The document discusses how sovereign wealth funds (SWFs) have emerged as major players in global financial markets due to a shift in the global economic landscape driven by globalization. SWFs now influence the global financial system as their investments have reversed traditional capital flows. Their long term investment horizons and risk tolerances differentiate them from other institutional investors. The rise of SWFs reflects a secular shift in global wealth from developed to developing economies and those with natural resources.
1. The Impact of SWFs
on financial markets
FX Invest Middle East conference
Abu Dhabi, October 2 2012
Fabio Scacciavillani
Chief Economist, OIF
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2. Agenda
The emergence of SWFs as an
epiphenomenon of the tectonic shift
driven by globalization
An economic environment favoring
newcomers rather than incumbents
How SWFs are influencing the new
financial architecture and
3. Millennial View
Contribution to global GDP in the last 6 centuries at 1990 International (PPP) US$
Western United
Europe FSU States Japan China India
1500 17.9% 3.4% 0.3% 3.1% 25.0% 24.5%
1600 20.0 3.5 0.2 2.9 29.1 22.5
1700 22.5 4.4 0.1 4.1 22.3 24.4
1820 23.6 5.4 1.8 3.0 32.9 16.0
1870 33.6 7.6 8.9 2.3 17.2 12.2
1913 33.5 8.6 19.1 2.6 8.9 7.6
1950 26.3 9.6 27.3 3.0 4.5 4.1
1973 25.7 9.4 22.0 7.7 4.6 3.1
1998 20.6 3.4 21.9 7.6 11.5 5.0
2006e 19.0 3.8 19.7 6.3 15.1 6.3
Source: Angus Maddison, The World Economy: A Millennial Perspective, OECD (2001); IMF; Morgan Stanley Research
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11. Globalization
Ironically, before the Great Recession the narrative on
globalization hinged on the expectations that Anglo-Saxon
finance and free markets paradigm would gradually extend
to the rest of the world
Few expected that the globalization would reshuffle the
economic landscape and pave the way for a shift of the
economic barycenter from mature economies to emerging
markets
Contrary to the script the extras have become the
protagonists giving raise to a multipolar world
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12. How The Extras Became
Protagonists
• Most Western countries have been living above
their means, thanks to mounting private liabilities
in the US, UK, Spain and public liabilities in
Continental Europe
• This came as a result of an attempt to counter the
loss of technological edge and a demographic
decline
• Public opinion and leaders in developed world are
still in denial
• Cuts to discretionary spending, marginal
entitlement trimmings and cuts in public
investments are mere palliatives
• It is required a re-engineering of the fundamental 12
functions of the public sector and its financing
14. Aftermath
• The world will deal with the
aftermath of this crisis for several
years.
• The illusion of quickly reverting to
the days of easy money and inflated
stock indices courtesy of the Fed are
giving way to the awareness that the
adjustment will be painful
• Some call it the ‘New Normal’
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15. State Capitalism?
“The crisis of Western liberal
capitalism has coincided with the rise
of a powerful new form of state
capitalism in emerging markets”
“The crisis of liberal capitalism has
been rendered more serious by the
rise of a potent alternative: state
capitalism which tries to meld the
powers of the state with the powers
of capitalism”.
Source : Special Report on State Capitalism
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16. SWFs: Public vs Private
• Historically, the demarcation between public and
private sphere in the economy swings like an
irregular pendulum in response to circumstances
and political mood.
• Financial markets were widely viewed as a
preserve of individuals, firms and private
institutions
• Any interference by a publicly owned entity was
deemed an undue interference at odd with well-
established laws, norms and practices.
• The massive bail out of key international banks
and industries like car manufacturing shattered
this sanctimonious attitude.
• KfW, EDF, ENI, Fannie & Freddie, Landesbanken etc.
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17. Reversal of Capital Flows
• Until the 1970s, the capital flows typically moved from the developed world
towards developing economies.
• This situation had prevailed since the industrial revolution and was a
dominant feature of the first wave of globalization (1870-1914) when the
British Empire and the US were the unmatched powerhouses.
• Until recently a Brazilian or an Asian company looking for financing would
obtain it directly or indirectly from London or New York.
• Slowly, but with a remarkable acceleration over the last few years capital
flows inverted their course: particularly from emerging economies to the US.
China, Japan, some Asian Tigers and MENA are net supplier of capital.
• ‘South-South’ flow are rising, including FDI. Intra emerging market flows
could be channeled directly without the intermediation of the developed
counties financial centers by strengthening the links among the outer nodes.
• Recent example: Qatar bought 20% of CITIC
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18. The role of SWFs
• The surge in capital flows that we have witnessed over
the last 25 years is the fundamental propeller of this re-
balancing because it transformed the sign of the
demographic variable in the equation of economic
development
• Qatar vs Russia
• The expanding role of SWF reflects this secular inversion
in the distribution of global wealth from mature
economies, primarily the United States and Europe, to
countries such as China, India and Brazil which enjoy
favourable demographics, and to those with sizable
natural resources such as the UAE, Norway, Australia and
Russia.
