Chandler: Future of SWFs Could Be in Their Own Backyard

Before the economic downturn, there had been concern that sovereign wealth funds would use their vast resources to pursue political rather than financial objectives. There were concerns about transparency and the revival of state capitalism. Based on linear projections, some observers warned that sovereign wealth funds grow bigger than central bank reserves themselves.

Now as the financial crisis unfolds, some of the anxiety over sovereign wealth funds has diminished. The collapse in the price of oil saps the growth of Middle East sovereign wealth funds.

The sharp slowdown in the global economy means that countries like China recycling its trade surplus in part into its sovereign wealth fund will also have less funds. In addition, given the performance of numerous asset class that sovereign wealth funds invested, included distressed banks, equities and emerging markets, like other investors the SWFs, must have experienced significant capital depreciation.

The financial crisis may prompt a new direction for sovereign wealth funds. Rather than look at the SWF as to help manage reserves, which means international diversification, it is possible that sovereign wealth funds begin looking at more local investments to support domestic markets. South Korea may point the way.

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The government plans to revise legislation to allow its SWF, the Korea Investment Corp, to invest domestically. The legislation also envisions the fund to borrow and issue bonds. The fund has almost $25 billion, and by its 2005 charter was only permitted to invest overseas.

In contrast, Russia has earmarked about 10 percent of its Wellbeing Fund with about $61 billion into domestic bonds and stocks. Reports suggest it has already invested roughly half the funds already into domestic markets. Given the pressure on Russian markets, it would not be surprising to see it expedite the plans to invest domestically.

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Marc Chandler is the global head of currency strategy for Brown Brothers Harriman. He has been analyzing, writing and talking about the foreign exchange market for more than 20 years. He is a regular guest on CNBC and his essays have been published in numerous economic and business publications. He previously served as the chief currency strategist for HSBC Bank USA and Mellon Bank.