but in most circumstances production changes more slowly than price. And the Gulf funds are known to be large investors in the world’s equity markets, so their performance is likely to track, at least in broad terms, movements in major equity indexes. Sure, they have invested in “alternatives” – London real estate, private equity, hedge funds – too. But most “alternative” investments also have performed poorly over the past year.

Rachel Ziemba of RGEMonitor and I used these basic insights to built a model of the Gulf funds that allows us to estimate – very roughly – the trajectory of the various Gulf funds over the past few years. That model is only going to be as good as our assumptions – and while we made every effort to calibrate the model using available data it no doubt is going to be somewhat off. That probably isn’t the best advertisement for the Setser/ Ziemba paper on the Gulf’s large sovereign funds. But sometimes caveats are important. This is a paper with a lot of known unknowns.

Among other things, Rachel and I argue:

– The capital losses on the Gulf’s existing portfolio overwhelmed large inflows from high oil prices in 2008. Close to $300 billion flowed into the big Gulf funds — the Abu Dhabi Investment Authority/ Abu Dhabi Investment Council, the Kuwait Investment Authority, the Qatar Investment Authority and the Saudi Arabian Monetary Agency’s foreign assets. But the market value of their Gulf’s foreign portfolio fell by an estimated $350 billion over the course of 2008. Throw in a roughly $30b fall in the Gulf’s reserves as hot money betting on a revaluation left and the total value of the Gulf’s external assets likely went down over the course of 2008.

Read more »

China’s formal foreign exchange reserves rose by about $40 billion in the fourth quarter, rising from $1906 billion to $1946 billion. Adjusted for valuation changes, that works to a $55 billion or so increase. But appearances can be deceiving.

In the past, China “hid” the pace of increase in its reserves by forcing the banks to hold dollars as part of their required reserves. Those dollars showed up on the PBoC’s balance sheet as “other foreign assets” but weren’t counted as part of China’s formal reserves. In the fourth quarter, China’s reported reserves overstate its true reserve growth, as the banks reserve requirement was cut. That led to a $26 billion fall in the PBoC’s other foreign assets in October and, I assume, a comparable fall in December. Given the size of the reduction in the reserve requirement in December, that is conservative.*

That means that the PBoC’s “true” reserves didn’t grow at all in the fourth quarter, best I can tell.

Valuation changes had a fairly modest impact on the data for the quarter as a whole, but a huge impact on the data for individual months. They pulled reserves down in October and pushed reserves up in December. Both effects were quite significant – in the $50 billion range. That has one big implication: China was adding to its reserves (if reserves are defined broadly to capture the PBoC’s other foreign assets) in October but not in December. My best guess is that China added about $15-20 billion to its reserves in October, another $10 billion in November and lost $20 billion in December. My numbers are a bit different than those of Morgan Stanley’s Wang Qing. He believs capital outflows peaked in October. I would put the peak in December — which incidentally implies that the small RMB devaluation that China tried in early December had a big impact on capital flows.

I wouldn’t put too much emphasis on the monthly estimates though. Combine China’s huge reserves and large moves in the currency markets and you get large valuation changes. If my estimate of the currency composition of China’s reserves is off, my monthly estimates will be a bit off too. The trend though is clear. Chinese reserve growth looks to have peaked earlier this year.* On a rolling 3m basis (adjusting for valuation changes and likely changes in the PBoC’s other foreign assets), Chinese reserve growth has essentially stopped.

Read more »

Ok, my title is a more-than-a-bit unfair.

But sovereign wealth funds are fundamentally vehicles for investing central bank reserves — or Treasury reserves from surplus oil revenue — in equities and real estate rather than in classic reserve assets. And this year classic reserve assets have done rather well. Equities and real estate have not.

The likely result has been large losses. Most sovereign funds remain, despite the efforts of Ted Truman, the US Treasury and the IMF, remain rather secretive, so we don’t know for sure. But it is hard to see how a large sovereign fund could have done well this year.

Take a large fund oil fund, one that started 2007 with maybe $500 billion.

– Say 60% of the fund was invested in equities. The fund started the year with $300 billion in equities, and probably ended the year with $150-$180 billion. Equities globally are down between 40% and 50% in dollar terms.
– Say 20% of the fund was invested in real estate, hedge funds and private equities. The fund started the year with $100 billion in “alternatives” and probably ended the year with between $60 and $80 billion. It is hard to tell exactly, as many “alternative” assets aren’t traded in liquid markets, though the fact that some endowments are trying to sell their limited parnerships in private equity funds at large discounts suggests that if these assets were marked to market, they would be down.
– Say 20% of the fund was invested in government bonds. Setting aside exchange rate moves, they held their value. For simplicity’s stake, let’s say $100 billion remained $100 billion (say mark to market gains on long-term treasuries offset any slide the dollar value of euro-denominated bonds).

