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the scariest funds of all
By Jack Ewing
Illustration by Scott Menchin

Sovereign funds worth $2.8 trillion from China, Russia, and the Mideast are dramatically changing the financial map

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Even among money managers, Gao Xiqing isn’t a household name. Yet the 54-year-old civil servant in Beijing oversees a pile of cash that would make any hedge fund manager swoon. Gao is general manager of the $200 billion China Investment Corp., created this year to invest the mainland’s foreign currency reserves in global capital markets. Don’t mistake him for some faceless Chinese bureaucrat, though. He graduated from Duke University School of Law in 1986, spent two years with a big New York law firm, then went home to help craft China’s securities regulations. It’s a combination that the global financial Establishment better get used to: a seemingly limitless pool of capital overseen by Western-trained managers. U.S. officials have been fretting about China Investment Corp. and other socalled sovereign wealth funds, calling on such outfits to provide greater insight into their operations, but there’s little the West can do about these funds. Russia, the Persian Gulf states, China, and others have amassed fortunes from exports of gas, oil, or manufactured goods, and now they’re looking to supercharge the returns they’re getting from that money. All told, these funds today control more cash than the world’s hedge funds combined: $2.8 trillion vs. $1.7 trillion, according to Morgan Stanley. By 2011 that figure may hit $8 trillion or more. For Americans and Europeans, the big worry is what sovereign fund managers plan to do with their huge pots of cash. Because their interests don’t always match those of the West, the looming question is whether they’ll simply go for maximum profit, or pursue more ominous political goals. The increasing economic clout of undemocratic governments could mean that “our markets will be less transparent, less yielding to outside law enforcement,” Christopher Cox, chairman of the Securities & Exchange Commission, said in a speech at Harvard University on Oct. 24. While few funds so far have thrown their weight around in pursuit of political and strategic goals, state-controlled companies from the same countries have done so, and many fear the funds will follow in their footsteps. Russia’s state-owned energy giant Gazprom, for instance, cut off gas supplies to Ukraine last year after relations between the two countries cooled. In October, Industrial & Commercial Bank of China paid $5.6 billion for 20% of South Africa’s largest bank, and last year state-owned oil company CNOOC bought into a Nigerian oil field for $2.3 billion. Dubai funds, meanwhile, have sought to bolster their hometown’s reputation as a world financial capital— and hone their investing skills—by taking stakes in NASDAQ and the London Stock Exchange. If Western officials are worried about the funds, they have only themselves to blame. The insatiable appetite of Americans and Europeans for oil and cheap manufactured goods has flooded developing countries with foreign currency. Western policymakers have spent years pushing to open global capital markets, creating the conditions that allow sovereign wealth funds to thrive. And as U.S. credit markets limp through the subprime mortgage crisis, the sovereigns may be the best place to go for financing. “The U.S. is going to have to import large amounts of capital from the rest of the world as long as there’s a big imbalance between what we save and what we spend,” says Robert D. Hormats, vice-chairman of Goldman Sachs (International). Saudi Arabia, China, and others have traditionally plowed their reserves into U.S. government bonds earning perhaps 5% annually, but they’re no longer satisfied with such paltry

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returns. In the past year, investment operations controlled by the emirate of Dubai have bought New York clothing retailer Barney’s and German industrial packaging maker Mauser, and have taken 3% stakes in both Airbus parent EADS and ICICI, India’s No.2 bank. The Government Investment Corp. of Singapore, a country known for stubbornly pursuing its own interests, owns some $80 billion in real estate assets worldwide, including such trophies as the 60-story AT&T Corporate Center in Chicago, Tokyo’s Shiodome City Center, and Merrill Lynch’s European headquarters in London. And Gao’s China Investment Corp. in May agreed to pay $3 billion for a 9.9% stake in private equity firm Blackstone Group (although the shares have since lost 18% of their value). The funds are already becoming the go-to guys for financial heavyweights the world over. In July, for instance, London’s Barclays bank needed billions in fast cash to bolster its bid for Dutch rival ABN Amro, but the subprime crisis was raging and the usual sources of credit were in lockdown mode. Barclays’ President Bob Diamond hopped an overnight flight to Singapore for an audience at the art deco headquarters of on of the city-state’s sovereign funds, Temasek Holdings. Within hours, Temasek pledged $5 billion. The Barclays bid ultimately failed, but the transaction left Temasek with a 2% stake in the bank. And in September, Temasek scored an M&A victory when the fund teamed up withy its subsidiary Singapore Airlines to take a 24% stake in China Eastern Airlines, acing out Hong Kong’s Cathay Pacific. Temasek has a track record that any of the newcomers might envy. Founded in 1974 to invest Singapore’s budget surpluses, Temasek has averaged a return of 18% annually and now holds assets worth $110 billion. Its diverse portfolio includes 25% of Indian broadcaster INX Media, 8% of Austrian vaccine-maker Intercell, and a slew of Asian banks including 5% of Bank of China. Temasek is run by the wife of Prime Minister Lee Hsien Loong, Ho Ching, who holds a master’s degree from Stanford University. And the fund also includes foreign talent, such as second-in-command Simon Israel, a

