A Closer Look at Sovereign Wealth Funds

Since sovereign funds have traditionally taken a long-term approach to investing, they have had a stabilizing influence on world financial markets, Herring says. But because the top 20 sovereign funds are so large, they do put a lot of concentrated economic power under the control of a small number of people, often in autocratic countries. The smaller sum controlled by hedge funds is divided among thousands of players.

Writing in the Financial Times last July, former Treasury Secretary and Harvard president Lawrence Summers noted that government shareholders may not always have the same interests as ordinary shareholders . "The logic of the capitalist system depends on shareholders causing companies to act so as to maximize the value of their shares," he wrote. "It is far from obvious that this will over time be the only motivation of governments as shareholders. They may want to see their national companies compete effectively, or to extract technology or to achieve influence."

Governments of target, or "host," countries could find themselves in awkward situations, he said. "What about the day when a country joins some 'coalition of the willing' and asks the U.S. president to support a tax break for a company in which it has invested? Or when a decision has to be made to bail out a company, much of whose debt is held by an ally's central bank?"

So far, there have not been any serious cases of this power being used for political or other noninvestment purposes. One of the few examples is relatively mild: In June 2006, the Norwegian fund sold its more than $400 million in Wal-Mart (WMT Quote - Cramer on WMT - Stock Picks) holdings, criticizing the way the company treated its workers.

Still, the temptation to use financial clout to further nonfinancial goals is ever-present, Herring says, recalling that many American universities and pension funds divested themselves in the 1980s of companies doing business in South Africa. "You had many large players reallocating their portfolios for other than economic reasons. That's simply the nature of things when government [of a fund] is in part political."

An Inside Look at Western Companies

According to Herring, the sovereign funds' investments in financial-services firms may be motivated not just by hopes of good investment returns , but by the desire to learn how those Western companies operate. In addition to the recent deals, China earlier this year paid $3 billion for a 9.3% share in Blackstone Group, the New York-based private-equity firm. "My guess is that these [investments] are substantially different than the kind of passive portfolio investment you see out of Norway."

Even so, he adds, that's no cause for alarm, as the U.S. government can step in if it sees a real problem. "The rules can change if we should become enormously concerned that, say, the agricultural-refining business is of strategic importance." U.S. law welcomes foreign investment so long as it poses no security risk.

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