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starbucks4ever (98.69)

What's the best way to deploy foreign reserves?

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July 22, 2009 – Comments (2)

Suppose that your government finally woke up to the reality of Fed printing that devalues your foreign reserves, and decided to finally deploy them. What's your best strategy then?

In the ideal world, you will have intelligent people evaluating foreign assets and making the right decisions. However, history shows time and again that goverment officials cannot be trusted to make the best choices. More often than not, an official chooses to buy a foreign company becuase he falls in love with its corporate HQ building or with a product commercial he sees on TV - and this is in the best case. In the worst case, the official just receives a small present from the CEO of the company in question, which makes him more than happy to make the wrong decision. When Chinese officials made their first foray into the US market, their best investment idea turned out to be a bank that soon went bankrupt. More recently, Putin's ally in charge of Sberbank wanted to invest in something high-tech that would make him look as someone who cares about technical progress, so he looked around and concluded that the best investment available at the moment was the  "Opel" division of the bancrupt GM.

But there is a very simple way for sovereigh wealth funds to avoid these tragic mistakes: index investing. This is a boring strategy, but it has one advantage: it takes incompetent officials completely out the picture. Also, it helps avoid the phenomenon when you approach a company that costs $100B, make the offer, and immediately they laugh in your face and tell you that their company is now worth twice as much just becuase you made that offer. Instead, you're just accumulating shares steadily and slowly, and there is no need for you to have superb negotiation skills. And, while the returns may not be stellar, you get a welcome diversification away from treasuries, coupled with protection against losing $100% of your principal. This unexciting strategy may well be the optimal choice in the long run.  

 

2 Comments – Post Your Own

#1) On July 22, 2009 at 3:10 PM, russiangambit (29.33) wrote:

Stocks are still paper assets. Only hard assets (bought at a reasonable price) provide protection from financial manipulation.

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#2) On July 22, 2009 at 3:30 PM, starbucks4ever (98.69) wrote:

Truth is, when you're a government, any foreign assets you hold are going to be paper assets. They could, for example, be confiscated. To the extent that one paper asset is better than another, stocks are far better than treasuries, and less subject to manipulation.

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