SINGAPORE — A year ago, before the financial crisis started to bite hard, the United States and Europe were worried that Asian and Middle East nations, armed with a mighty war chest of surplus foreign exchange reserves from their exports of manufactured goods and oil, would gobble up so-called strategic assets in the West.

Then, as the credit crunch turned into an economic recession, the state-owned investment companies, known as sovereign wealth funds (SWFs), found that they were being hailed as saviors of tottering banks and ailing firms in America and Europe.

Today, like many private institutional investors, the SWFs are saddled with huge paper losses and reviewing what to do — just as some Japanese lawmakers and politicians are considering whether Japan should join dozens of other countries with bulging foreign exchange reserves and set up a sovereign fund.

But as the financial crisis has proved, global investing can be a high-risk business. Singapore’s Temasek Holdings, the world’s 10th-biggest SWF, recently announced that its chief executive, Ho Ching, a technocrat married to the country’s Prime Minister Lee Hsien Loong, would be replaced in October by the former CEO of mining and resources giant BHP Billiton.

Temasek’s change of leadership is part of a much wider review process by top executives and governing boards of global investing groups. The mandate of most SWFs is to earn better long-term returns than is normal with conservative handling of reserves and thus increase savings for future generations.

A study of world markets over more than a century by ABN Amro bank shows that, after adjustment for inflation, annual equity returns have beaten bond returns, 5.8 percent to 1.7 percent, since 1900. Temasek has reported annualized returns of about 13 percent over the past 20 years. For Singapore’s other SWF, the Government of Singapore Investment Corporation (GIC), the annual average return over the same period was 5.8 percent as of March 2008.

But Parliament was told Feb. 10 that Temasek’s net portfolio value dropped 31 percent between March 31 and Nov. 30 last year, to S$127 billion, and that the value of GIC’s investments also fell, although the percentage decline was not disclosed. However, Temasek’s slide was less than the 44 percent fall of the benchmark MSCI Singapore stock Index and the 45 percent plunge of the MSCI Asia (excluding Japan) Index.

Morgan Stanley bank estimated late last year that the value of equities, property and other assets owned by SWFs dropped by as much as 25 percent in 2008, causing losses of between $500 billion and $700 billion and bringing their total value down to between $2.3 trillion to $2.5 trillion. Moreover, the slump in the oil price and international trade in the last six months will mean that petro-dollar and manufacturing export revenues previously swelling SWF coffers will fall sharply.

The SWF Institute still values the assets of the more than 50 sovereign funds that it tracks at nearly $4 trillion, with 46 percent of this pool owned by Middle Eastern governments and 35 percent by Asian states. However, such figures are only a rough guide because some SWFs do not make their holdings or investment strategies public while others have yet to report for the last financial year.

As they plot their future investment strategies, SWFs are trying to gauge how deep the recession will be, how long it will last and what shape a recovery will take.

Some funds are facing pressure to invest more at home instead of abroad. The French government announced in November that it would establish a 20 billion euro SWF not just to help local companies cope with the effects of the credit freeze but also to prevent the takeover of strategic French firms by “foreign predators.”

Other SWFs in Asia and the Middle East, burned by investing early in the current crisis, are wary of going back into the market until they are more confident an upturn is in sight and the financial system has stabilized.

Lou Jiwei, chairman of the $200 billion China Investment Corp., said in December that “we don’t have the courage to invest in financial institutions anymore, because we don’t know what problems we’ll have.” Like the Singapore SWFs and some Gulf Arab funds, CIC invested early in the crisis in Western financial services companies and has lost billions of dollars on paper.

Analysts say China’s other SWF, the $312 billion SAFE Investment Company, is also sitting on book losses on some of its foreign investments, although they appear to be smaller than those of CIC.

Before buying abroad on a significant scale again, SWFs will have to make an assessment about the future strength of the global economy, and where its most vibrant growth centers and sectors will be. This recession is the worst since World War II, and possibly since the Great Depression in the 1930s. Unlike previous downturns, it has hit all major markets, both developed and developing. Demand for exports is down everywhere.

This undermines the export-oriented growth model that since the ’70s helped to power the economies of Japan, China, South Korea, Taiwan, Hong Kong, Singapore, Thailand, Malaysia, the Philippines, India and Indonesia.

Stephen Roach, Morgan Stanley’s Asia chairman, said at the World Economic Forum in Davos last month that the global trade boom of the past eight years had ended and that Asia must focus much more on boosting economic growth by government and consumer spending instead of exports.

Tony Tan, GIC deputy chairman and executive director, said recently that if the recession continued into 2010, it could be a sign the current slump was not a normal economic cycle but a sign of systemic change in the world economy — from one that has been steadily expanding since World War II to one that is becoming stagnant or even contracting, as Japan did in 1990s.

“If such a dire scenario were to result, then obviously governments and investors will have to re-examine basic assumptions and prepare for a different world,” he added.

Michael Richardson is a visiting senior research fellow at the Institute of Southeast Asian Studies in Singapore.

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