Market volatility during the economic crisis impacted heavily on sovereign wealth fund (SWF) investment portfolios,which, according to some estimates,collectively lost the equivalent of$430bn during the course of 2008.

Yet assets under management are expected to continue accumulating, forecast to increase by 11% in 2010.

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“Despite significant losses in book values, large funds have emerged strongly from the economic crisis. In fact, it is remarkable how well they performed in 2009,” says Steffen Kern, director for international financial markets policy at Deutsche Bank.

“Revenue erosion and decline of portfolio book values were reversed.”

At the end of 2009, assets under management were $3700bn, which had recovered from a trough of $3000bn.

With more active investment management, coupled with the global economic recovery contributing to more resilient demand pressures, stronger market performance and firmer commodity prices, SWF assets should continue to grow for the foreseeable future – despite the fact that global current and capital account imbalances, which in part contributed to the surge in SWF assets,are expected to diminish as the global economy rebalances. In 10 years, total assets under management are expected to amount to $7000bn, about two times what they are today.

A search for alternatives

While capital flows stagnate as governments increase their demand, the search for alternative sources of investment will intensify. The actual and potential impact of SWFs therefore needs to be set in context. This was among the points raised at the Edinburgh Dialogue, a gathering of international analysts and practitioners that took place in the Scottish capital in June.

Discussion concentrated on the need to achieve investment reciprocity and an understanding of the real nature of SWFs, as well as their various structures. Transparency was cited as an issue but it was seen as much more important to accurately comprehend what SWFs can provide and what actual opportunities are on offer to SWFs.

Overplayed importance?

SWFs are still less significant in the global investment arena than all the media attention suggests;and sentiment towards the funds has varied markedly over the past few years – and it would seem inversely to the strength, or lack, of economic performance in Europe and North America. These have ranged from periods of concern, if not outright hostility, to obsequious courting, while SWFs have themselves not been immune to shifts in perception of market opportunities and investment appetite.

“SWF investments are still relatively small and are not dominating global capital at all. The message that SWFs are no ‘saviours’ or ‘investors of last resort’ is now clear to recipient countries,” says Mr Kern.

“SWF investments are still relatively small and are not dominating global capital at all. The message that SWFs are no ‘saviours’ or ‘investors of last resort’ is now clear to recipient countries,

Mr Kern

“We are progressing towards a new equilibrium for the industry, with SWFs being seen as normal institutional investors.”

A new feature

Although SWFs are not in themselves new – many are a number of decades old – the scale and degree to which they have been able to accumulate assets (and lose value) relatively recently means that they are effectively a new market feature, especially given the rapid increase in the number of sovereigns developing such institutional investment structures.

Transparency, depending on how it is defined on both sides of the investment equation, will only provide part of the answer. Morecrucial is understanding the institutional structure of SWFs and the ways and degree to which the profit motive is specifically articulated. Correspondingly, understanding the actual investment opportunities that are realistically available for SWFs, and the services that specific financial centres offer, will assist their full integration into the global financial architecture.