Sovereign wealth fund tease: now Latin America is considering getting into the game.

• Author: Lachman, Desmond

China's announcement in August 2007 that it too would be entering the ranks of those countries with sovereign wealth funds by setting up the China Investment Corporation has set hearts racing in Latin America. Market participants are now eagerly pondering what the prospective explosive trend in sovereign wealth funds might mean for Latin American financial markets. And they are also hoping that those trends will make the continent less vulnerable to swings in the global economic cycle. Might not Asia's more aggressive approach to managing its vast international reserves permanently improve Latin America's terms of trade as these countries' funds stockpile commodities? And might not those wealth funds provide a new impetus to Latin American equity markets and to foreign direct investment as they search for new investment outlets?

For their part, Latin American policymakers are wondering whether China's example is not pointing in the right direction for how they too might manage their own excess international reserves. Might this not be the right time to think about getting those reserves to earn higher returns than have been obtained to date on staid short-term government debt instruments?

Given the many vicissitudes in Latin America's fortunes over the post-war period, one can well empathize with those who are hoping that sovereign wealth funds will allow the continent's good times to roll on. However, before jumping to overly sanguine conclusions, it might be well to consider how big a difference sovereign wealth funds are really likely to make to global financial markets over the next few years. It might also be well to consider how those funds are likely to invest their countries' excess reserves and how far they are likely to stray from highly developed and Asian markets before venturing further afield in any major way.

THE RISE OF THE SOVEREIGN WEALTH FUNDS

Sovereign wealth funds are hardly new to the international financial system. Indeed, these funds have been around at least since the 1950s and over the past decade they have provided increased support to world financial markets. Before China's recent announcement, twenty-five countries had already set up such funds to better manage their excess international reserve holdings, while an additional six countries had announced plans to set up their own funds.

Although sovereign wealth funds have been around for some time, what is new is how rapidly these funds are now growing. Whereas...