A Closer Look at Sovereign Wealth Funds

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When the Abu Dhabi government announced late in November that it was buying 4.9% of Citigroup C for $7.5 billion, the general reaction was relief that the firm was finding a way out of the subprime mortgage mess.

The same response followed the early December news that UBS UBS was selling a 10.8% share to the government of Singapore and an unnamed Middle Eastern investor for $11.5 billion, for much the same reason.

But is foreign ownership -- or, more precisely, foreign government ownership -- really a good thing? Many experts think this mushrooming trend bears watching, especially for any sign that these funds are evolving from pure investment vehicles into tools for exerting political pressure on the "target" countries. "I think pressure is a legitimate worry, but I'm not sure we have seen signs of that yet," says Wharton finance professor Franklin Allen.

There is nothing intrinsically wrong with foreign ownership, suggests Wharton finance professor Richard Marston, but ownership by foreign governments could be different from ownership by foreign businesses. "Clearly, there are industries where we would be concerned about certain countries having an ownership interest," he says, citing airlines and military contractors. "You do worry that these are governments, and you worry about their motivation."

Governments, through investment pools known as sovereign wealth funds, have put tens of billions of dollars into Western financial firms this year, from Bear Stearns BSC and Barclays BCS to HSBC Holdings HBC and Blackstone Group BX, investing at bargain prices amid the subprime crisis. Two Middle Eastern government funds now even own a third of the London Stock Exchange.

None of this investment has drawn the kind of outrage that greeted a 2006 plan for a government-owned business in the United Arab Emirates to buy a firm that ran a number of U.S. ports. Much of that involved unease with a Middle Eastern country having a role controlling potential entry points for terrorists. "A lot of this becomes emotional when you're talking about the Chinese and Arabs as opposed to the French," Marston says.

Concerns Over Secrecy

Still, some politicians and economists are concerned about the growing power of sovereign wealth funds, most of which are based in the Middle East and Asia. The International Monetary Fund estimates that sovereign funds control as much as $3 trillion in assets , up from $500 million in 1990, and it expects them to grow to $10 trillion by 2012.

While cross-border investments are nothing new, the sovereign funds raise special questions because the investment decisions are controlled by governments rather than individuals or corporations. And, unlike central banks , which tend to invest reserves in assets like U.S. Treasury bonds , the sovereign funds often invest in corporations. This year, the largest target country for such investment has been the United States.

The 20 largest sovereign wealth funds, each worth more than $10 billion, are estimated to control more than $2 trillion in assets, overshadowing the $1.5 trillion thought to be managed by hedge funds , which have been subject to calls for greater regulation because of their market clout. Like hedge funds, most sovereign funds are secretive. There is no comprehensive list of what they own, nor any mandatory reporting of their investment policies.