All Hail the Sovereign Wealth Fund!

Ever wonder who bails out the banks? I do.

So today, I’m going to give you an inside look at a global trend in the growing world of giant investment funds, otherwise known as the Sovereign Wealth Fund.

As we all know, almost every major Wall Street investment brokerage firm and commercial bank has been hit hard by multibillion-dollar losses from mortgage-related business activities. You name the bank, and they’ve most likely been bit by the mortgage fall-out. But what many investors don’t realize is that many of these firms (like Citigroup and Morgan Stanley) had to be bailed out by sovereign wealth funds from China and other emerging Asian countries.

In fact, financial support from these sovereign wealth funds have prevented top-tier Western firms like these from going belly-up.

Bailing Out the Banks

Sovereign wealth funds (SWFs) are state-owned funds that contain financial assets like stocks, bonds, property and other financial instruments. SWFs are designed to allow countries to make large-scale investments around the world. China formed its own $200 billion sovereign wealth fund just last year, and thus became one of the world’s largest institutional investors overnight. I wasn’t at all surprised to see China start its own SWF. China established the fund mainly to follow in Singapore’s profitable example.

That’s because Singapore’s leading sovereign wealth investment company is a huge player in Asian institutional investment circles, with substantial investments in everything from shopping malls in Taipei to state-controlled banks in Beijing. China wants to copy Singapore’s success with its new sovereign wealth fund, China Investment Company (CIC).

Sovereign Wealth Funds: What You Need to Know

Since Sovereign Wealth Funds have the potential to move the international markets, let’s quickly take a look at the three main investment strategies these funds use.

Strategy #1: SWFs Buy Stakes in Leading U.S. and European Financial Institutions. The recent mortgage and housing-related losses suffered by commercial and investment banks have created a unique buying opportunity for sovereign wealth funds.

Countries that are manufacturing and natural resource powerhouses are instructing their SWFs to invest in Western financial institutions because they want to gain the financial market expertise that they might lack. Despite recent troubles with Western banks, there is still much for developing countries to learn from them.

Through they are investing in troubled banks, these Sovereign Wealth Funds have stabilized financial markets during the recent credit crisis. I believe we’ll see this bailout trend continue as China and oil-rich Middle Eastern countries become wealthier and seek out more strategic assets abroad.

Strategy #2: SWFs Buy Stakes in Natural Resources. The global competition for natural resources has become one of the most important investment themes of the 21st century.

However, one problem with this is that Western governments, led by the United States, are increasingly regulating investments from foreign SWFs. As a result, SWFs have invested elsewhere in the world, including aggressively investing in Africa and other resource-rich regions.

In fact, China has sent more than $10 billion in foreign aid to African countries during the past five years. This kind of global investment gives countries like China an advantage over private-sector competitors like Exxon Mobil when negotiating with resource-rich African governments.

Strategy #3: SWFs are Increasing Their Exposure to Untapped Emerging Markets. Sovereign Wealth Funds are also investing in emerging markets throughout Asia. In November, a Sovereign Wealth Fund controlled by the United Arab Emirates set up its Asian investment headquarters in Shanghai. This fund just invested $3 billion in Chinese infrastructure projects and is planning to invest heavily in India as well.

Sovereign Wealth Funds are also investing in emerging markets throughout Asia. In November, a Sovereign Wealth Fund controlled by the United Arab Emirates set up its Asian investment headquarters in Shanghai. This fund just invested $3 billion in Chinese infrastructure projects and is planning to invest heavily in India as well.

The Sovereign Wealth Fund: The Kings of Global Finance

As Sovereign Wealth Funds increasingly impact national policies, financial markets and strategic natural resources, it will pay off for investors to buy what they buy. I’ll continue watching this trend and let you know if any opportunities develop from it.

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