Sovereign wealth funds — government-owned funds often amassed from petrodollar surpluses and geared toward investment in foreign industrial and financial assets — have become seemingly overnight a major force in global financial markets. Estimates of their current size range to $3 trillion, and recent projections expect them to swell to between $13 trillion and $15 trillion by 2015, larger than the current US GDP.
Concern in Washington about this kind of money deployed to buy companies in sensitive sectors has been growing, resulting in the passage of the Foreign Investment and National Security Act, requiring that acquisitions of U.S. companies by foreign state-owned entities undergo a 45-day review by the Congressional Committee on Foreign Investment. For once, the United States and its allies in Europe see eye to eye on this issue. French President Nicolas Sarkozy and German Chancellor Angela Merkel have spoken out against such investments and are considering legislation to protect strategic domestic companies and sectors.
Naturally, not all sovereign funds are a source of concern. The one owned by the government of Norway, for instance, is not the target of this legislation despite amassing some $360 billion on its books. Norway is a member of NATO, and besides, its sovereign fund is extremely transparent. It can buy no more than 5 percent of any company it invests in, but its actual average stake is far smaller, measuring around half a percent.
The Peterson Institute for International Economics, a Washington think tank, has ranked sovereign funds based on a variety of factors, including transparency, accountability and investment goals. Not surprisingly, while the Norwegian fund scored near the top of the rankings, funds controlled by such countries as China, Venezuela, Sudan and oil-rich Persian Gulf countries were all well below average.
Massive Amounts of CashAbu Dhabi Investment Authority (ADIA), the world's largest sovereign wealth fund, is believed to hold an eye-popping $900 billion. The United Arab Emirates have announced recently the creation of a new investment fund called the Emirates Investment Authority, to invest its oil profits and generate revenues for the government. And Saudi Arabia, with its sea of petrodollars, has plans to establish an even larger fund that would dwarf the ADIA.
For all the legitimate political concerns, it will be difficult to prevent such sums from reaching the markets — especially since world stock prices have started to wobble and the global financial sector is going through a dangerous patch.
The truth is that over the past two decades, corporate takeovers have been the driving force of the global economy and equity markets. Both actual acquisitions and the threat of a hostile bid have powered cost cutting, innovation and increased efficiency. This underpinned the rally in stock prices, boosted fees for investment banks and law firms and made quite a few among those who played the game fabulously rich.
The M&A game, however, has changed considerably since 2000. During the late 1990s, acquisitions were spurred by rising stock prices and most takeovers used shares of the new owner as currency to buy out existing shareholders. Leveraged buyouts, on the other hand, were rare, following the frenzy of the 1980s and the Drexel Burnham junk-bond scandal.
But LBOs made a spectacular comeback in this decade, after the Internet bubble burst and stock prices imploded in 2000-2001. More to the point, borrowed funds became remarkably cheap, whereas financial institutions were flush with cash and eager to back corporate takeover firms. For private equity investors, the use of cheap leverage greatly enhanced returns on their own money. Top corporate managers, who stood to make a fortune in an LBO, were only too happy to be approached by private equity firms.