suPersiZed soVereiGns
Abu dhabi Singapore Norway Kuwait China

Value of major national investment funds, in billions*

900 $ 438 $ 367 $ 213 $ 200
$

Russia Qatar Australia Alaska Brunei

$

133 $ 50 $ 49 $ 39 $ 30

*Highest estimate Data: Peterson Institute for International Economics

New Zealander who previously headed the Asian operations of French food giant Danone. It’s no surprise that investment banks and asset managers love the sovereigns. While such funds are still only about an eighth the total size of the world’s pension funds (which have $21.6 trillion in assets), they’re becoming increasingly important customers for investment banks. Norway uses more than 50 outside firms to help manage its $367 billion fund, handing out $73 million in bonuses last year to the likes of Lehman Brothers and Morgan Stanley. All told, the sovereigns are likely to fork over fees of $4 billion to $8 billion to asset managers worldwide over the next five years, Merrill Lynch estimates. “The big investment banks are salivating at the prospect of [doing business with] these funds, says Kenneth S. Rogoff, a ” professor at Harvard and former chief economist at the International Monetary Fund. Many economists argue that the sovereigns make global capital markets safer. The funds don’t have to worry about panicky investors withdrawing money when markets tank, and most don’t have to make regular payments the way pension funds do. That means they can take the long view, helping stabilize the prices of stocks and While some say the funds are good for markets, others fret about their growing clout bonds that they own. “We are able to hold on to our positions in times of turmoil,” says Martin Skancke, director general of the positives the Negatives the Asset Management Dept. in the Norwegian Finance Ministry, which oversees Most are notoriously secretive the funds could help stabilize about their activities, making other the country’s Government Pension Fund. markets because they invest investors guess what they’re up to long-term and don’t need to cater (Despite its name, the agency doesn’t to panicky clients actually pay pensions and is instead deBy buying into strategic signed to build a national nest egg for the companies abroad, the funds Some, such as Norway’s fund, day when Norway’s oil reserves run dry). may give governments undue have aggressively pushed for Sovereign wealth funds may also take influence over industry better corporate governance a more gentle approach to acquisitions than private equity or hedge fund inIf too many of the funds show the funds typically have a vestors, whose aggressive restructuring a strong preference for strong appetite for risk, helping often provokes public ire. When Dubai emerging markets, the dollar shore up new ventures and International Capital bought British could tumble emerging markets theme park operator Madame Tussauds

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in 2005, for instance, it left management in place. “We don’t have the resources to manage companies or spend months finding replacement management teams,” says Sameer Al Ansari, CEO of Dubai International. Western policymakers fret that, like hedge funds, no one knows for sure what most sovereign funds are up to. Without reliable information about their investment strategies and holdings, rumor mongering takes over, which can create turmoil in the markets. While Norway issues a detailed annual report, the Abu Dhabi Investment Authority, with holdings estimated at as much as $875 billion, discloses almost no information. Analysts assume most of the Abu Dhabi money is in ultrasafe U.S. Treasury bills, but a recent Citigroup report said the fund also has extensive investments in Middle East banks as well as two cement companies in the region. Through its Mubadala Fund, with a value of some $10 billion, the government of the United Arab Emirates is also experimenting with riskier investments. In September it paid $1.35 billion for a 7.5% stake in private equity firm Carlyle Group. To counter concerns over the funds’ lack of transparency, U.S. and European officials are pressing the sovereigns to disclose more about their activities. Leaders of the Group of Seven nations, meeting in Washington in October, asked the International Monetary Fund to examine the issue—although it’s unclear what the IMF might be able to do. The goal in pushing for more accountability is to head off harsher measures that might hurt U.S. commercial interests abroad, says Clay Lowery, Assistant Secretary for International Affairs at the Treasury Dept. “We are worried about an over-reaction leading to protectionism, putting up barriers in the U.S. to legitimate investment,” Lowery says. In any event, it may be

hard for Western policymakers to argue that the sovereigns should be more open without imposing similar rules on hedge funds or private equity, which are generally no more transparent. The best hope is that sovereign funds decide it’s in their interest to open up. One of the biggest victims of the rising power of the sovereigns could well be the dollar. As the funds shift their enormous assets away from U.S. Treasury bills, for instance, one of the greenback’s biggest pillars of support could start to crumble. And with the funds showing a strong preference for emerging-market assets, the dollar could suffer even more. Indeed, many of the funds don’t seem very interested in buying in the U.S. at all. “Why would you want assets denominated in a declining currency?” asks Merrill Lynch economist Alex Patelis. So far, the track record of the sovereign funds suggests they will move carefully to avoid provoking major opposition. Last year, Dubai International Capital gave up an attempt to buy the Liverpool soccer team amid fervent public opposition, though DIC cited price as its reason for withdrawing. And when Dubai was ready to seal a deal with Nasdaq, it spent big money on Washington lobbyists and carefully briefed key legislators. “It’s not our country, says Soud Ba’alawy, executive ” chairman of Dubai Group. “Whether we like it or not, we have to adapt. ^ ” –With Chi-Chu Tschang in Beijing, Assif Shameen in Singapore, Stanley Reed in London, Jane Sasseen and Emily Thornton in New York, and Jason Bush in Moscow

