The New Financial Heavyweights

Sovereign funds totaling $2.8 trillion from China, the Mideast, and elsewhere are redrawing the global investment map

by Jack Ewing

Even in the financial world, Gao Xiqing isn't a household name. Yet the 54-year-old civil servant in Beijing oversees a pile of cash that would make any hedge fund manager swoon. Gao is general manager of the $200 billion China Investment Corp., created this year to invest the mainland's foreign currency reserves in global capital markets. Don't mistake him for some faceless Chinese bureaucrat, though. He graduated from Duke University School of Law in 1986, spent two years with a big New York law firm, and then went home to help craft China's securities regulations.

Here's a combination the global financial Establishment better get used to: a seemingly limitless pool of capital overseen by Western-trained managers. U.S. officials have been fretting about China Investment and other so-called sovereign wealth funds, calling on such outfits to provide greater insight into their operations. But there's little the West can do. Russia, the Persian Gulf states, China, and others have amassed fortunes from exports of gas, oil, or manufactured goods, and now they're looking to supercharge the returns they're getting from that money. All told, these funds today control more cash than the world's hedge funds combined: $2.8 trillion vs. $1.7 trillion, according to Morgan Stanley (MS). By 2011 that figure may hit $8 trillion or more.

For Americans and Europeans, the big worry is what sovereign fund managers plan to do with their huge pots of cash. Because their interests don't always match those of the West, the looming question is whether they'll simply go for maximum profit, or also pursue more ominous political goals. The increasing economic clout of undemocratic governments could mean that "our markets will be less transparent, less yielding to outside law enforcement," Christopher Cox, chairman of the Securities & Exchange Commission, said in a speech at Harvard University on Oct. 24.

While few funds so far have thrown their weight around for political and strategic ends, state-controlled companies from the same countries have done so, and many fear the funds will follow in their footsteps. Russia's state-owned energy giant Gazprom, for instance, cut off gas supplies to Ukraine last year after relations between the two countries cooled. In October, Industrial & Commercial Bank of China paid $5.6 billion for 20% of South Africa's largest bank, and last year state-owned oil company CNOOC bought into a Nigerian oil field for $2.3 billion. Dubai funds, meanwhile, have sought to bolster their hometown's reputation as a world financial capital by taking stakes in Nasdaq and the London Stock Exchange.

If Western officials are worried about the funds, they have only themselves to blame. The insatiable appetite of Americans and Europeans for oil and cheap manufactured goods has flooded developing countries with foreign currency. Western policymakers have spent years pushing to open global capital markets, creating the conditions that allow sovereign wealth funds to thrive. And as U.S. credit markets limp through the subprime mortgage crisis, the sovereigns may be the best place to go for financing. "The U.S. is going to have to import large amounts of capital from the rest of the world as long as there's a big imbalance between what we save and what we spend," says Robert D. Hormats, vice-chairman of Goldman Sachs (International) (GS).