The fund would have ended the year with between $310 billion and $360 billion.

Even if the fund received $50 billion from high oil prices (and kept the entire $50 billion in cash, avoiding any losses over the course of the year), it would end the year with between $360 and $410 billion.

This fund, of course, is fictional. But it is meant to capture the dynamics of a fund like the Abu Dhabi Investment Authority.

Read more »

Estimates of the break-even oil price in Saudi Arabia’s budget vary, ranging from under $40 a barrel to around $50 a barrel.

Sometimes that is because of different assumptions about Saudi Arabia’s actual production — the more the Saudis cut back production, the higher the oil price they need to balance their budget.

Sometimes that reflects different assumptions about the relevant oil price: the price Saudi Arabia gets on its actual production blend is a bit lower than the benchmark price for sweet light oil.

And sometimes it just reflects a failure to adjust for the games the Saudis play with their budget.

Formally, the Saudis plan to spend 410 billion Saudi Riyal — or $109 billion — in 2008 (more here). That incidentally is less that the 443 SAR ($118 billion) the Saudis actually spent in 2007, as spending ran a bit over the 380 billion SAR ($101b) in the formal budget. I don’t believe for a second that the Saudis are really going to spend less in 2008 than in 2007. Rachel Ziemba — who watches the local press closely for RGE — thinks the Saudis actual 2008 spending will come in around 532b SAR ($142 billion).

That works out to a break-even price for the Saudis’ blend — using the IMF’s assumption of 7.5 mbd of exports — of around 51 or 52 dollars a barrel.

My calculation ignored the Saudis non-oil revenue. But it also ignored the Saudis production costs. Neither amounts to all that much though, so I doubt my rough math is too far off. The IMF estimated the Saudis 2008 break-even price at $50 a barrel.

Moreover, Saudi spending has been growing at something like 15% a year, if not a bit more — remember, the Saudis had to increase their budget substantially just to assure that salaries kept up with inflation. And the Saudis probably aren’t going to scale back spending immediately. They don’t want the Saudi economy to come to a sudden halt. Projecting existing spending patterns out, I wouldn’t be surprised if the Saudis spent 585 SAR ($156) in 2009 — a spending level that produces a crude estimated break-even price of the Saudi blend of around $57. For sweet light, that works out to an oil price of $60 or more ..

Read more »

Only a few sovereign funds disclose their performance. But it reasonable to think that many sovereign wealth funds – particularly the well-established funds that invested heavily in equities – have had a bad year. Any sovereign fund overweight emerging economy equities – say those who were seduced by talk of a new Silk Road linking the Gulf to Asia – would have done worse. Ask some prominent US institutional investors.

Indeed, the United States Social Security Trust Fund likely has outperformed most sovereign funds over the past few years. The Social Security Trust Fund invests in nothing other than US Treasuries. That currently looks to have been a good choice. An enterprising Norwegian journalist supposedly has calculated that Norway would be better off now if it had just put all its spare oil revenue in the bank.

The fall in equity markets this fall implies that sovereign wealth funds now likely manage far less than $2 trillion in foreign assets. We don’t know how much sovereign funds had at their peak — in part because there isn’t a consensus on what constitutes a sovereign fund and in part because key funds don’t disclose much. And we don’t know how much they have now. But if funds that have been managed by central banks and invested fairly conservatively (Russia’s future fund as well as the non-reserve foreign assets of the Saudi Monetary Agency) are excluded, the size of the external portfolio managed by sovereign funds likely fell this year. Sovereign funds received large inflows in 2006, 2007 and the first half of 2008 – high oil prices increased inflows into many existing funds and new countries created funds.

Norway offers a case in point. I think it had around $380 billion in assets earlier this year. It now has around $300 billion. Norway has more exposure to Europe than most funds, so it has been hurt by the euro’s fall against the dollar. But it also has a relatively high share of its assets in bonds, which helped. It probably isn’t atypical.

The confluence of four trends suggests that the sovereign wealth fund moment has passed – at least for the time being.

– One, sovereign funds are fundamentally vehicles for investing government funds in equities and equity markets have not performed well. Nor for that matter have many “alternative investments.” Hedge fund returns have been not been great – and have been correlated with the equity market. Private equity is still “equity.” I would guess that London real estate isn’t doing that well these days.

Some countries with sovereign funds are subject to democratic pressure and it isn’t clear that there is still consensus in those countries to put public money at risk of (further) large losses. Korea is the most obvious example. Norway’s fund argues that the fall in equity markets provides an ideal time to rebalance Norway’s portfolio toward equities. Perhaps. I will be interested to see if the formal release of Norway’s third quarter results triggers a debate inside Norway over the wisdom of adding to Norway’s equity exposure. My guess is that Norway hasn’t been able to rebalance its portfolio fast enough to offset the market’s fall, and its “equity’ share is now well below target.

Read more »