Sovereign wealth funds have been in the news recently amid rising concern about their activities. But what are sovereign wealth funds, who is behind them, and why are people worried about them?

Sovereign wealth funds are government-controlled investment funds, created when countries with surplus cash elect to invest some of that money. Most of the significant sovereign wealth funds are owned by the governments of booming Asian countries, such as China, or oil-rich countries such as Kuwait or Norway. Their substantial assets under management mean that, when they buy shares in a company, their stake tends to be sizeable.

Sovereign wealth funds hit the headlines initially last year as investment banks took their investments as support in the outbreak of the credit crisis. More recently, a Chinese fund has accrued a stake of almost 1% in UK oil giant BP, following the acquisition of an already significant stake in French oil company Total. Some market watchers have become concerned about the motives behind these purchases; China needs to have oil in order to fuel its ongoing expansion, and some commentators have flagged the possibility that China might be building stakes in major oil companies in order to gain influence within the sector.

Most of these funds tend to be secretive, a factor that has fuelled these questions about motivation. Many detractors are concerned about the possibility that an underlying government might actually aim to interfere in the running of a company in which they are invested. In addition, accusations of speculative activity have been levelled against some managers. However, defendants of the funds argue that the managers are just looking for long-term, stable returns like any other investor.

Although sovereign wealth funds have hit the headlines relatively recently, they are hardly the new kids on the block. Indeed, some have been around for a long time; for example, the Kuwait Investment Authority was founded more than fifty years ago in 1953.

Looking ahead, there are moves afoot to persuade sovereign wealth funds to sign up to a code of conduct that would ensure greater disclosure about their assets and investment strategy. It is unlikely that all the governments involved would be willing to accede to such an agreement; however, until sovereign wealth funds become more open about their investment activity, their detractors are likely to remain critical.

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It’s a tough time to be a borrower at the moment. Until relatively recently, credit was cheap and easily available, and mortgage lenders were all but fighting each other to win business.

However, the boot is now on the other foot. Since the credit crunch took hold last year, it has become increasingly difficult and expensive to borrow; banks and building societies have tightened their lending criteria and raised their rates, and the availability of mortgages has contracted sharply.

In its recent Credit Conditions Survey, the Bank of England has warned not only of a decline in the availability of mortgages, but also of a likely increase in the proportion of defaults by struggling homeowners. The heightened risk that some borrowers might default on their mortgage payments has spurred many lenders to make their lending criteria more restrictive, reducing the opportunity for higher-risk applicants to borrow money.

Meanwhile, new mortgage approvals declined from 74,000 to 73,000 during February, a drop that took the figures close to their 13-year low. Steepening mortgage rates are deterring potential first-time buyers from entering the housing market. However, demand is still relatively high in certain areas – the fixed-rate deals of over a million borrowers will expire this year, forcing them to look for new deals. Meanwhile, following the collapse of Northern Rock and its subsequent nationalisation, many of its customers are looking to move their mortgages to an alternative lender.

Several lenders have reduced access to their mortgages; and attractive deals have become increasingly rare, so any company offering competitive rates has been swamped with potential customers. First Direct has temporarily stopped offering mortgages to new customers while it catches up with the paperwork, and Abbey has now withdrawn the last straightforward 100% deal ‘in order to maintain high service levels’.

The Bank of England has cut interest rates to 5.5%, and rates are widely expected to fall further over coming months. Despite this, many lenders have actually raised their mortgage rates; the global credit crunch has deterred banks and building societies from lending to one another, so the companies are working to protect their profit margins. In the long term, banks and building societies are likely to regard the current situation as an opportunity to clean up their lending books and emerge in better shape; in the immediate future, both borrowers and lenders are likely to feel the pain.

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Prospects for US interest rates remain firmly in the spotlight. An unscheduled and drastic cut in US rates in January was swiftly followed by an additional and substantial reduction at the Federal Reserve’s scheduled January meeting. In March, another 0.75% cut was announced as markets reacted badly to the takeover of Bear Stearns by JP Morgan Chase following a US$30 billion Federal Reserve (Fed) aid package. US interest rates are now just 2.25%.

Nevertheless, investors remain nervous and the Fed has been criticised for what some economists view as a short-term approach to the deeper-seated problem. The economic outlook continues to deteriorate following the collapse of the domestic housing market, the global credit crunch, and soaring fuel prices.

US interest rates have now undergone six cuts since September 2007 – so where do we go from here? The Fed has cut its forecast for economic growth in the US and appears to anticipate a greater-than-expected rise in unemployment over the course of 2008. Meanwhile, inflation is forecast to reach as high as 2.4% in 2008, driven by surging prices. The current scenario has raised the unwelcome spectre of stagflation, in which prices continue to rise while growth stagnates.

Despite the risks to inflation, the deteriorating environment had boosted expectations of interest-rate cuts in 2008, and Fed chairman Ben Bernanke has favoured monetary easing to stave off a recession in the US and ease the effects of the credit crunch. Lower interest rates in the US will have a direct influence on the global economy: the US economy is still the largest in the world and an economic slowdown in the US would have a negative effect on economic growth in many countries in Europe and Asia, where exports to the US can make up a significant proportion of revenue.

Any recovery in US demand would be well received, but lower interest rates do undermine the already weak US dollar, providing additional impetus for the booming oil price, which could stoke inflationary pressures. Where the Fed now goes from here remains to be seen, but policymakers are having to perform a delicate balancing act in trying to ensure the economy does not stall, at the same time as keeping inflation in check.

