Widespread public fears about Sovereign Wealth Funds (SWFs) may lead to backlash of protectionism.  However, on balance “these fears are not well-founded,” says Robert Pozen, Chairman of MFS. 

Pozen provided data on the size and growth of SWFs, who have gained prominence through their recent investments in financial institutions, such as UBS, Merrill Lynch, Citibank, and Morgan Stanley.   As evidence of public misperceptions, he cited a Wall Street Journal survey from February of 2008, showing that 72% of the Americans believe foreign governments control large amounts of Treasury debt and are gaining “leverage over America’s financial security.”  The same percentage believes SWFs provide insufficient disclosure about their investments.

The source of sovereign wealth funds is rapidly growing trade surpluses, primarily funded by exports of commodities and oil.  Oil and gas exports represent the source of two thirds of the assets in these funds.  Singapore now has the largest SWF, estimated to be just over $200Bn, and China’s fund is almost as large.  SWFs hold approximately $2.5 trillion in assets, roughly one-quarter the size of the US mutual fund assets.  In the context of $55 trillion in capital in the world’s equity markets, SWF holdings are large but not overly significant.

Much of the public concern regarding SWFs stems from fear they could buy control of US companies, particularly those related to national security.  Pozen pointed to a number of laws which will stop this from happening.  The Exon-Florio provisions allow the President to block investment if it jeopardizes national or homeland security, and its charter was recently expanded to require extra scrutiny of critical infrastructure (energy, communications, transportation).  Foreign ownership is restricted in specific industries (aviation, banking, communication/broadcasting, maritime/shipping, mineral leases, and power/utilities).  No foreign ownership is permitted for nuclear power industries.

Another concern centers on whether SWFs will act to optimize their economic interests in their investment process or, if not, what the potential adverse effects might be.   For example, SWFs might invest for political motives, in order to dominate certain industries, and use their power to drive down prices in certain markets.   However, Pozen pointed to antitrust legislation regulating ownership in industries as well as predatory pricing laws that will mitigate or eliminate these concerns.  “So far,” said Pozen, “sovereign wealth funds have invested with their economic interests in mind, and without political motivation.”

It is also unlikely SWFs will adversely impact market stability.  SWFs have long-term investment horizons and, given their large size and lack of liquidity pressure, are unlikely to cause short-term volatility in the markets.

Two specific concerns have been raised relative to SWFs and insider trading.  First, will SWFs and foreign countries cooperate with the SEC with respect to enforcement?  Pozen believes they will, and cites no evidence of any failure on the part of SWFs to cooperate.  In the past, foreign state-owned industries have cooperated in such matters.  Second, a concern has been raised that foreign governments will provide insider information giving SWFs an advantage in trading.  Pozen cites no evidence of this occurring and believes information flows could be traced.  “Maybe this could happen once or twice before it is stopped,” says Pozen.

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