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the froZen chosen
thanks to its pipeline payoff, Alaska has $40 billion to burn
By Eamon Javers

The huge wealth of sovereign funds has sparked lots of anxiety in Washington. But one of the biggest such outfits is headquartered in Juneau, Alaska. Since 1976, 25% of the state’s mineral and oil revenue has gone into the Alaska Permanent Fund. Now worth $40 billion, its goal is twofold: to generate dividends for residents, and to build up funds for the day when the oil runs out. In recent years, a small amount has also gone to pay for capital projects around the state. This year, the 604,000 Alaskans each got $1,654. “For a place like Alaska, this is an extreme amount of money,” says Michael J. Burns, chief
uPI

executive of the Permanent Fund’s management corporation. Burns runs the outfit much like a public pension fund in the Lower 48. Early on, it primarily invested in Treasury bills and corporate debt, but managers have gradually embraced greater risk. That shift allowed the Alaskans to dive into venture capital and hedge funds, including a $40 million investment in Blackstone Capital Partners in 2005. Now, publicly traded stocks make up 53% of the fund, bonds 29%, real estate 10%, and alternative assets, such as hedge funds, 8%. Alaska’s voters own, among other things, more than 7 million shares of General Electric, an

apartment building on East 87th Street in Manhattan, and stakes in four dozen private equity funds. All the details are publicly disclosed. Although oil production in Alaska is declining, the state contributed about $575 million in new petrodollars to the Permanent Fund this year. But that was dwarfed by the fund’s $5.4 billion in investment returns. The hefty payoff is a sign that the fund—if not the state itself—is already weaning itself from oil. Burns points out that many sovereign funds around the globe face a common problem. “When you’re in the extraction business,” he says, “you know there’s an end to what you can get from the earth.”

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CopyDesk Header Info (Do not delete the sentence above) Slug: sovereign46 Reporter/Writer: Ewing NY Editor: Rocks Copy Editor: Newman

COMPANY INDEX (Do not delete the sentence above) China Investment Corp. Morgan Stanley (MS) Gazprom VTB Airbus EADS Goldman Sachs (GS) Dubai International Capital Mauser Government Investment Corp. Merrill Lynch (MER) Blackstone Group (BX) Barclays (BCS) ABN Amro (ABN) Temasek Holdings (CK) JPMorgan Chase (JPM) Citigroup (C) Abu Dhabi Investment Authority Carlyle Group Dubai Group HSBC (HBC) Dubai Investment Group Dubai Holding

DESK QUERIES: Please DO NOT return story to desk without confirming or correcting. (Do not delete the sentence above) Duke University Law School (we show it’s School of Law) ... sure law firm is Mudge Rose Guthrie Alexander & Ferdon, dotters show -- no need to name Mauser as industrial packaging maker (dotters find it’s an arms maker) --different company. this one makes steel drums tk-story AT&T center (dotters show it’s 60 stories) .. 60 is fine Barclay’s (it’s Barclays) ... sure Bob Diamond, chief operating officer (we show Robert E. Diamond, president and executive director) ... Robert E. Diamond Jr., president Temasek fund (we show it’s Temasek Holdings) ... Temasek Holdings 1974 as year Temasek founded (dotters show 1975) ...1974 Citicorp (Citigroup?) ... citigroup m.i. “S.” ok for Rogoff? Abu Dhabi Investment Authority & Corp. (we don’t show the & Corp. but only Abu Dhabi Investment Authority) ...Abu Dhabi Investment Authority is fine Mubdala fund (we show Mubadala Fund) ... Mubadala fund (lc) is correct The Carlyle Group (just Carlyle Group) ... no “the” is ok Dubai Group (we show Dubai Group and Dubai International Capital both part of Dubai Holding) ...that’s correct Dubai Investment Corp. (we show Dubai Investment Group) ... should be Dubai International Capital ... DIC (DIG?) ... correct second ref for Dubai International Capital ... So’ud Balawy (we show Soud or Saud Baalaway or Ba’alaway) ...Soud Ba’alawy, executive chairman of Dubai Group

thanks and regards/desk suggested hed: The New Flags Of Fortune Sovereign funds from the likes of China, Russia, and the Mideast control $2.8 trillion——more than all hedge funds—and are dramatically changing the global financial landscape

Banks and other financial players have been favorite acquisition targets for sovereign funds. It helps that such deals haven’t created much opposition. But the funds also are interested in getting their hands on banks to gain knowhow and influence in the West and to bolster their financial systems back home. Government-controlled Borse Dubai, for instance, is chasing a $6.5 billion deal that would give it a 20% stake in Nasdaq, in part because it wants to create a similar stock exchange in the Gulf. And Dubai International Capital, also controlled by Dubai’s ruler, owns 3% of British bank HSBC, worth $6 billion. Borse Dubai also has 20% of the London Stock Exchange while the Qatar Investment Authority has 15%.

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