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The price of gold has reached new highs recently, boosted by ongoing speculation over further cuts in US interest rates. Many investors view gold not only as a “safe haven” in times of stock-market turmoil, but also as a way to mitigate the effects of rising inflation and a weak US dollar.

Growing fears of a recession in the US have led policymakers to reduce US interest rates in order to stimulate economic growth. However, these lower interest rates could help to stoke inflation and exacerbate the decline of the faltering US dollar. A weak dollar helps to drive the gold price higher: like oil, gold is priced in US dollars, so dollar weakness makes gold cheaper for investors buying in other currencies.

The effects of increased demand for gold have been compounded by a growing shortage of supply. Electrical power cuts have halted production at some of South Africa’s most important mines when the South African government was forced to take the radical decision to ration electrical power. This, combined with fears that gold production could be halted for several weeks, helped to boost gold prices to their recent highs.

A good diversifier

Volatile market conditions, coupled with the fallout from the global credit crunch and growing fears over prospects for the global economy, have led many investors to add gold to their investment portfolios. However, gold does not have to be viewed purely as a safe haven; for many investors, it has become an important, long-term element within a diversified investment portfolio. It is vital to acknowledge that gold is not a risk-free investment: its price is volatile and can fluctuate rapidly. Nevertheless, gold’s low correlation with the equity market and bond market make it a useful means of diversification within an investment portfolio.

Some investors favour owning gold directly, which can be bought in the shape of gold coins and bullion bars; others prefer to gain exposure via exchange-traded funds: investment funds that track the price of gold. A lower-risk approach – in relative terms – might be to opt for a diversified commodities or natural resources fund, thereby spreading an investment over a wider area than just gold.

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A: In January, Mervyn King warned that 2008 could be a tough year for the UK economy. He forecast a slowdown as consumers tighten their belts and reduce their spending. This fuelled expectations of an interest rate cut. However, fuel prices and energy bills are high and King predicted “a period of above-target inflation”. This leaves the Bank of England caught between a rock and hard place. If rates are eased further, it could fuel inflation – but if rates stay on hold, this risks suppressing the prospects for economic growth.

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Gifting your houseIf your estate is above the inheritance tax threshold, it can seem a good idea to gift away your house to your children now. As long as you survive 7 years from the date you give it, it’s theirs, right? Not exactly. There are a few things you need to bear in mind. First, you will have to pay them a full market rent to live there or it stays inyour estate as a ‘gift with reservation’ – and your children will pay tax on that rent. As it becomes their property, if they become bankrupt, or divorce, it may be sold from under you. And, as a second home, they will be subject to capital gains tax on the price rise when they do sell anyway. Take advice to find a better way.

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Credit fallout leads to turmoil 

Looking ahead, investor sentiment is likely to remain fragile and bad news will likely meet with a disproportionate level of disappointment. Investors have good reason to be wary in the short term; however, stock markets tend to be driven not by logic, but by emotional factors such as fear: the key is to stay calm, think long term, and be selective. Astute long-term investors should remain objective and remember that, in the words of Franklin D Roosevelt, “the only thing we have to fear is fear itself”.

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UK bank Lloyds TSB has announced it is selling its Abbey Life insurance business for £977m to Deutsche Bank. Abbey Life is a subsidiary of Lloyds’ Scottish Widows unit and has been closed to new business since 2000.

Lloyds TSB concluded that the sale of Abbey Life was in the “best interest of the group, as well as Abbey Life’s policyholders and staff”.

As of 31 December 2006, Abbey Life managed £12bn of assets held in 1.2 million policies, do you own one of the policies? It will be interesting to see what if any benefit there will be for policyholders. If you would like us to review your Abbey Life plan in view of this announcement then please contact us.

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State pensions (particularly womens) have been given a boost with a proposed change to the rules regarding voluntary National Insurance contributions.

Currently there is a six year time limit on paying these contributions. This means that if you did not pay National Insurance in a tax year you are not entitled to any extra state pension income for that tax year, unless you pay voluntary National Insurance within the next six tax years.

Generally speaking though it is not until State Pension Age that people really look at what they are entitled to, by which time it can be long since the tax years that National Insurance was unpaid with no way of making this up. Bearing in mind what good value the State Pension is for most people, this means a lot of people are missing out on a good way to top up their retirement income.

The new Pensions Bill is going to allow people to defer the decision until their own State Pension Age and allow people to buy up to nine years. This will give everyone a great opportunity to top up this pension when they are at a time when they are more likely to have the funds to pay the voluntary contributions. The big winners will be women, currently only 25% of women have a full State Pension compared to 90% of men.

The government may try to overturn the decision but the recent defeat in the House of Lords will make this more difficult.

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For years, the UK property market has been on a phenomenal run, outstripping inflation by a significant amount. The upshot is that young people can no longer get on to the housing ladder and it is reported that average property prices now exceed five times national income. But is this a one way bet? Why are prices rising? The answer is that property prices will rise until the costs of servicing the debt consume such a proportion of income that prices can rise no further. So if interest rates are low properties seem cheap because they consume a smaller proportion of income. Interest rates are now standing at 5.75%. Within living memory of anybody over the age of about 30 interest rates have been at 12% or more and it looks like interest rates are gently moving upwards while inflation is potentially reappearing.   Much of the reason for no inflation recently has been the phenomenal growth in