Financial Markets Operations Management (17 page)

According to the Sovereign Wealth Fund Institute,
⁶
a sovereign wealth fund (SWF) is a state-owned investment fund or entity that is commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatisations, governmental transfer payments, fiscal surpluses and/or receipts resulting from resource exports. The definition of a sovereign wealth fund excludes, among other things, foreign currency reserve assets held by monetary authorities for the traditional balance of payments or monetary policy purposes, state-owned enterprises in the traditional sense, government employee pension funds and assets managed for the benefit of individuals.

One example of an SWF is the Kuwait Investment Authority, established in 1953 from its oil revenues. In fact, the sources of SWF funds are either oil/gas-related or non-oil/gas-related, as the list of the ten largest SWFs by assets under management
⁷
in
Table 4.5
demonstrates.

Based on OECD data and TheCityUK's estimates,
⁸
global SWFs totalled USD 4.8 trillion at the end of 2011. This compares with global conventional assets under management of the global fund management industry of USD 79.8 trillion. This illustrates the importance of the SWF fund industry to the financial markets.

A group of economists at the United Nations' International Labour Organization
⁹
has calculated that the world's average salary is just under purchasing power parity USD 18,000 per annum.
¹⁰
Allowing for various data limitations and missing data from some countries, the report shows that the average salary is low. By the time the salary earner has paid the usual monthly bills, there is not much cash left in the household budget to save or invest. Therefore, the main investment vehicle available to most people is the collective investment route of mutual funds.

There are, however, a substantial number of wealthy individuals who own large amounts of assets of one form or another. Based on the annual CapGemini/RBC Wealth Management Report for 2013,
¹¹
there were some 12.0 million people described as “high-net-worth individuals” (HNWIs) with a total investable wealth of USD 46.2 trillion. OECD data and TheCityUK estimate
¹²
that global conventional assets and alternative assets under management of the global fund management industry were USD 120.0 trillion. This illustrates the importance of the private wealth industry to the financial markets.

An HNWI is someone defined as having investable assets
¹³
worth USD 1 million or more, and “Ultra-HNWIs” are people with investable assets in excess of USD 30 million.

The Wealth Management Report authors surveyed some 4,400 individuals across 21 major wealth markets and found that the source of their respondents' wealth included:

• Salary and bonuses;
  
• Investments;
  
• Real estate (excluding primary residence);
  
• Business ownership;
  
• Stock options;
  
• Inheritance;
  
• Proceeds from selling off a business.
  

Salary, bonuses, business ownership and investments made up more than two-thirds of the source of wealth for respondents.

Who are the managers and what do HNWIs expect from their wealth managers? Wealth management is provided by financial institutions such as banks, professional trust companies and brokerage companies. The largest managers by assets under management are shown in
Table 4.6
.

Financial assets of HNWIs for 1Q 2014 globally can be broken down into the classes of asset shown in
Table 4.7
.

The breakdown of HNWI alternative investments is shown in
Table 4.8
.

HNWIs' attitudes towards their relationships with their wealth managers and the services they use are summarised in
Table 4.9
.

The main investment objectives tend to focus on asset safety and wealth preservation/growth. In addition, HNWIs look for highly personalised everyday banking services, loans, wealth planning and specialist advice on sectors, such as:

• Trust and fiduciary services.
  
• Charities and foundations.
  
• Media and entertainment.
  
• Diamonds and jewellery.
  

The largest private foundation in the world is the Bill & Melinda Gates Foundation (see
www.gatesfoundation.org
) founded by the Gateses in 1994 with the primary aims, globally, to enhance healthcare and reduce extreme poverty, and in America, to expand educational opportunities and access to information technology. The Foundation had an endowment of USD 36.4 billion as at 31 December 2012, with Bill Gates's donation amounting to USD 28 billion.

For those of us who are not regarded as high-net-worth individuals, our access to the investment world might be regarded as being rather limited. With a few hundred dollars, it is certainly possible to purchase some shares in a company.

So that you can overcome these problems, you should create a portfolio of a diverse number of securities that will spread the risk associated with holding a small number of investments. Ideally, the investments should be spread across types of securities (equities, bonds, etc.), markets (your domestic market and foreign markets) and industries (banking, manufacturing, telecommunications, etc.). Perhaps you can appreciate that you might need more cash than you can afford to invest in order to create the ideal portfolio of investments!

There is an alternative approach that you can take; together with other investors, you can pool your collective amounts of cash and use that larger amount of cash to purchase a more diverse portfolio of suitable securities. For example, instead of buying 500 Company “X” shares at a cost of USD 500 (as above), you pay the USD 500 into a pool of, say, USD 5,000,000. This five million dollars is invested in a selection of securities that are focused on earning dividends in the USA. Let's call this collection of securities a
fund
, to be known as the North American Equity Fund. Your investment is no longer in Company “X”; rather, it is in the fund and your holding will be shares in the fund. How many shares will you own? That depends on the value of the fund (USD 5 million) and the value of each share. If you and the other investors decide to issue shares at a price of USD 1.00 per share, then there are 5 million shares in total, with you having a holding of 500 shares. As the constituent companies held by the fund increase or decrease in value and/or pay dividends from time to time, then you will benefit from this in proportion to your holding of the fund's shares.

You can summarise this by saying that if you diversify your capital, you lower your capital risk. This diversification is one of the main advantages of a collective investment. An investment in a single asset (your Company “X”) may do well, but it may collapse for any number of reasons. By investing in a range of securities you reduce your capital risk.

Depending on the country in which you have invested your cash, the fund might be known as a mutual fund, investment fund or managed fund; however, all of these variations are known generically as
collective investment schemes
.

Collective investment schemes may be formed under company law, by legal trust or by statute. Typically, the structure of a scheme contains the following:

• A fund manager (investment manager) who manages the investment decisions;
  
• A fund administrator who manages the trading, reconciliations, valuation and unit pricing;
  
• A board of directors or trustees who safeguard the assets and ensure compliance with laws, regulations and rules;
  
• The shareholders (or unit-holders) who own (or have rights to) the assets and associated income;
  
• A “marketing” or “distribution” company to promote and sell shares/units of the fund.
  

The largest global investment managers, as at the end of 2010, are shown in
Table 4.10
.

Based on OECD data and TheCityUK's estimates,
¹⁴
mutual fund assets totalled USD 23.8 trillion at the end of 2011. This compares with global conventional assets under management
of the global fund management industry of USD 79.8 trillion and illustrates the importance of the mutual fund industry to the financial markets.