This is the concluding observation of a ADB report titled 'Developing Asia's Sovereign Wealth Funds and Outward Foreign Direct Investment' by Donghyun Park and Gemma B. Estrada.

The report said that developing Asia is no longer merely the recipient of investments from internationally active multinationals but the home region of a rising number of companies with operations all over the world.

Another major rationale behind the growth of outward FDI from the region is its transformation from a net importer of capital to a net exporter of capital since the Asian crisis of 1997-1998. Prior to that crisis, developing Asia was a capital-scarce region that relied on FDI and other external inflows to fuel its rapid growth. For the most part, the intermediation of developing Asia's surplus savings was performed by the public sector rather than the private sector. In particular, the region's central banks accumulated FX reserves on an unprecedented scale and speed since the crisis, and invested them mostly in safe and liquid but low-yield assets (i.e., traditional reserve assets) such as US government bonds.

Therefore, although the region's outward FDI have grown rapidly, it remains small relative to its large and growing amounts of capital outflows.

The FX reserves have reached levels where there is a consensus that the region now has substantially more reserves than all plausible estimates of what it needs for liquidity purposes. SWFs have emerged in developing Asia as a policy response to political pressures for more active management of surplus reserves or reserves that are in excess of liquidity needs, with a view toward maximizing risk-adjusted returns.

Therefore, notwithstanding the concerns of host countries about noncommercial ulterior motives, SWFs are fundamentally commercial creations created with the very purpose of making as much money as possible for their owners—the government—subject to tolerable risk.

FDI, which typically involves equity shares large enough to influence the management and a long-term relationship, is certainly one mode of investment available for earning higher returns than can be earned from traditional reserve assets. Indeed some older well-established SWFs, most notably Temasek but also others such as Norway's GPF, have achieved superior investment performance partly by undertaking active handson investments in which they seek to exercise some control over the management of companies in which they invest. This suggests that FDI is a viable investment option for SWFs seeking more profitable uses of surplus reserves.

It should be abundantly clear from the analysis of this paper that the
potential for SWFs to engage in successful FDI and, more generally, pursue profitoriented commercial investments, is quite limited. The underlying reason is that inadequate institutional capacity and the political sensitivity of state-led FDI severely constrains the ability of developing Asia's SWFs to undertake FDI on a significant scale.

It should be emphasized that SWFs are a relatively new phenomenon in the region and they do not yet have the stock of knowledge or expertise to successfully invest abroad.

Until they build up their institutional capacity to a level that enables them to effectively handle the substantial risks associated with foreign investment, a process that inevitably will take some time, developing Asia's SWFs are unlikely to become major sources of outward FDI. An additional cause for pessimism about the prospects for outward FDI by the region's SWFs is the threat of financial protectionism. A number of high-profile attempts by state-owned firms from developing countries to purchase foreign assets have been aborted due to politically motivated opposition from host countries. The threat of financial protectionism has receded as a result of the global financial crisis but the crisis has also served as a sobering reminder to SWFs about the high risks involved in investing abroad. The Santiago Principles will further blunt financial protectionism by signaling the commitment of SWFs to comply with the rules and regulations of the host countries.

One additional specific factor that casts a big cloud over the SWFs' ambition to become major sources of outward FDI is a growing backlash against FDI in both developed and developing countries. This backlash is part and parcel of financial protectionism but targeted more specifically toward inward FDI. It is true that in the past few decades countries around the world have adopted a much more open, welcome, and receptive stance toward FDI, which has come to be seen as a source of investment, know-how, technology, jobs, and growth. In particular, due to its greater stability and longer time horizon, FDI has generally been viewed much more favorably than portfolio inflows or “hot money”, which has sometimes been volatile and disruptive.

However, as Sauvant (2006) points out, the pendulum may be shifting toward a more hostile environment for FDI, especially FDI which takes the form of cross-border M&A. Such hostility tends to be more pronounced when the cross-border M&A targets domestic firms that are regarded by the host-country government and public as national champions. The underlying concern relates to national security, cultural identity, or economic development in the case of industries considered “commanding heights” of an economy. This deterioration of the
investment climate for M&A FDI is especially relevant for SWFs, since M&A FDI is, as noted earlier, their preferred mode of FDI.

Due to a number of factors, the potential for developing Asia's SWFs
to become major conduits for the region's growing outward FDI is limited at best.
Nevertheless, although FDI currently accounts for only 0.2% of all assets held by SWFs, it has been growing rapidly in recent years, albeit from a very small base.

In the short run, one major promising option for SWFs to become better at identifying and taking advantage of profitable FDI opportunities is to form strategic partnerships with other domestic companies from industries in which the SWF is investing.

In the longer run, it is unclear why the public sector should be in charge of intermediating developing Asia's surplus savings.

The report says, 'Since the private sector tends to be better than the public sector in seeking out and realizing profit opportunities, including profit opportunities in foreign countries, it is desirable to allocate a greater role to the private sector in the intermediation of the region's surplus savings.'#