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News & Analysis

Sovereign Wealth Funds are likely to pick up strategic equity stakes in commodity firms

December 16, 2009, Wednesday, 11:39 GMT | 06:39 EST | 16:09 IST | 18:39 SGT
Contributed by Nirmal Bang

By Nirmal Bang


Sovereign Wealth Funds are not a new phenomenon.They have been discussed for many years, but their importance has risen considerably since the start of the recent global financial crisis. Governments with revenue streams dependent on the value of one underlying commodity, through exports, often pursue diversification of investments by setting up odies and allocating funds with the goal of stabilizing the revenues.

Thus, most SWFs have been established in countries that are rich in natural resources, with oil-related SWFs being the most common ones. The foreign exchange wealth accumulated by these countries is used for investment opportunities in different asset classes across the globe. This wealth is accumulated through revenue generation by exporting its natural resources.


Also, countries which accumulate a substantial proportion of foreign exchange reserves through a positive balance of trade by substantial amount of exports of its merchandise and invisibles, allocate their earnings. They do this by setting up investment arms which seek investment opportunities worldwide, with a view of diversification, stabilization and maximizing returns and work according to its nation’s strategic objectives. Countries like China, Singapore and Korea are some of the examples of this kind.


According to the official website of the Sovereign Wealth Funds Institute, in September the total assets under management of the SWFs were $3,752 billion with natural resource rich nations contributing 61% (around $2,289 billion) of the total funds and countries with current account surpluses and pension funds accounting for the rest.



SWF To Foreign Currency Exchange Ratio

This study is conducted to understand what proportion of a country’s foreign exchange reserves has been recognized and allotted to Sovereign Wealth Funds. It can be noted that some oil-producing nations have leveraged more funds to its SWF vehicle than its foreign currency exchange reserves, thus reflecting a more aggressive stance to seek higher returns. Countries like Saudi Arabia (110%), United Arab Emirates (1642%), Bahrain (403%), Kuwait (1033%) and others are some of them.


Some non oil-producing countries have also done well to park a substantial amount of foreign exchange reserves in the Sovereign Wealth Funds; China (32%), Singapore (203%) and Australia (106%) are some of the non oil -producing countries which have done extremely well in accumulating foreign exchange reserves, with China topping the list. It has, therefore, allotted a substantial amount of its reserves to its SWFs in accordance with its strategic choices and decisions.



While some developed and developing countries including Japan, India, UK, etc have still not floated any investment vehicle SWFs and are still presuming ways to do the same.


Although India is ranked sixth in the world in terms of foreign exchange reserves held by regions of the world, the government has still not set up an investment arm that uses its foreign exchange reserves and seeks investment opportunities abroad.


On the other hand, smaller countries not as developed as India, are making the most of the financial opportunities worldwide through investments. So, it’s now time for the sleeping tiger to wake-up while its neighbours continue to roar.



SWF Consensus Meter (A Strategy Evaluation Tool)

The SWF Institute's Consensus Demand Meter is an indicator to track and predict what Sovereign Wealth Funds would demand in the next three quarters from therelative start date. Going forward three quarters, the demand meter indicates how asset allocations, sectors and investment strategies rank.


Over the next three quarters, Sovereign Wealth Funds (SWFs) are expected to pick up strategic equity stakes in commodity firms that have scored a nine, suggesting a preferred option among other investment avenues as shown by the Consensus Demand Meter.


Equity holdings in the oil sector are also attractive, with crude prices having risen consistently for the past four months. The effects are already visible as China is acquiring stakes in oil exploring firms and stockpiling various metals thus adding to its strategic reserves.






World Historical And Predicted Population & It’s
Impact On Natural Resources


According to the World Bank, the current world population stands at 6.7 billion and has grown significantly over the years. In the year 2050, the population is expected to reach 8.9 billion and it will be 9.75 billion in the year 2150. The natural resources are vanishing at an alarming rate. It is said that we would need five more Earths to produce the resources needed if the population and consumption keep on increasing at the estimated rate.





A report by International think tank, the Global Footprint Network states that every year we use resources equivalent to nearly one-and-a-half Earths to meet its needs. And if we continue to use natural resources and produce waste at the current rate, it will require resources of two planets to meet the demand by 2030. Thus, this ideology has prompted many a nation to diversify and stabilize its economy by searching for opportunities worldwide to gather natural resources and build upon the strategic reserves for future generations.


SWFs And India: Do We Have It In Us?


India is the sixth largest region of the world in terms of the Foreign Currency Exchange reserve held by the government. It accounts for nearly 3% of the total foreign currency reserves held by the nations of the world.


China, on the other hand, has the largest share. It accounts for nearly 1/4th of the total foreign currency reserves of the nations of the world.



There has been a spurt in the number of nations buying gold after India bought around 200 tonnes of the yellow metal from the IMF at $1,045 per tonne. Since then, gold has been trading above that level on the COMEX and has touched a record high of $1,125.


China, on the other hand, has been very active in building its strategic reserves in energies as well as metals. In the recent past, China filled its first 100 million barrels of onshore emergency crude oil tanks and invested in acquiring African oil reserves also. It has been a constant importer of industrial metals from across the globe.


China has been seeking investment in industrial metals since the start of the financial crisis when the prices of these metals were hit the most. At the start of the year, copper was trading at around $3,200 per tonne and recently copper traded above $7,000 on the London Metal Exchange (LME).


China has already stockpiled large quantities of such metals to its strategic reserves through increased production measures and imports.

