Monday, November 5, 2007

Merrill Lynch: More on Sovereign Wealth Funds

Following up on their very well received
"The overflowing bathtub, the running tap and SWF's"
Mother gives us a follow-up (4 page PDF):

A high level of investor interest
Our recent report on Sovereign Wealth Funds has triggered a high level of investor interest. We provide an extension to the report and highlight some of the common questions we received.

The SWF put
Investors seem to believe that SWFs will support the price of risky assets. In a way, the SWFs are perceived to be writing a put –akin to the so-called Greenspan put– in the assets that they are most likely to be involved in. This feeds back into markets today and creates the possibility that SWFs end up paying a higher price than otherwise, when they are able to actually deploy their capital.

Calls for transparency are somewhat misplaced, in our opinion, given the enormous size of SWFs as too much information would affect the price of the assets SWFs would invest in.

Strategic objectives
A torrent of recently announced deals underscore the importance that SWFs have in achieving national strategic objectives in addition to increasing returns and portfolio diversification. It is also our belief that asset allocation decisions are likely to evolve over time, with many SWFs ‘learning by doing’.

Which asset managers?
SWFs are likely to use as external managers firms with a global reach, large proportion of institutional assets, long standing relationships with consultants, long investment track records and those also able to provide intellectual capital transfer in return. We see a strong possibility that an SWF elects to acquire a direct stake in a global asset manager.

As SWF investments generate returns, there will be an increasing temptation by governments to repatriate part of these funds to finance potential budget deficits. SWFs can act as ‘automatic stabilisers’. Over the very long run, repatriation of SWF assets back into their home countries is likely to put significant upward pressure on their currencies.