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19. SWF and FX reserves
Source: Castelli & Scacciavillani, The New Economics of SWFs
21. Global Role
• The end of the saving glut and the coming era
of capital scarcity
• Long term investments: SWFs as the ultimate
risk bearers
• SWF emerging investments trends
• SWFs investing in the less developed
economies: Africa as the last investment
frontier: savings – investment bottleneck
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22. Financial Barycenter
• The “hubs and spikes” model of global financial
markets is inadequate for a multipolar world
and implies a dangerous concentration of
systemic risks
• Pinnacles: London and New York
• Cobweb model is the most natural alternative
• South-South relationships need to strengthen
and find alternatives linkages
• Towards a multi-currency regime
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23. Capitalism is Risk
• Growth, progress, new ventures, technological
advances and implementation of new discoveries
are subject to uncertainty
• Risk will materialize no matter how many
precautions one adopts, so a capitalist system is
inherently subject to instability, cycles, crises
and disruptions.
• This does not imply that capitalism is ‘wrong’. it
implies that risk management is at the core of
capitalism and the cornerstone of free markets.
• Widespread ineptitude in risk management is more
dangerous for free markets than any
collectivist ideology.
• Incompetent bankers can obliterate free
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25. The strategies of most
SWFs or FWFs display a
higher risk tolerance on
longer term
investments, with far
reaching implications for
their risk management.
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26. SWFs as an Asset Class
• SWFs rarely face sudden redemptions, hence they do
not need to be over-concerned about liquidity risk or
crippling margin calls.
• Stable endowment and long-term focus do not imply
complacency on risk management or careless risk
assessment.
• It means that they need to assign a different set of
weights to various sources of risks than mainstream
asset managers.
• But the risk management for long term investing is
completely different from the mainstream concept.
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27. Risk Management
• If you cannot estimate risk, you cannot estimate a
meaningful measure of true return and profit
• Without this estimate capitalism cannot function
• Risk determination is built upon US Treasury Bill
yields.
• Add equity risk premiums, market betas, political risk
etc. ...and you get the target rate for capital
remuneration.
• FX is the key driver of performance for global asset
managers
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31. Six Killer Applications
• Political and economic competition
Institutional
• Rule of law Capital
• Scientific revolution
• Modern medicine Human
• Education Capital
• The work ethic
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32. Turn off the Autopilot
• Risk management is human judgment guided by a set of
imperfect quantitative tools and constantly updated
qualitative assessment. Quantitative tools must not be
considered an auto-pilot system
• Asset valuations are probability distributions, not exact
calculations
• These probability distributions will always be influenced
by the business cycle, which remains the fundamental
driver of market and systemic risk.
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33. Macroeconomics
• Forming expectations on the macroeconomic
outlook is critical but not enough, because the link
between macroeconomic fluctuations and asset
prices is inherently unstable
• Models that aim to estimate the parameters of such
a relationship are not reliable, nor are models that
rely on past data to estimate a probability
distribution of returns and correlations
• Sloppy currency risk management is financial
suicide in a multi-polar world. FX is a fundamental
driver of performance
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34. Long Run Growth Drivers
and Implications for Risk
Management
What drives long term growth? => Investment Themes
rather than asset classes in order to diversify risk.
• Demographics & Education
• Infrastructure & Urbanization
• Natural Resources Super-cycle
• Technological Advances
• Logistics and integration of value chains
• “Fluidification” of Business Environment
• The Six Killer Applications (Niall Ferguson)
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35. International Role of the Dollar
Post WWII
was an Exorbitant
unusual privilege
period from turns into
a historical unbearable
perspective burden New source of
international
liquidity for a
multipolar
The Triffin Currency Debasing => world =>
Hard SDR
dilemma Commodity inflation =>
and the Oil shock => Recession =>
relative size Financial Crisis
of major
economies
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36. Concluding Remarks
• The classification of developed economies and emerging economies starts to be out of
touch with reality, because some of the emerging economies have in fact emerged and
overtaken some of those classified as developed which in turn are sinking (Greece is
just a point in case) like South America in the 1960s. So it would be more apt to talk
about mature and high growth economies.
• The expanding role of SWF reflects this secular inversion in the distribution of global
wealth from mature economies, primarily the United States and Europe, to countries
such as China, India and Brazil which enjoy favourable demographics, and to those
with sizable natural resources such as the UAE, Norway, Australia and Russia.
• The surge in capital flows that we have witnessed over the last 25 years is the
fundamental propeller of this re-balancing because it transformed the sign of the
demographic variable in the equation of economic development.
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37. Thank You
Fabio Scacciavillani
Oman Investment Fund (OIF)
P. O. Box 329, P.C. 115
Sultanate of Oman
T: +968-2464 3035
M: +968-9321 4978
F: +968-2469 1344
E: fabio@oif.om
W: http://www.oif.om
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