Some investments made by China across the world are mentioned below: China Investment Corporation acquired 17.2% stake in Canadian miner Trek Resources which owns mines of gold, zinc and copper. The Chinese FDI in Canada tripled over 2005 levels to reach around $2.8 billion in 2008.




Chinese FDI in Argentina increased to $157.19 million in 2007 from $1.05 million in 2003. China National Petroleum Corporation and China National Offshore Oil Corporation are bidding for around 84% stake in Argentina’s biggest oil company.

China Investment Corporation paid nearly $1 billion to buy an 11% stake in JSC KazMunaiGas Exploration Production, Kazakhstan oil and gas company.


China Investment Corporation also paid $850 million to acquire 14.9% of Noble Group, the Hong Kong commodity-trading powerhouse.


Chinese state-owned enterprise CNOOC Ltd is trying to buy 6 billion barrels of oil - or sixth of the proven reserves in Nigeria. This move could put China in competition with Royal Dutch Shell PLC, Chevron and Exxon Mobil Corp. These companies control all or parts of the 23 oil blocks sought by China.

The Chinese FDI in South Africa increased from $44.77 million in 2003 to $702.37 million in the year 2007. The state-run Industrial and Commercial Bank of China bought a 20% stake in South Africa’s Standard Bank for $5.2 billion.


Baosteel Group, China’s largest steel mill bought around 15% stake in Australia’s Aquila resources for $240.4 million. China’s FDI in Australia increased from $1.4 billion at the start of 2008 while it increased to $13 billion during the same period in 2009.




The Indian economy rose by 7.9% in the second quarter of FY09, belying analysts’ expectations of 6.3% growth for the period. If India has to grow in the coming years, then it needs a strong infrastructure, which is considered as the platform for launching itself to the next level of growth. During the last quarter of year 2008, most commodities from metals to agro were trading at their multi-year lows.


China has set a example for all developing countries on how to beat the recessionary blues. China’s State Reserve Bureau and various provinces started buying commodities as it remained the top consumer for these commodities and prices were trading at multi-year lows.


Once buying emerged from various Chinese organizations, prices started to move up and today most of them are up by more than 50% to 60%. In case of gold, the demand is expected to be more than 450 metric tonnes compared with 395.6 tonnes in 2008 as advertisements on State-run television channels were seen promoting gold and silver coins.


Commodities are the base for economies. If economies have to grow, commodity prices should also move up. These huge reserves of commodities have helped China to diversify its foreign exchange reserve. It has been partly hedging against the weaker dollar and any sharp appreciation in prices of these commodities would also benefit them.


Natural resources are scarce and it’s time developing countries start thinking about building strategic reserves for commodities if they do not have one.


India & Singapore: One More Lesson For The Tiger


Singapore’s foreign exchange reserves are around $182 billion, while that of India is around $286 billion. Singapore’s SWF Temasek Holdings is an active stateowned enterprise, seeking returns through investments in various asset classes in different projects across the globe. Temasek has a book value of S$118 billion, up 80% from March ’04.

The exposure of its portfolio is 31% in Singapore, 43% in the rest of Asia (27% in North Asia, 9% in ASEAN, 7% in South Asia), 22% in OECD economies and 4% in new markets such as Latin America, Russia and other regions.

Let us look at India’s applications of the foreign exchange reserves.



Temasek Holdings comparatively has a more diversified portfolio than India. The returns generated by Temasek Holdings since its inception is 16% compounded annually as per the market value as well as the shareholders’ funds. India’s rate of earnings on foreign currency assets and gold, after accounting for depreciation, increased to 4.8% in 2007-08 from 4.6% in 2006-07.

Last year due to the global financial crisis, Temasek Holdings’ returns accounted a negative 30%. And India, due to its conservative approach, has been able to generate a positive return of 4.8%. But, this argument does not stand correct as a conservative approach does include an opportunity cost. And India has been a victim of opportunity costs over the past few years.



Strategic Petroleum Reserves Of Nations


Strategic petroleum reserves refer to crude oil inventories or stockpiles held by the government of a particular country as well as the private industry for the purpose of providing economic and national security during an energy crisis.


Geo-political tensions between any two nations can take prices of all metals and energies to their highest levels. For such situations we need to be self-sufficient in our resources. The Strategic Petroleum Reserves of India stand at 37.4 million barrels which is enough for two-week consumption at the prevailing consumption rate of the country.

China’s Strategic Petroleum reserves total about 481.34 million barrels and South Korea’s reserves stand at 146 million barrels, which is a 34-day storage capacity for the nation at the prevailing consumption rate.


South Korea, a relatively smaller nation than India, has realized the importance of building its strategic reserves and is making the most of the opportunities offered by stockpiling commodities.



The question to ask is whether India has the power to generate returns by seeking investment opportunities in commodities. The answer is in India’s favour with its recent purchase of 200 tones of gold from the IMF. 


The main reason why India is lagging behind in this arena is that all investment decisions are taken by the government and the RBI. No special purpose vehicle, which can seek worldwide investment in commodities, called SWFs, has been floated by India till now.


The need of the hour for any individual, organization, state or nation is to have savings, follow investment practices and set up a Sovereign Wealth Fund.


The rising geopolitical tensions have prompted countries to have a substantial amount of resources as strategic reserves. India, on the other hand, has been quite conservative in its approach in access to natural resources of the world. We certainly have all that it takes to build up a SWF; but its time now to wake up and act.