I believe four major actors—petrodollar investors, Asian central banks, hedge funds, and private equity—are today’s the key power brokers playing an increasingly important role in the world’s financial markets.
Excluding cross-investments between them, oil investors, Asian central banks, hedge funds, and private-equity firms together held $20 trillion in assets at the end of 2012. Their assets have tripled since 2000, making them two-thirds the size of global pension funds.
Together these four players are reshaping global capital markets in a major way. They each represent large new pools of liquidity with longer-term investment horizons than traditional investors that allow them to pursue higher returns—and risks. They have markedly diversified the investor base and expanded private markets for capital. They are spurring financial innovation, enabling the more efficient spreading of risk, and spreading liquidity.
Although the boom years ended in late 2008 as the financial crisis escalated and the global economy slumped, we believe the power brokers fared relatively well though their paths have greatly diverged: petrodollar and Asian sovereign investors are more influential than ever, while the rapid growth of hedge funds and private-equity firms has halted abruptly.
Petrodollar investors—including central banks, sovereign-wealth funds, high-net-worth individuals, and other investors from the major oil-exporting countries—remain today the largest of the four classes of power brokers over the next five years under all of our scenarios. In the base case, we project that the foreign financial assets of these investors will rise to nearly $9 trillion by year end 2013. In the quick fix, with the price of oil staying at nearly $100 a barrel, their assets grow to more than $13 trillion, nearly half as large as the assets of the world’s pension funds for that same year.
The sovereign investors of Asia—its central banks and sovereign-wealth funds—see their foreign wealth grow to $7.5 trillion by year end 2013 in our base case. China, with its foreign financial assets growing to $4 trillion, accounts for more than half of this total, though its current-account surplus declines relative to GDP. In the quick fix, with world GDP and trade recovering more quickly, the foreign assets of Asian sovereign investors grow to $8.5 trillion.
Regarding the hedge fund industry, although it is starting to slowly recover from the bloodbath of 5 years ago, we expect assets to recover slowly to $1.5 trillion by year end 2013. That’s slightly better than the total at the end of 2008 but still well below the peak in 2007. A major constraint on the growth of hedge funds is the size of their investors’ portfolios: the collective wealth of pension funds, insurance companies, endowments, sovereign-wealth funds, high-net-worth individuals, and other such investors fell from $91 trillion in 2007 to an estimated $75 trillion by the end of 2008. In our conservative base-case scenario, battered but resilient, in which the economic recovery doesn’t begin until mid-2015 – bar any extraordinary event that could delay the process – , it takes four to five years for these investors’ assets to regain their 2007 levels. Unless the appetite for investments in hedge funds increases a good deal, this delay will substantially curtail their fund-raising.
As for private-equity buyout funds, their assets under management fall in our base case, to $1 trillion by year end 2013. For starters, the collective wealth of their investors (like those of hedge funds) has declined sharply. Second, this scenario assumes that megadeals—leveraged buyouts worth more than $3 billion a piece, which dominated private equity during the boom—won’t revive anytime soon, because investors have less appetite for them, and banks working through credit losses face funding constraints. Meanwhile, private-equity managers are looking beyond buyouts, to other types of investments, such as distressed debt, infrastructure, real estate, and venture capital. We therefore project that total private-equity assets under management will grow modestly in our base case, to $3.4 trillion by year end 2013.
No one knows how the still prevailing financial and economic turmoil will play out, but our analysis shows that in virtually any scenario, the power brokers will remain a significant force in global capital markets. Oil exporters and Asian and Middle East sovereign investors will continue to be major players, controlling vast pools of wealth. Hedge funds and private-equity buyout funds are down but not out.
The evidence to date gives some reason for optimism that the risks these players pose are manageable. Nevertheless, the concerns being raised by the rise of the new power brokers are real and justify careful monitoring.
We at the Financial Policy Council suggest that the four players would be wise to note public concerns and voluntarily take steps to minimize them.
Share your thoughts